EDGAR 10-K Filing

Company CIK: 1085913
Filing Year: 2021
Filename: 1085913_10-K_2021_0001140361-21-008518.json

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ITEM 1. BUSINESS
Item 1. Business
General Development of the Business
August 1, 1916, marked the first day of business for Farmers & Merchants Bank (the “Bank”). The Bank was incorporated under the laws of the State of California and licensed as a state-chartered bank. Farmers & Merchants’ first venture out of Lodi occurred when the Galt office opened in 1948. Since then the Bank has opened full-service branches in Linden, Manteca, Riverbank, Modesto, Sacramento, Elk Grove, Turlock, Hilmar, Stockton, Merced, Walnut Creek, Concord, Napa and Lockeford.
During 2018, the Company completed the acquisition of Bank of Rio Vista, headquartered in Rio Vista, California. This provided the Company entry into both Rio Vista and Walnut Grove, enhancing the Bank’s market share in Lodi.
In addition to 29 full-service branches, the Bank serves the needs of its customers through three stand-alone ATMs located on the grounds of the Lodi Grape Festival, in the Trilogy Residential Community clubhouse in Rio Vista and the Shadelands business center in Walnut Creek. In 2007, the Bank began offering certain banking products over the internet at www.fmbonline.com.
On March 10, 1999, the Company, pursuant to a reorganization, acquired all of the voting stock of the Bank. The Company is a bank holding company incorporated in the State of Delaware and registered under the Bank Holding Company Act of 1956, as amended. The Company’s outstanding securities as of December 31, 2020, consisted of 789,646 shares of common stock, $0.01 par value and no shares of preferred stock issued. The Bank is the Company’s principal asset.
The Bank’s two wholly owned subsidiaries are Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. Farmers & Merchants Investment Corporation is currently dormant and Farmers/Merchants Corp. acts as trustee on deeds of trust originated by the Bank.
F & M Bancorp, Inc. was created in March 2002 to protect the name “F & M Bank.” During 2002, the Company completed a fictitious name filing in California to begin using the streamlined name, “F & M Bank,” as part of a larger effort to enhance the Company’s image and build brand name recognition. Since 2002, the Company has converted all of its daily operating and image advertising to the “F & M Bank” name and the Company’s logo, slogan and signage were redesigned to incorporate the trade name, “F & M Bank.”
During 2003, the Company formed a wholly owned Connecticut statutory business trust, FMCB Statutory Trust I, for the sole purpose of issuing trust-preferred securities. See Note 13, located in “Item 8. Financial Statements and Supplementary Data.”
The Company’s principal business is to serve as a holding company for the Bank and for other banking or banking related subsidiaries, which the Company may establish or acquire. As a legal entity separate and distinct from its subsidiary, the Company’s principal source of funds is, and will continue to be, dividends paid by and other funds received from the Bank. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company. See “Supervision and Regulation - Dividends and Other Transfer of Funds.”
The Bank’s deposit accounts are insured under the Federal Deposit Insurance Act up to applicable limits. See “Supervision and Regulation - Deposit Insurance.”
As a bank holding company, the Company is subject to regulation and examination by the Board of Governors of the Federal Reserve System (“FRB”). The Bank is a California state-chartered non-FRB member bank subject to the regulation and examination of the Department of Financial Protection and Innovation (“DFPI”) and the Federal Deposit Insurance Corporation (“FDIC”).
Acquisition of Bank of Rio Vista (“BRV”)
On October 10, 2018, the Company completed its acquisition of Bank of Rio Vista, which occurred through a series of stock purchases beginning in April 2017. The total consideration paid for the acquisition was $40.73 million. The Company engaged in this transaction with the expectation it would be accretive to income and add a new market area with a demographic profile consistent with many of the Central Valley markets served by the Company.
Service Area
Since 2014, the Company has broadened its geographic footprint by opening offices in Walnut Creek, Concord, Napa, Rio Vista and Walnut Grove. The Company continues to look for opportunities to further expand its branch network in the East Bay area of San Francisco, and over the past two years has purchased buildings in Walnut Creek, Lafayette and Montclair that will become future branch locations.
Despite the recent expansion of our geographic footprint, the Company’s primary service area remains the mid Central Valley of California, including Sacramento, San Joaquin, Stanislaus and Merced counties, where we operate 28 full-service branches and 3 stand-alone ATM. This area encompasses:
• The Sacramento Metropolitan Statistical Area (“MSA”), with branches in Sacramento, Elk Grove, Galt and Walnut Grove. This MSA has a Population of 2.4 million and a Per Capita Income of approximately $58,843. The MSA includes significant employment in the following sectors: government, education & health trade, and transportation & utilities. Unemployment currently stands at 6.7%.
• The Stockton-Lodi MSA, with branches in Lodi, Linden, Stockton, Lockeford and Manteca. This MSA has a Population of 0.76 million and a Per Capita Income of approximately $47,139. The MSA includes significant employment in the following sectors: trade, transportation, and utilities, government, and education and health services. Unemployment currently stands at 9.0%.
• The Modesto MSA, with branches in Modesto, Riverbank and Turlock. This MSA has a Population of 0.55 million and a Per Capita Income of approximately $45,742. The MSA includes significant employment in the following sectors: trade, transportation and utilities, educational & health services, and government. Unemployment currently stands at 8.3%.
• The Merced MSA, with branches in Hilmar and Merced. This MSA has a Population of 0.28 million and a Per Capita Income of approximately $41,077. The MSA includes significant employment in the following sectors: government, trade, transportation and utilities and farming. Unemployment currently stands at 9.0%.
All of the Company’s Central Valley service areas are heavily influenced by the agricultural industry, however, with the exception of the State of California in the Sacramento MSA, no single employer represents a material concentration of jobs in any of our service areas.
See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Overview” and “Financial Condition - Loans & Leases” for additional discussion regarding the Company’s market conditions.
Through its network of banking offices, the Company emphasizes personalized service along with a broad range of banking services to businesses and individuals located in the service areas of its offices. Although the Company focuses on marketing its services to small and medium sized businesses, a broad range of retail banking services are made available to the local consumer market.
The Company offers a wide range of deposit instruments. These include checking, savings, money market, time certificates of deposit, individual retirement accounts and online banking services for both business and personal accounts.
The Company provides a broad complement of lending products, including commercial, commercial real estate, real estate construction, agribusiness, consumer, credit card, residential real estate loans, and equipment leases. Commercial products include term loans, leases, lines of credit and other working capital financing and letters of credit. Financing products for individuals include automobile financing, lines of credit, residential real estate, home improvement and home equity lines of credit.
The Company also offers a wide range of specialized services designed for the needs of its commercial accounts. These services include a credit card program for merchants, lockbox and other collection services, account reconciliation, investment sweep, on-line account access, and electronic funds transfers by way of domestic and international wire and automated clearinghouse.
The Company makes investment products available to customers, including mutual funds and annuities. These investment products are offered through a third party, which employs investment advisors to meet with and provide investment advice to the Company’s customers.
Human Capital
As of December 31, 2020, we employed 366 full-time equivalent employees. The Company believes that its employee relations are satisfactory. For the year ended December 31, 2020, salaries and employee benefits expense totaled $57 million, representing 69% of our total non-interest expense. Expenses related to education, training, recruiting and placement exceeded $250,000 for the three year period ended December 31, 2020.
We are led by an experienced management team with substantial experience in the markets that we serve and the financial products that we offer. Our business strategy focuses on providing products and services through long-term relationship managers. As a result, our success depends heavily on the performance of our employees, as well as on our ability to attract, motivate and retain highly qualified employees at all levels of the Company. We believe that our work environment contributes to employee satisfaction and retention.
We are committed to maintaining a work environment where every employee is treated with dignity and respect, free from the threat of discrimination and harassment. As stated in our Board approved (i) Code of Conduct and (ii) Prohibited Harassment Policy, we expect these same standards apply to all stakeholders, to our interactions with customers, vendors and independent contractors.
We are firmly committed to providing equal employment and advancement opportunities to all qualified individuals and will not tolerate any illegal discrimination or harassment of any kind. Team members are encouraged to immediately report any improper discrimination or harassment to their supervisor and human resources.
Policies and Planning
We are proud to be an Equal Opportunity Employer and enforce those values throughout all of our operations. We prohibit discrimination in hiring or advancement against any individual on the basis of race, color, religion, gender, sex, national origin, age, marital status, pregnancy, physical or mental disability, genetics, veteran status, sexual orientation, or any other characteristic protected by applicable law.
We strive to ensure our team members have access to working conditions that provide a safe and healthy environment, free from work-related injuries and illnesses. Many of our locations employ badges and keypads to enter or to enter restricted areas of locations that have a public presence. As a company designated as an “essential industry” during the COVID-19 crisis, we have been focused on safety and health regimens that protect our employees who have reported to work during this difficult time. This has resulted in our ability to keep all of our branches open for business while providing a safe work environment for our employees.
Each year our annual planning and budgeting process involves an assessment of staffing levels and skills and results in the development of targets for recruitment and training. In addition the Board reviews all succession plans in place for key personnel.
Recruitment
We strive to recruit talent from both local educational institutions and the banking industry. The Company has full-time staff dedicated to our recruitment efforts and we utilize many of the major recruitment firms and websites. Annually we visit local colleges and universities for job fairs and other recruitment events, which we believe allows us to identify those students who have the skills and aptitudes we need in the Company. The results of these efforts has been a consistent flow of candidates to fill our staffing needs as we grow.
Compensation
Salary and Bonuses
We have job descriptions and salary grade ranges for all of our positions. Annually we use outside survey firms to provide information on market pay. We also pay generous performance based bonuses to employees. During 2020, total bonus compensation amounted to over 30% of base salaries. This “pay-for-performance” approach allows us to effectively recruit and retain key employees.
Retirement Plans
All employees are eligible to participate in our Profit Sharing Plan after 1 year of service and having worked at least 1,000 hours. The Company makes mandatory contributions equal to 5% of the employee’s eligible compensation and discretionary contributions determined annually by the Board of Directors. This is not a matching based program, employees receive these contributions regardless of whether they make individual contributions to our 401(K) program. During 2020 total expenses for the profit sharing plan amounted to over 10% of base salaries, a generous level that helps us in recruitment and retention.
Medical and Other Benefits
In addition to competitive salaries, incentives and retirement benefits, we provide comprehensive medical, dental, and vision plans, health savings accounts, paid sick time, long-term disability, basic life and AD&D insurance, flexible spending accounts, and employee assistance and wellness programs.
Training
Job Related
We support team members should they wish to continue their education in subjects and fields that are directly related to our operations, activities and objectives. We encourage our team members to pursue educational opportunities that will help improve job performance and professional development. To further this goal, we reimburse tuition and certain fees for satisfactory completion of approved educational courses and certain certifications. Included are college credit courses at accredited colleges and universities, continuing education courses and certification exams.
Diversity and Inclusion
To foster a deeper understanding regarding diversity and inclusion, The Company assigns all employees diversity and inclusion training - Diversity Made Simple. The diversity course is mandatory for all staff. As of December 31, 2020, all employees have met their diversity and inclusion training obligations.
Harassment Prevention
The Company assigns all employees prohibitive harassment training. Every two years nonsupervisory employees receive one hour of harassment prevention training while supervisors receive two hours of harassment prevention training. Newly hired employees are assigned harassment prevention and must complete the training within six months of hire or promotion. Following the initial training, all employees must complete training every two years, at minimum. As of December 31, 2020, all employees have met their prohibitive harassment training requirements.
Performance Evaluation
The Company has implemented a Performance Planning, Coaching and Evaluation (“PPC&E) system that requires each year that employees and their managers establish detailed goals and objectives. Annually employees are reviewed relative to their progress in achieving those goals, with the objective of reducing performance surprises and encouraging behavior that is consistent with Company objectives. We believe that this PPC&E discipline is important in retaining and growing our employees.
Competition
The banking and financial services industry in California generally, and in the Company’s market areas specifically, is highly competitive. 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 service providers. The Company competes with other major commercial banks, diversified financial institutions, credit unions, savings institutions, money market and other mutual funds, mortgage companies, and a variety of other non-banking financial services and advisory companies. Federal legislation encourages competition between different types of financial service providers and has fostered new entrants into the financial services market. It is anticipated that this trend will continue. Using the financial holding company structure, insurance companies and securities firms may compete more directly with banks and bank holding companies.
Many of our competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader range of financial services than the Company. In order to compete with other financial service providers, the Company relies upon personal contact by its officers, directors, employees, and stockholders, along with various promotional activities and specialized services. In those instances where the Company is unable to accommodate a customer’s needs, the Company may arrange for those services to be provided through its correspondents.
Government Policies
The Company’s profitability, like most financial institutions, is primarily dependent on interest rate differentials. The difference between the interest rates paid by the Company on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Company on its interest-earning assets, such as loans & leases extended to its customers and securities held in its investment portfolio, comprise the major portion of the Company’s earnings. These rates are highly sensitive to many factors that are beyond the control of the Company and the Bank, such as inflation, recession and unemployment. The impact that changes in economic conditions might have on the Company and the Bank cannot be predicted.
The business of the Company is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the FRB. The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S. Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of bank loans & leases, investments, and deposits and also affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact on the Company of any future changes in monetary and fiscal policies cannot be predicted.
From time to time, legislative acts, as well as regulations, are enacted which have the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies, and other financial institutions and financial services providers are frequently made in the U.S. Congress, in the state legislatures, and before various regulatory agencies. This legislation may change banking statutes and the operating environment of the Company and the Bank in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings institutions, credit unions, and other financial institutions. The Company cannot predict whether any of this potential legislation will be enacted, and if enacted, the effect that it, or any implemented regulations, would have on the financial condition or results of operations of the Company or any of its subsidiaries.
Supervision and Regulation
General
Bank holding companies and banks are extensively regulated under both federal and state law. The regulation is intended primarily for the protection of the banking system and the deposit insurance fund and not for the benefit of stockholders of the Company. This supervisory and regulatory framework subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which results in examination reports and ratings that, while not publicly available, can affect the conduct and growth of their businesses. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.
Set forth below is a summary description of the material laws and regulations, which relate to the operations of the Company and the Bank. This description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
The Company
The Company is a registered bank holding company and is subject to regulation under the Bank Holding Company Act of 1956 (“BHCA”), as amended. Accordingly, the Company’s operations are subject to extensive regulation and examination by the FRB. The Company is required to file with the FRB quarterly and annual reports and such additional information as the FRB may require pursuant to the BHCA. The FRB conducts periodic examinations of the Company.
The FRB may require that the Company terminate an activity or terminate control of or liquidate or divest certain subsidiaries of affiliates when the FRB believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The FRB also has the authority to regulate provisions of certain bank holding company debt. Under certain circumstances, the Company must file written notice and obtain approval from the FRB prior to purchasing or redeeming its equity securities.
Under the BHCA and regulations adopted by the FRB, a bank holding company and its non-banking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with an extension of credit, lease or sale of property, or furnishing of services. For example, with certain exceptions, a bank may not condition an extension of credit on a promise by its customer to obtain other services provided by it, its holding company or other subsidiaries, or on a promise by its customer not to obtain other services from a competitor. In addition, federal law imposes certain restrictions on transactions between Farmers & Merchants Bancorp and its subsidiaries. Further, the Company is required by the FRB to maintain certain levels of capital. See “Capital Standards.”
The Company is prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to its subsidiaries. However, the Company, subject to the prior notice and/or approval of the FRB, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
A bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the FRB’s policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. This support may be required at times when a bank holding company may not be able to provide such support. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB’s regulations or both.
The Company is not a financial holding company for purposes of the FRB.
The Company is also a bank holding company within the meaning of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the DFPI.
The Company’s securities are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, the Company is subject to the reporting, proxy solicitation and other requirements and restrictions of the Exchange Act.
The Bank
The Bank, as a California chartered non-FRB member bank, is subject to primary supervision, periodic examination and regulation by the DFPI and the FDIC. If, as a result of an examination of the Bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory, or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the Bank’s deposit insurance, which for a California chartered bank would result in a revocation of the Bank’s charter. The DFPI has many of the same remedial powers.
Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank’s operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans & leases, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements. Further, the Bank is required to maintain certain levels of capital. See “Capital Standards.”
The Dodd Frank Wall Street Reform and Consumer Protection Act (the “Dodd Frank Act”) - The Dodd-Frank Act implemented sweeping reform across the U.S. financial regulatory framework, including, among other changes:
• creating a Financial Stability Oversight Council tasked with identifying and monitoring systemic risks in the financial system;
• creating the Consumer Financial Protection Bureau (“CFPB”), which is responsible for implementing, examining and enforcing compliance with federal consumer financial protection laws;
• requiring the FDIC to make its capital requirements for insured depository institutions countercyclical, so that capital requirements increase in times of economic expansion and decrease in times of economic contraction;
• imposing more stringent capital requirements on bank holding companies and subjecting certain activities, including interstate mergers and acquisitions, to heightened capital conditions;
• changing the assessment base for federal deposit insurance from the amount of the insured deposits held by the depository institution to the depository institution’s average total consolidated assets less tangible equity, eliminating the ceiling on the size of the FDIC’s Deposit Insurance Fund and increasing the floor of the size of the FDIC’s Deposit Insurance Fund;
• eliminating all remaining restrictions on interstate banking by authorizing state banks to establish de novo banking offices in any state that would permit a bank chartered in that state to open a banking office at that location;
• repealing the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts; and
• in the so-called “Volcker Rule,” subject to numerous exceptions, prohibiting depository institutions and affiliates from certain investments in, and sponsorship of, hedge funds and private equity funds and from engaging in proprietary trading.
On February 3, 2017, President Trump signed an executive order calling for his administration to review existing U.S. financial laws and regulations, including the Dodd-Frank Act, in order to determine their consistency with a set of “core principles” of financial policy.
On May 24, 2018 President Trump signed the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Economic Growth Act”), which repeals or modifies certain provisions of the Dodd-Frank Act and eases regulations on all but the largest banks. The Economic Growth Act’s highlights include improving consumer access to mortgage credit that, among other things: (i) exempt banks with less than $10 billion in assets from the ability-to-repay requirements for certain qualified residential mortgage loans; (ii) not require appraisals for certain transactions valued at less than $400,000 in rural areas; (iii) exempt banks and credit unions that originate fewer than 500 open-end and 500 closed-end mortgages from the Home Mortgage Disclosure Act’s (“HMDA”) expanded data disclosures (the provision would not apply to nonbanks and would not exempt institutions from HMDA reporting altogether); (iv) amend the SAFE Mortgage Licensing Act by providing registered mortgage loan originators in good standing with 120 days of transitional authority to originate loans when moving from a federal depository institution to a non-depository institution or across state lines; (v) require the CFPB to clarify how TRID applies to mortgage assumption transactions and construction-to-permanent home loans as well as outline certain liabilities related to model disclosure use; and (vi) provide that federal banking regulators may not impose higher capital standards on High Volatility Commercial Real Estate exposures unless they are for acquisition, development or construction (“ADC”), and clarifies ADC status. In addition, the Economic Growth Act’s highlights also include regulatory relief for certain institutions, whereby among other things, it simplifies capital calculations by requiring regulators to adopt a threshold for a community bank leverage ratio of between 8% to 10%. Institutions under $10 billion in assets that meet such community bank leverage ratio will automatically be deemed to be well-capitalized, although regulators retain the flexibility to determine that a depository institution may not qualify for the community bank leverage ratio test based on the institution’s risk profile, and exempts community banks from Section 13 of the Bank Holding Company Act if they have less than $10 billion in total consolidated assets; and exempts banks with less than $10 billion in assets, and total trading assets and liabilities not exceeding more than five percent of their total assets, from the Volcker Rule restrictions on trading with their own capital. The Economic Growth Act also adds certain protections for consumers, including veterans and active duty military personnel, expanded credit freezes and creation of an identity theft protection database. The Economic Growth Act also makes changes for bank holding companies, as it raises the threshold for automatic designation as a systemically important financial institution from $50 billion to $250 billion in assets, subjects banks with $100 billion to $250 billion in total assets to periodic stress tests, exempts from stress test requirements entirely banks with under $100 billion in assets, and requires the federal banking regulators to, within 180 days of passage, raise the asset threshold under the Small Bank Holding Company Policy Statement from $1 billion to $3 billion. The Economic Growth Act also adds certain protections for student borrowers.
On June 17, 2019, the federal bank regulatory agencies jointly issued a final rule to streamline regulatory reporting requirements and committed to further review of reporting burdens for smaller institutions. The rule permits insured depository institutions with total assets of less than $5 billion that do not engage in certain complex or international activities to file the most streamlined version of the call report, the FFIEC 051 Call Report. This streamlined reporting reduces the data items required to be reported in the first and third quarters by approximately 37% and became effective July 22, 2019. The Bank elected not to adopt the new streamlined version FFIEC 051 Call Report.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on us. In addition, the Economic Growth Act modifies several provisions in the Dodd-Frank Act, but are subject to implementing regulations. Although the reforms primarily target systemically important financial service providers (which the Bank is not), the Dodd-Frank Act’s influence has and is expected to continue to filter down in varying degrees to smaller institutions over time. We will continue to evaluate the effect of the Dodd-Frank Act; however, in many respects, the ultimate impact of the Dodd-Frank Act will not be fully known for years, and no current assurance may be given that the Dodd-Frank Act, or any other new legislative changes, will not have a negative impact on the results of operations and financial condition of the Company and the Bank.
Capital Standards
The federal banking agencies have risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations, both for transactions reported on the balance sheet as assets and for transactions, such as letters of credit and recourse arrangements, that are recorded as off-balance sheet items. In 2013, the FRB, FDIC, and Office of the Comptroller of the Currency issued final rules (the “Basel III Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee’s December 2010 framework, commonly referred to as Basel III, for strengthening international capital standards, as well as implementing certain provisions of the Dodd-Frank Act.
The Basel III Capital Rules became effective for the Company and the Bank on January 1, 2015 (subject to phase-in periods for some of their components). The Basel III Capital Rules: (i) introduce a new capital measure called Common Equity Tier 1 (“CET1”), and a related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments, which are instruments treated as Tier 1 instruments under the prior capital rules that meet certain revised requirements; (iii) mandate that most deductions or adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and adjustments to capital, as compared to existing regulations. Under the Basel III Capital Rules, for most banking organizations, the most common form of additional Tier 1 capital is noncumulative perpetual preferred stock and the most common form of Tier 2 capital is subordinated notes and a portion of the allowance for loan and lease losses, in each case, subject to the Basel III Capital Rules’ specific requirements.
Under the Basel III Capital Rules, the following are the initial minimum capital ratios applicable to the Company and the Bank:
• 4.0% Tier 1 leverage ratio;
• 4.5% CET1 to risk-weighted assets;
• 6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets; and
• 8.0% total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets.
The Basel III Capital Rules also introduced a “capital conservation buffer,” composed entirely of CET1, on top of these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The implementation of the capital conservation buffer began on January 1, 2016 and was phased in over a three-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019). The Company and the Bank must now maintain the following minimum capital ratios:
• 4.0% Tier 1 leverage ratio;
• 4.5% CET1 to risk-weighted assets, plus the capital conservation buffer, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%;
• 6.0% Tier 1 capital to risk-weighted assets, plus the capital conservation buffer, effectively resulting in a minimum Tier 1 capital ratio of at least 8.5%; and
• 8.0% total capital to risk-weighted assets, plus the capital conservation buffer, effectively resulting in a minimum total capital ratio of at least 10.5%.
The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that: (i) mortgage servicing rights; (ii) deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks; and (iii) significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and has been fully phased-in over a four-year period ended on January 1, 2019. Under the Basel III Capital Rules, the effects of certain accumulated other comprehensive income or loss items are not excluded for the purposes of determining regulatory capital ratios; however, non-advanced approaches banking organizations (i.e., banking organizations with less than $250 billion in total consolidated assets or with less than $10 billion of on-balance sheet foreign exposures), including the Company and the Bank, may make a one-time permanent election to exclude these items. The Company and the Bank made this election in the first quarter of 2015’s call reports in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of its available-for-sale investment securities portfolio.
The Basel III Capital Rules prescribe a new standardized approach for risk weightings that expands the risk weighting categories from the previous four Basel I-derived categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive number of categories, generally ranging from 0% for U.S. Government and agency securities, to 600% for certain equity exposures, depending on the nature of the assets. The new capital rules generally result in higher risk weights for a variety of asset classes. Additional aspects of the Basel III Capital Rules that are relevant to the Company and the Bank include:
• consistent with the Basel I risk-based capital rules, assigning exposures secured by single-family residential properties to either a 50% risk weight for first-lien mortgages that meet prudent underwriting standards or a 100% risk weight category for all other mortgages;
• providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (set at 0% under the Basel I risk-based capital rules);
• assigning a 150% risk weight to all exposures that are nonaccrual or 90 days or more past due (set at 100% under the Basel I risk-based capital rules), except for those secured by single-family residential properties, which will be assigned a 100% risk weight, consistent with the Basel I risk-based capital rules;
• applying a 150% risk weight instead of a 100% risk weight for certain high volatility commercial real estate acquisition, development and construction loans; and
• applying a 250% risk weight to the portion of mortgage servicing rights and deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks that are not deducted from CET1 capital (set at 100% under the Basel I risk-based capital rules).
As of December 31, 2020, the Company’s and the Bank’s capital ratios exceeded the minimum capital adequacy guideline percentage requirements of the federal banking agencies for “well capitalized” institutions under the Basel III capital rules on a fully phased-in basis.
With respect to the Bank, the Basel III capital rules also revise the prompt corrective action regulations pursuant to Section 38 of the Federal Deposit Insurance Act.
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms, which standards are commonly referred to as Basel IV. Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including the recalibration of the risk weights and the introduction of new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provides a new standardized approach for operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Bank. The impact of Basel IV on us will depend on how it is implemented by the federal bank regulators.
Prompt Corrective Action (“PCA”)
The Federal Deposit Insurance Act, as amended (“FDIA”), requires federal banking agencies to take PCA in respect of depository institutions that do not meet minimum capital requirements. The FDIA includes the following five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The Basel III Capital Rules revised the PCA requirements effective January 1, 2015. Under the revised PCA provisions of the FDIA, an insured depository institution generally will be classified in the following categories based on the capital measures indicated:
Capital Category
Total
Risk Based
Capital Ratio
Tier 1
Risk-Based
Capital Ratio
Common Equity
Tier 1 (CET1)
Capital Ratio
Leverage Ratio
Tangible Equity
to Assets
Supplemental
Leverage Ratio
Well Capitalized
10% or greater
8% or greater
6.5% or greater
5% or greater
n/a
n/a
Adequately Capitalized
8% or greater
6% or greater
4.5% or greater
4% or greater
n/a
3% or greater
Undercapitalized
Less than 8%
Less than 6%
Less than 4.5%
Less than 4%
n/a
Less than 3%
Significantly Undercapitalized
Less than 6%
Less than 4%
Less than 3%
Less than 3%
n/a
n/a
Critically Undercapitalized
n/a
n/a
n/a
n/a
Less than 2%
n/a
An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios, if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying PCA regulations and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.
The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company, if the depository institution would thereafter be “undercapitalized.” “Undercapitalized” institutions are subject to growth limitations and are required to submit capital restoration plans. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.
The capital classification of a bank holding company and a bank affects the frequency of regulatory examinations, the bank holding company’s and the bank’s ability to engage in certain activities and the deposit insurance premium paid by the bank. As of December 31, 2020, we met the requirements to be “well-capitalized” based upon the aforementioned ratios for purposes of the prompt corrective action regulations, as currently in effect.
The Community Bank Leverage Ratio
On November 4, 2019, the federal banking agencies jointly issued a final rule that provides for an optional, simplified measure of capital adequacy, the community bank leverage ratio (“CBLR”) framework, for qualifying community banking organizations consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. The final rule was effective on January 1, 2020.
In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9%, less than $10 billion in total consolidated assets, off-balance-sheet exposures of 25% or less of total consolidated assets, and trading assets and liabilities of 5% or less of total consolidated assets. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations. Such a community banking organization would not be subject to other risk-based and leverage capital requirements (including the Basel III and Basel IV requirements). The CBLR is determined by dividing a financial institution’s tangible equity capital by its average total consolidated assets. The rule describes what is included in tangible equity capital and average total consolidated assets. The CBLR framework was available for banks to use in their March 31, 2020, call report. A CBLR bank that ceases to meet any of the qualifying criteria in a future period but maintains a leverage ratio greater than 8% will be allowed a grace period of two reporting periods to satisfy the CBLR qualifying criteria or to otherwise comply with the generally applicable capital requirements. Further, a CBLR bank may opt out of the framework at any time, without restriction, by reverting to the generally applicable capital requirements. The Company and Bank did not opt into the CBLR framework.
Anti-Money Laundering and Office of Foreign Assets Control Regulation
Title III of the United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”), is designed to deny terrorists and criminals the ability to obtain access to the U.S. financial system and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act mandates financial services companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation between financial institutions and law enforcement authorities. Regulatory authorities routinely examine financial institutions for compliance with these obligations, and failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required. Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions found to be violating these obligations.
Treasury’s Office of Foreign Assets Control (“OFAC”), administers and enforces economic and trade sanctions against targeted foreign countries and regimes under authority of various laws, including designated foreign countries, nationals and others. OFAC publishes lists of specially designated targets and countries. Financial institutions are responsible for, among other things, blocking accounts of and transactions with such targets and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Banking regulators examine banks for compliance with the economic sanctions regulations administered by OFAC and failure of a financial institution to maintain and implement adequate OFAC programs, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.
Privacy Restrictions
The Gramm-Leach-Bliley Act (“GLBA”) requires financial institutions in the U.S. to provide certain privacy disclosures to customers and consumers, to comply with certain restrictions on the sharing and usage of personally identifiable information, and to implement and maintain commercially reasonable customer information safeguarding standards.
The Company believes that it complies with all provisions of the GLBA and all implementing regulations and the Bank has developed appropriate policies and procedures to meet its responsibilities in connection with the privacy provisions of GLBA.
Dividends and Other Transfer of Funds
Dividends from the Bank constitute the principal source of cash to the Company. The Company is a legal entity separate and distinct from the Bank. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Company. Under such restrictions, the amount available for payment of dividends to the Company by the Bank totaled $87.3 million at December 31, 2020. During 2020, the Bank paid $19.9 million in dividends to the Company.
The FDIC and the DFPI also have authority to prohibit the Bank from engaging in activities that, in their opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC or the DFPI could assert that the payment of dividends or other payments might, under some circumstances, be an unsafe or unsound practice. Further, the FRB and the FDIC have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding companies under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends that the Bank or the Company may pay. An insured depository institution is prohibited from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. The DFPI may impose similar limitations on the Bank. See “Prompt Corrective Action” and “Capital Standards” for a discussion of these additional restrictions on capital distributions.
Transactions with Affiliates
The Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of the Company or other affiliates, the purchase of, or investments in stock or other securities thereof, the taking of such securities as collateral for loans & leases, and the purchase of assets of the Company or other affiliates. Such restrictions prevent the Company and other affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in the Company or to or in any other affiliates are limited, individually, to 10% of the Bank’s capital and surplus (as defined by federal regulations), and such secured loans and investments are limited, in the aggregate, to 20% of the Bank’s capital and surplus (as defined by federal regulations).
In addition, the Company and its operating subsidiaries generally may not purchase a low-quality asset from an affiliate, and other specified transactions between the Company or its operating subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices.
Also, the Company and its operating subsidiaries may engage in transactions with affiliates only on terms and under conditions that are substantially the same, or at least as favorable to the Company or its subsidiaries, as those prevailing at the time for comparable transactions with (or that in good faith would be offered to) non-affiliated companies.
California law also imposes certain restrictions with respect to transactions with affiliates. Additionally, limitations involving the transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See “Prompt Corrective Action.”
Safety and Soundness Standards
The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the financial institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If a financial institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the financial institution’s rate of growth, require the financial institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal bank regulatory agencies, including cease and desist orders and civil money penalty assessments.
During the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong internal controls when evaluating the activities of the financial institutions they supervise. Properly managing risks has been identified as critical to the conduct of safe and sound banking activities and has become even more important as new technologies, product innovation, and the size and speed of financial transactions have changed the nature of banking markets. The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity, operational, legal, and reputational risk. In particular, recent regulatory pronouncements have focused on operational risk, which arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses. New products and services, third-party risk management and cyber-security are critical sources of operational risk that financial institutions are expected to address in the current environment. The Bank is expected to have active board and senior management oversight; adequate policies, procedures, and limits; adequate risk measurement, monitoring, and management information systems; and comprehensive internal controls.
Deposit Insurance
As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The premiums fund the Deposit Insurance Fund (“DIF”). The FDIC assesses a quarterly deposit insurance premium on each insured institution based on risk characteristics of the institution and may also impose special assessments in emergency situations. Effective July 1, 2016, the FDIC changed the deposit insurance assessment system for banks, such as the Bank, with less than $10 billion in assets that have been federally insured for at least five years. Among other changes, the FDIC eliminated risk categories for such banks and now uses the “financial ratios method” to determine assessment rates for all such banks. Under the financial ratios method, the FDIC determines assessment rates based on a combination of financial data and supervisory ratings that estimate a bank’s probability of failure within three years. The assessment rate determined by considering such information is then applied to the amount of the institution’s average assets minus average tangible equity to determine the institution’s insurance premium.
The Dodd-Frank Act required the FDIC to ensure that the DIF reserve ratio, which is the amount in the DIF as a percentage of all DIF-insured deposits, reached 1.35% by September 3, 2020. The Dodd-Frank Act also altered the minimum designated reserve ratio for the DIF, increasing the minimum from 1.15% to 1.35%, and eliminated the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds. At least semi-annually, the FDIC updates its loss and income projections for the DIF and, if needed, may increase or decrease the assessment rates, following notice and comment on proposed rulemaking if required. As a result, the Bank’s FDIC deposit insurance premiums could increase.
The Bank’s FDIC premiums were $517,000 in 2020 and $624,000 in 2019. Future increases in insurance premiums could have adverse effects on the operating expenses and results of operations of the Company. Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC or the Bank’s primary regulator. Management of the Company is not aware of any practice, condition or violation that might lead to termination of the Company’s deposit insurance.
Community Reinvestment Act (“CRA”) and Fair Lending
The Bank is subject to certain fair lending requirements involving lending, investing, and other CRA activities. CRA requires each insured depository institution to identify the communities served by the institution’s offices and to identify the types of credit and investments the institution is prepared to extend within such communities including low and moderate-income neighborhoods. It also requires the institution’s regulators to assess the institution’s performance in meeting the credit needs of its community and to take such assessment into consideration in reviewing applications for mergers, acquisitions, relocation of existing branches, opening of new branches, and other transactions. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws.
A bank’s compliance with the Community Reinvestment Act is assessed using an evaluation system, which bases CRA ratings on an institution’s lending, service and investment performance. An unsatisfactory rating may be the basis for denying a merger application. The Bank’s latest CRA examination was completed by the Federal Deposit Insurance Corporation in May 2019 and the Bank received an overall Outstanding rating in complying with its CRA obligations.
On December 12, 2019, the FDIC and the OCC announced a proposal to modernize the agencies’ regulations under the CRA that have not been substantively updated for nearly 25 years. On May 20, 2020, the OCC issued a final rule for CRA Modernization, however, the FDIC did not join the OCC and finalize the rule.
Consumer Protection Regulations
Banks and other financial institutions are subject to numerous laws and regulations intended to protect consumers in their transactions with banks. These laws include, among others, laws regarding unfair and deceptive acts and practices and usury laws, as well as the following consumer protection statutes: Truth in Lending Act, Truth in Savings Act, Electronic Fund Transfer Act, Expedited Funds Availability Act, Equal Credit Opportunity Act, Fair and Accurate Credit Transactions Act, Fair Housing Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, Gramm-Leach-Bliley Act, Home Mortgage Disclosure Act, Right to Financial Privacy Act, Servicemembers Civil Relief Act, Military Lending Act and Real Estate Settlement Procedures Act.
Many states and local jurisdictions have consumer protection laws analogous, and in addition, to those listed above. These federal, state and local laws regulate the manner in which financial institutions deal with customers when taking deposits, making loans or conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, customer rescission rights, action by state and local attorneys general and civil or criminal liability. Failure to comply with consumer protection requirements may also result in our failure to obtain any required bank regulatory approval for merger or acquisition transactions we may wish to pursue or our prohibition from engaging in such transactions even if approval is not required.
The structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce consumer protection laws. The consumer protection provisions of the Dodd-Frank Act and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more intense and complex environment for consumer finance regulation. The CFPB has significant authority to implement and enforce federal consumer protection laws and new requirements for financial services products provided for in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive or abusive acts and practices. The review of products and practices to prevent such acts and practices is a continuing focus of the CFPB, and of banking regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination, additional remediation efforts and possible penalties. In addition, the Dodd-Frank Act provides the CFPB with broad supervisory, examination and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. The Dodd-Frank Act does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential enforcement actions could also adversely affect our business, financial condition or results of operations.
The CFPB is authorized to issue rules for both bank and nonbank companies that offer consumer financial products and services, subject to consultation with the prudential banking regulators. In general, however, banks with assets of $10 billion or less, such as the Bank, will continue to be examined for consumer compliance by their primary bank regulator.
Notice and Approval Requirements Related to Control
Banking laws impose notice, approval and ongoing regulatory requirements on any stockholder or other party that seeks to acquire direct or indirect "control" of an FDIC-insured depository institution. These laws include the BHCA and the Change in Bank Control Act. Among other things, these laws require regulatory filings by a stockholder or other party that seeks to acquire direct or indirect "control" of an FDIC-insured depository institution or bank holding company. The determination whether an investor "controls" a depository institution is based on all of the facts and circumstances surrounding the investment. As a general matter, a party is deemed to control a depository institution or other company if the party owns or controls 25% or more of any class of voting stock. Subject to rebuttal, a party may be presumed to control a depository institution or other company if the investor owns or controls 10% or more of any class of voting stock. Ownership by family members, affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a party's ownership of the Company were to exceed certain thresholds, the investor could be deemed to "control" the Company for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.
In addition, except under limited circumstances, bank holding companies are prohibited from acquiring, without prior approval:
• control of any other bank or bank holding company or all or substantially all the assets thereof; or
• more than 5% of the voting shares of a bank or bank holding company which is not already a subsidiary.
Incentive Compensation
In 2010, the federal bank regulatory agencies issued comprehensive guidance intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of those organizations by encouraging excessive risk-taking. The incentive compensation guidance sets expectations for banking organizations concerning their incentive compensation arrangements and related risk-management, control and governance processes. The incentive compensation guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon three primary principles: (1) balanced risk-taking incentives; (2) compatibility with effective controls and risk management; and (3) strong corporate governance. Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or take other actions. In addition, under the incentive compensation guidance, a banking organization’s federal supervisor may initiate enforcement action if the organization’s incentive compensation arrangements pose a risk to the safety and soundness of the organization.
In 2016, several federal financial agencies (including the FRB and FDIC) re-proposed restrictions on incentive-based compensation pursuant to Section 956 of the Dodd-Frank Act for financial institutions with $1 billion or more in total consolidated assets. For institutions with at least $1 billion but less than $50 billion in total consolidated assets, the proposal would impose principles-based restrictions that are broadly consistent with existing interagency guidance on incentive-based compensation. Such institutions would be prohibited from entering into incentive compensation arrangements that encourage inappropriate risks by the institution: (i) by providing an executive officer, employee, director, or principal shareholder with excessive compensation, fees, or benefits; or (ii) that could lead to material financial loss to the institution. The comment period for these proposed regulations has closed, but a final rule has not been published. Depending upon the outcome of the rule making process, the application of this rule to us could require us to revise our compensation strategy, increase our administrative costs and adversely affect our ability to recruit and retain qualified employees. Further, as discussed above, the Basel III Capital Rules limit discretionary bonus payments to bank executives if the institution’s regulatory capital ratios fail to exceed certain thresholds that started being phased in on January 1, 2016.
Available Information
Company reports filed with the SEC including the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and ownership reports filed by directors, executive officers and principal stockholders can be accessed through the Company’s website at http://www.fmbonline.com. The link to the SEC is on the About Us page. The Company’s reports may also be accessed at the SEC’s Internet website (http://www.sec.gov).

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors
An investment in our common stock is subject to risks inherent in our business. The material risks and uncertainties that management believes may affect our business are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this 10-K Report. The risks and uncertainties described below are not the only ones facing our business. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This 10-K Report is qualified in its entirety by these risk factors.
If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.
Risks Associated With Our Business
Economic Conditions Nationally And In Our Service Areas Could Adversely Affect Our Operations And/Or Cause Us To Sustain Losses - The national economy and the economy of other portions of California had, for the most part, experienced solid improvements since the recession of 2007-2012, but in 2020 the spread of COVID-19 has placed many sectors of the economy under stress. The economy of the Central Valley of California, which remains the Company’s primary market area, has remained fairly resilient because of its strong agricultural base. However, this could change if the impacts of COVID-19 continue for an extended period of time.
Although we have initiated efforts to broaden our geographic footprint to include Contra Costa, Solano and Napa counties, our retail and commercial banking operations remain primarily concentrated in Sacramento, San Joaquin, Stanislaus and Merced counties. See “Item 1. Business - Service Area.” As a result of this geographic concentration, our results of operations depend largely upon economic conditions in these areas. Whereas much of this area has improved, real estate values remain below peak prices and unemployment remains above most other areas in the state and country. As a result, risk still remains from the possibility that losses will be sustained if a significant number of our borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans or leases. We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan & lease performance and diversifying our credit portfolio. These policies and procedures; however, may not prevent unexpected losses that could materially and adversely affect our results of operations in general and the market value of our stock. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Overview - Looking Forward: 2021 and Beyond.”
Additionally, despite the stability of our earnings over the last several years, economic uncertainties could return and the full extent of the repercussions on our local economies in general and our business in particular are still not fully known at this time. Such events may have a negative effect on: (i) our ability to service our existing customers and attract new customers; (ii) the ability of our borrowers to operate their business as successfully as in the past; (iii) the financial security and net worth of our customers; and (iv) the ability of our customers to repay their loans or leases with us in accordance with the terms thereof.
Our Allowance For Credit Losses May Not Be Adequate To Cover Actual Losses - A significant source of risk arises from the possibility that losses could be sustained because borrowers, guarantors, and related parties may fail to perform in accordance with the terms of their loans & leases. The underwriting and credit monitoring policies and procedures that we have adopted to address this risk may not prevent unexpected losses that could have a material adverse effect on our business, financial condition, results of operations and cash flows. Unexpected losses may arise from a wide variety of specific or systemic factors, many of which are beyond our ability to predict, influence, or control.
Like all financial institutions, we maintain an allowance for credit losses to provide for loan & lease defaults and non-performance. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Provision and Allowance for Credit Losses.” The allowance is funded from a provision for credit losses, which is a charge to our income statement. Our allowance for credit losses may not be adequate to cover actual loan & lease losses, and future provisions for credit losses could materially and adversely affect our business, financial condition, results of operations and cash flows. The allowance for credit losses reflects our estimate of the probable losses in our loan & lease portfolio at the relevant balance sheet date. Our allowance for credit losses is based on prior experience, as well as an evaluation of the known risks in the current portfolio, composition and growth of the loan & lease portfolio and other economic factors. The determination of an appropriate level of credit loss allowance is an inherently difficult process and is based on numerous assumptions. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond our control and these losses may exceed current estimates.
The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments.
While we believe that our allowance for credit losses is adequate to cover our estimate of the current probable losses, we cannot assure you that we will not increase the allowance for credit losses further or that regulators will not require us to increase this allowance. Either of these occurrences could materially adversely affect our business, financial condition, results of operations and cash flows.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update, Financial Instruments: Credit Losses (“CECL”), which establishes a new impairment framework also known as the "current expected credit loss model." In contrast to the incurred loss model currently used by financial entities like us, the current expected credit loss model requires an allowance be recognized based on the expected credit losses (i.e. all contractual cash flows that the entity does not expect to collect from financial assets or commitments to extend credit). It requires the consideration of more forward-looking information than is permitted under current U.S. generally accepted accounting principles. In addition to relevant information about past events and current conditions, such as borrowers’ current creditworthiness, quantitative and qualitative factors specific to borrowers, and the economic environment in which the entity operates, the new model requires consideration of reasonable and supportable forecasts that affect the expected collectability of the financial assets’ remaining contractual cash flows, and evaluation of the forecasted direction of the economic cycle, as well as time value of money. This proposed impairment framework is expected to have wide reaching implications to financial institutions such as us. The CECL model will become effective for the Bank for fiscal year 2022. See Note 21, located in “Item 8. Financial Statements and Supplementary Data.”
We Are Dependent On Real Estate And Downturns In The Real Estate Market Could Hurt Our Business - A significant portion of our loan portfolio is dependent on real estate. See “Item 1. Business - Supervision and Regulation - Prompt Corrective Action.” At December 31, 2020, real estate served as the principal source of collateral with respect to approximately 69% of our loans outstanding. Stresses in economic conditions in our local markets or rising interest rates could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing loans and the value of real estate owned by us, as well as our financial condition and results of operations in general and the market value of our common stock. Additionally we have credit exposure to the Hospitality and Entertainment industries (See “Covid-19 Disclosure”) that have been significantly impacted by COVID-19 and the primary collateral for those borrowers is real estate.
Acts of nature, including earthquakes, floods and fires, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.
Our Real Estate Lending Also Exposes Us To The Risk Of Environmental Liabilities - In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.
Our Business Is Subject To Interest Rate Risk And Changes In Interest Rates May Adversely Affect Our Performance And Financial Condition - Our earnings are impacted by changing interest rates. Changes in interest rates impact the demand for new loans & leases, the credit profile of our borrowers, the rates received on loans & leases and securities and rates paid on deposits and borrowings. The difference between the rates received on loans & leases and securities and the rates paid on deposits and borrowings is known as the net interest margin. The FRB decreased short-term interest rates by 1.5% during 2020, and that has already impacted the Company’s net interest margin. Looking forward, if short-term rates remain low, when combined with aggressive competitor pricing strategies, our net interest margin could be adversely impacted in 2021.
Future levels of market interest rates could adversely affect our earnings. Our CRE and commercial loans carry interest rates that, in general, adjust in accordance with changes in the prime rate. We are also significantly affected by the level of loan & lease demand available in our market. The inability to make sufficient loans & leases directly affects the interest income we earn. Lower loan & lease demand will generally result in lower interest income realized as we place funds in lower yielding investments. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Overview - Looking Forward: 2021 and Beyond.”
Although we believe our current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates and increasing competition may have an adverse effect on our business, financial condition and results of operations. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Net Interest Income/Net Interest Margin” and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk.”
Changes To LIBOR May Adversely Impact The Value Of, and The Return On, Our Financial Instruments That Are Indexed To LIBOR - On July 27, 2017, the Financial Conduct Authority (the authority that regulates the London Interbank Funding Rate (“LIBOR”) announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021 (although it may now be postponed until June 30, 2023). The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee (“AARC”), is considering replacing U.S. dollar LIBOR with a newly created index called the Secured Overnight Financing Rate (“SOFR”) calculated based on repurchase agreements backed by treasury securities. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR, whether LIBOR rates will cease to be published before December 31, 2021 or June 30, 2023, as applicable, or whether any additional reforms to LIBOR may be enacted. Although the ARRC has announced SOFR as its recommended alternative to LIBOR, SOFR may not gain market acceptance or be widely used as a benchmark. Uncertainty as to the nature of such potential changes, alternative reference rates, the elimination or replacement of LIBOR, or other reforms may adversely affect the value of, and the return on our financial instruments
Our Accounting Estimates And Risk Management Processes Rely On Analytical And Forecasting Models - The processes we use to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depends upon the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset-liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models we use to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition and results of operations.
Failure To Successfully Execute Our Strategy Could Adversely Affect Our Performance - Our financial performance and profitability depends on our ability to execute our corporate growth strategy. Continued growth however, may present operating and other problems that could adversely affect our business, financial condition and results of operations. Accordingly, there can be no assurance that we will be able to execute our growth strategy or maintain the level of profitability that we have recently experienced. Factors that may adversely affect our ability to attain our long-term financial performance goals include those stated elsewhere in this section, as well as the:
• inability to maintain or increase net interest margin;
• inability to control non-interest expense, including, but not limited to, rising employee and healthcare costs and the costs of regulatory compliance;
• inability to maintain or increase non-interest income;
• the need to raise additional capital to support growth and regulatory requirements; and
• continuing ability to expand through de novo branching or otherwise.
Growth May Produce Unfavorable Outcomes - We seek to expand our franchise safely and consistently. A successful growth strategy requires us to manage multiple aspects of the business simultaneously, such as following adequate loan underwriting standards, balancing loan and deposit growth without increasing interest rate risk or compressing our net interest margin, maintaining sufficient capital, and recruiting, training and retaining qualified professionals.
Our growth strategy also includes acquisition possibilities (such as Delta National Bancorp & Bank of Rio Vista) that either enhance our market presence or have potential for improved profitability through financial management, economies of scale or expanded services. We may be exposed to difficulties in combining the operations of acquired institutions into our own operations, which may prevent us from achieving the expected benefits from our acquisition activities. Inherent uncertainties exist in integrating the operations of an acquired institution and there is no assurance that we will be able to do so successfully. Among the issues that we could face are:
• unexpected problems with operations, personnel, technology or credit;
• loss of customers and employees of the acquiree;
• difficulty in working with the acquiree's employees and customers;
• the assimilation of the acquiree's operations, culture and personnel;
• instituting and maintaining uniform standards, controls, procedures and policies; and
• litigation risk not discovered during the due diligence period.
Undiscovered factors as a result of an acquisition could bring liabilities against us, our management and the management of the institutions we acquire. These factors could contribute to our not achieving the expected benefits from our acquisitions within desired time frames, if at all. Further, although we anticipate cost savings as a result of mergers, we may not be able to fully realize those savings. Any cost savings that are realized may be offset by losses in revenues or other charges to earnings.
New Market Areas And New Lines Of Business Or New Products And Services May Subject Us To Additional Risks. A Failure To Successfully Manage These Risks May Have A Material Adverse Effect On Our Business - As part of our growth strategy, we have implemented and may continue to implement new market areas and new lines of business. We recently have begun to: (i) expand into the East Bay area of San Francisco and Napa, which are new market areas for us; and (ii) introduce equipment leasing as a new product line. There are risks and uncertainties associated with these efforts, particularly in instances where such product lines are not fully mature. In developing and marketing new lines of business and/or new products and services and/or shifting the focus of our asset mix and/or expanding into new markets, we may invest significant time and resources. Initial timetables may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives in these markets and shifting market preferences, may also impact the successful implementation. Failure to successfully manage these risks could have an adverse effect on our business, financial condition and results of operations.
Our Financial Results Can Be Impacted By The Cyclicality and Seasonality Of Our Agricultural Business And The Risks Related Thereto - The Company has provided financing to agricultural customers in the Central Valley throughout its history. We recognize the cyclical nature of the industry, often caused by fluctuating commodity prices, changing climatic conditions and the availability of seasonal labor, and manage these risks accordingly. The Company remains committed to providing credit to agricultural customers and will always have a material exposure to this industry. Although the Company’s loan portfolio is believed to be well diversified, at various times during 2020 approximately 29% of the Company’s loan balances were outstanding to agricultural borrowers. Commitments are well diversified across various commodities, including dairy, grapes, walnuts, almonds, cherries, apples, pears, and various row crops. Additionally, many individual borrowers are themselves diversified across commodity types, reducing their exposure, and therefore the Company’s, to cyclical downturns in any one commodity. Agriculture has been deemed an “essential” industry during the COVID-19 pandemic, helping mitigate economic stress in the industry.
The Company’s service areas can also be significantly impacted by the seasonal operations of the agricultural industry. As a result, the Company’s financial results can be influenced by the banking needs of its agricultural customers (e.g., generally speaking during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and the planting of crops. Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).
The Impact of Climate and Government on The Availability of Water is a Long Term Risk That Could Affect Our Customers’ Businesses - The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought conditions in California. As a result, current reservoir levels are adequate and the availability of water in our primary service area should not be an issue. However, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.
The farming belt of the Central Valley was often cited as an example of an area that experienced extreme drought during 2013 - 2016. However, it is important to understand that not all areas of the state were impacted equally, and this is particularly true in the Central Valley, which stretches some 450 miles from Bakersfield in the south to Redding in the north. The vast majority of the Company’s agricultural customers are located in the more northern portion of the Central Valley, an area that benefits from the drainage of the Sacramento, American, Mokelumne and Stanislaus rivers. As a result, even during the worst of the drought farmers in this area still had access to reasonable ground water sources that were economical to pump.
Importantly, the Company has minimal credit exposure in the more southern portion of the Central Valley, defined broadly as an area south of Highway 152, but more importantly the Fresno area and south (including the Westlands Water District). In most of these areas ground water levels were depleted, making farmers increasingly dependent on the delivery of surface water from the Central Valley Project, which cut back deliveries to many farmers during the worst of the drought.
In addition to the impact of climate on the availability of water, the “politics” of water, and how the state and federal governments ultimately manage this resource, could also impact how much water our customers have access to. For example, in 2014, the State of California passed the Sustainable Groundwater Management Act. All Water Districts must develop plans to comply with the Act, including groundwater recharge programs. Although the exact impact of compliance is not currently known, and even prior to 2014 most of the Water Districts in the Bank’s service area had been developing and implementing management plans, it is possible that some Water Districts will have to ultimately fallow some ground to achieve compliance with the Act.
This example points out how the “politics” of water can also affect the availability of water.
The Company monitors the water situation through: (i) regularly reviewing ground water level reports provided by California’s Department of Water Resources; (ii) requiring water budgets and plans from all of our agricultural borrowers that detail the sources of their irrigation water and the irrigation requirements to achieve their crop plan; and (iii) in the case of new permanent crop development projects, requiring well tests.
We Face Strong Competition From Financial Service Companies And Other Companies That Offer Banking Services That Could Adversely Impact Our Business - The financial services business in our market areas is highly competitive. It is becoming increasingly competitive due to changes in regulation, technological advances, and the accelerating pace of consolidation among financial services providers. We face competition both in attracting deposits and in making loans & leases. We compete for loans & leases principally through the interest rates and loan & lease fees we charge and the efficiency and quality of services we provide. Increasing levels of competition in the banking and financial services business may reduce our market share, decrease loan & lease demand, cause the prices we charge for our services to fall, or decrease our net interest margin by forcing us to offer lower lending interest rates and pay higher deposit interest rates. Therefore, our results may differ in future periods depending upon the nature or level of competition.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Many of our competitors offer products and services that we do not offer, and many have substantially greater resources, such as greater capital resources and more access to longer term, lower cost funding sources. Many also have greater name recognition and market presence that benefit them in attracting business. In addition, larger competitors may be able to price loans & lease and deposits more aggressively than we do. Our larger competitors generally have easier access to capital, and often on better terms. Some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies and federally insured state-chartered banks, national banks and federal savings institutions. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services. Other competitors are subject to similar regulation but have the advantages of larger established customer bases, higher lending limits, extensive branch networks, numerous automated teller machines, greater advertising and marketing budgets or other factors. Some of our competitors have other advantages, such as tax exemption in the case of credit unions, and lesser regulation in the case of mortgage companies and specialty finance companies.
Deposit Insurance Assessments Could Increase At Any Time, Which Will Adversely Affect Profits - FDIC deposit insurance expense for the years 2020, 2019, and 2018 was $517,000, $624,000, and $912,000, respectively. During 2016 the FDIC changed its methodology for calculating deposit premiums, See “Item 1. Business - Supervision and Regulation - Deposit Insurance.” Any increases could have adverse effects on the operating expenses and results of operations of the Company.
We May Not Be Able To Attract And Retain Skilled People - Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most of our activities can be intense and we may not be able to hire people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
Our Internal Operations Are Subject To A Number Of Risks - We are subject to certain operations risks, including, but not limited to, information 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.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan & leases and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
Natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans and lessees to make lease payments, impair the value of collateral securing loans & leases, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Operations in several of our markets could be disrupted by both the evacuation of large portions of the population as well as damage and or lack of access to our banking and operation facilities. While we have not experienced such an occurrence to date, other natural disasters, acts of war or terrorism or other adverse external events may occur in the future. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
The Value of Goodwill and Other Intangible Assets May Decline in the Future - As of December 31, 2020, we had goodwill totaling $11.2 million and a core deposit intangible asset totaling $4.0 million from business acquisitions. A significant decline in expected future cash flows, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock could necessitate taking charges in the future related to the impairment of goodwill or other intangible assets. If we were to conclude that a future write-down of goodwill or other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our business, financial condition and results of operations.
We Depend On Cash Dividends From The Bank To Meet Our Cash Obligations - As a holding company, dividends from the Bank provide a substantial portion of our cash flow used to service the interest payments on our subordinated debentures issued in 2003 and our other obligations, including cash dividends. See “Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.” Various statutory provisions restrict the amount of dividends our subsidiary bank can pay to us without regulatory approval.
A Lack Of Liquidity Could Adversely Affect Our Operations And Jeopardize Our Business, Financial Condition And Results Of Operations - Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, the sale of our investment securities, Federal Home Loan Bank advances, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our most important source of funds consists of deposits. Deposit balances can decrease when customers perceive alternative investments as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, we would lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income.
Other primary sources of funds consist of cash flows from operations, investment maturities and sales of investment securities and proceeds from the issuance and sale of any equity and debt securities to investors. Additional liquidity is provided by the ability to borrow from the Federal Reserve Bank and the Federal Home Loan Bank and our ability to raise brokered deposits. We also may borrow funds from third-party lenders, such as other financial institutions. Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us directly or the bank or non-bank financial services industries or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the bank or non-bank financial services industries.
As of December 31, 2020, approximately $2.2 billion, or 53.3%, of our deposits consisted of interest-bearing demand deposits, savings and money market accounts. Based on past experience, we believe that our deposit accounts are relatively stable sources of funds. If we increase interest rates paid to retain deposits, our earnings may be adversely affected, which could have an adverse effect on our business, financial condition and results of operations. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to our stockholders or to fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, financial condition and results of operations.
System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities - The computer systems and network infrastructure we use could be vulnerable to hardware and cyber-security issues. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. We could also experience a breach by intentional or negligent conduct on the part of employees or other internal or external sources, including our third-party vendors. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by us, including our internet banking activities, against damage from physical break-ins, cyber-security breaches and other disruptive problems caused by the internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability, damage our reputation and inhibit the use of our internet banking services by current and potential customers.
We rely heavily on communications, information systems (both internal and provided by third-parties) and the internet to conduct our business. Our business is dependent on our ability to process and monitor large numbers of daily transactions in compliance with legal, regulatory and internal standards and specifications. In addition, a significant portion of our operations relies heavily on the secure processing, storage and transmission of personal and confidential information, such as the personal information of our customers and clients. In recent periods, several governmental agencies and large corporations, including financial service organizations and retail companies, have suffered major data breaches, in some cases exposing not only their confidential and proprietary corporate information, but also sensitive financial and other personal information of their clients and their employees or other third-parties, and subjecting those agencies and corporations to potential fraudulent activity and their clients and other third-parties to identity theft and fraudulent activity in their credit card and banking accounts. Therefore, security breaches and cyber-attacks can cause significant increases in operating costs, including the costs of compensating clients and customers for any resulting losses they may incur and the costs and capital expenditures required to correct the deficiencies in and strengthen the security of data processing and storage systems. These risks may increase in the future as we continue to increase mobile payments and other internet-based product offerings and expand our internal usage of web-based products and applications.
In addition to well-known risks related to fraudulent activity, which take many forms, such as check “kiting” or fraud, wire fraud, and other dishonest acts, information security breaches and cyber-security related incidents have become a material risk in the financial services industry. For example, U.S. financial institutions have experienced significant distributed denial-of-service attacks, some of which involve sophisticated and targeted attacks intended to disable or degrade service, or sabotage systems. Other potential attacks attempt to obtain unauthorized access to confidential information, steal money, or manipulate or destroy data, often through the introduction of computer viruses or malware, cyber-attacks and other means. Other threats of this type may include fraudulent or unauthorized access to data processing or data storage systems used by us or by our clients, electronic identity theft, “phishing,” account takeover, and malware or other cyber-attacks. To date, none of these types of attacks have had a material effect on our business or operations. Such security attacks can originate from a wide variety of sources, including persons who are involved with organized crime or who may be linked to terrorist organizations or hostile foreign governments. Those same parties may also attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or clients.
We are also subject to the risk that our employees may intercept and transmit unauthorized confidential or proprietary information. An interception, misuse or mishandling of personal, confidential or proprietary information being sent to or received from a customer or third-party could result in legal liabilities, remediation costs, regulatory actions and reputational harm.
Unfortunately, it is not always possible to anticipate, detect, or recognize these threats to our systems, or to implement effective preventative measures against all breaches, whether those breaches are malicious or accidental. Cyber-security risks for banking organizations have significantly increased in recent years and have been difficult to detect before they occur because of the following, among other reasons:
• the proliferation of new technologies, and the use of the Internet and telecommunications technologies to conduct financial transactions;
• these threats arise from numerous sources, not all of which are in our control, including among others human error, fraud or malice on the part of employees or third-parties, accidental technological failure, electrical or telecommunication outages, failures of computer servers or other damage to our property or assets, natural disasters or severe weather conditions, or terrorist acts;
• the techniques used in cyber-attacks change frequently and may not be recognized until launched or until well after the breach has occurred;
• the increased sophistication and activities of organized crime groups, hackers, terrorist organizations, hostile foreign governments, disgruntled employees or vendors, activists and other external parties, including those involved in corporate espionage;
• the vulnerability of systems to third-parties seeking to gain access to such systems either directly or using equipment or security passwords belonging to employees, customers, third-party service providers or other users of our systems; and
• our frequent transmission of sensitive information to, and storage of such information by, third-parties, including our vendors and regulators, and possible weaknesses that go undetected in our data systems notwithstanding the testing we conduct of those systems.
Our investments in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and our conduct of periodic tests of our security systems and processes, may not succeed in anticipating or adequately protecting against or preventing all security breaches and cyber-attacks from occurring. Even the most advanced internal control environment may be vulnerable to compromise. Targeted social engineering attacks are becoming more sophisticated and are extremely difficult to prevent. Additionally, the existence of cyber-attacks or security breaches at third-parties with access to our data, such as vendors, may not be disclosed to us in a timely manner. 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 or incidents. We maintain a system of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition and results of operations.
As is the case with non-electronic fraudulent activity, cyber-attacks or other information or security breaches, whether directed at us or third-parties, may result in a material loss or have material consequences. Furthermore, the public perception that a cyber-attack on our systems has been successful, whether or not this perception is correct, may damage our reputation with customers and third-parties with whom we do business. A successful penetration or circumvention of system security could cause us negative consequences, including loss of customers and business opportunities, disruption to our operations and business, misappropriation or destruction of our confidential information and/or that of our customers, or damage to our customers’ and/or third-parties’ computers or systems, and could expose us to additional regulatory scrutiny and result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, additional compliance costs, and could adversely impact our results of operations, liquidity and financial condition.
We Rely On Third-Party Vendors For Important Aspects Of Our Operation - We depend on the accuracy and completeness of information and systems provided by certain key vendors, including but not limited to data processing, payroll processing, technology support, investment safekeeping and accounting. Our ability to operate, as well as our financial condition and results of operations, could be negatively affected in the event of an interruption of an information system, an undetected error, a cyber breach, or in the event of a natural disaster whereby certain vendors are unable to maintain business continuity.
We May Be Adversely Affected By The Soundness Of Other Financial Institutions - Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, broker-dealers, investment banks and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated if our collateral cannot be foreclosed upon or is liquidated at prices not sufficient to recover the full amount of the credit or cover the derivative exposure due. Any such losses could have a material adverse effect on our business, financial condition and results of operations.
Deterioration Of Credit Quality Or Insolvency Of Insurance Companies May Impede Our Ability To Recover Losses - The financial crisis led certain major insurance companies to be downgraded by rating agencies. We have property, casualty and financial institution risk coverage underwritten by several insurance companies. In addition, some of our investments in obligations of state and political subdivisions are insured by insurance companies. While we closely monitor credit ratings of our insurers and insurers of our municipality securities, and we are poised to make quick changes if needed, we cannot predict an unexpected inability to honor commitments. We also invest in bank-owned life insurance policies on certain members of senior Management, which may lose value in the event of the carriers' insolvency. In the event that our bank-owned life insurance policy carriers' credit ratings fall below investment grade, we may exchange policies underwritten by them to another carrier at a cost charged by the original carrier, or we may terminate the policies that may result in adverse tax consequences.
Our loan portfolio is also primarily secured by properties located in earthquake or fire-prone zones. In the event of a disaster that causes pervasive damage to the region in which we operate, not only the Bank, but also the loan collateral may suffer losses not recovered by insurance.
Risks Associated With Our Industry
We Are Subject To Government Regulation That Could Limit Or Restrict Our Activities, Which In Turn Could Adversely Impact Our Financial Performance - The financial services industry is regulated extensively and we are subject to examination, supervision and comprehensive regulations by various regulatory agencies. Federal and state regulations are designed primarily to protect the deposit insurance funds and consumers, and not to benefit our stockholders. These regulations can sometimes impose significant limitations on our operations and increase our cost of doing business.
Further, federal monetary policy, particularly as implemented by the FRB, significantly affects economic conditions for us.
Proposals to change the laws and regulations governing the operations and taxation of, and federal insurance premiums paid by, banks and other financial institutions and companies that control such institutions are frequently raised in the U.S. Congress, the California legislature and before bank regulatory authorities. The likelihood of any major changes in the future and the impact such changes, including the Dodd-Frank Act, might have on us or the Bank are impossible to determine. Similarly, proposals to change the accounting treatment applicable to banks and other depository institutions are frequently raised by the SEC, the federal banking agencies, the IRS and other appropriate authorities. The likelihood and impact of any additional future changes in law or regulation and the impact such changes might have on us or the Bank are impossible to determine at this time.
Risks Associated With Our Stock
Our Stock Trades Less Frequently Than Others - The Company’s common stock is not widely held or listed on any exchange. However, trades are reported on the OTCQX under the symbol "FMCB". The limited trading market for the Company’s common stock may make it difficult for stockholders to dispose of their shares.
Our Stock Price Is Affected By A Variety Of Factors - Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors discussed in this section, including, among other things:
• actual or anticipated variations in quarterly results of operations;
• operating and stock price performance of other companies that investors deem comparable to our Company;
• news reports relating to trends, concerns and other issues in the financial services industry;
• available investment liquidity in our market area since our stock is not listed on any exchange; and
• perceptions in the marketplace regarding our Company and/or its competitors.
Our Common Stock Is Not An Insured Deposit - Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments
The Company has no unresolved comments received from staff at the SEC.

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ITEM 2. PROPERTIES
Item 2. Properties
Farmers & Merchants Bancorp and its subsidiaries are headquartered in Lodi, California. Executive offices are located at 111 W. Pine Street. Banking services are provided in twenty-eight branches in the Company's service area. Of the twenty-eight branches, nineteen are owned and nine are leased. The expiration of these leases occurs between the years 2021 and 2028. See Note 20, located in “Item 8. Financial Statements and Supplementary Data.”

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings
Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. Based upon information available to the Company, its review of such lawsuits and claims and consultation with its counsel, the Company believes the liability relating to these actions, if any, would not have a material adverse effect on its consolidated financial statements.
There are no material proceedings adverse to the Company to which any director, officer or affiliate of the Company is a party.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures
Not Applicable
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The common stock of Farmers & Merchants Bancorp is not widely held or listed on any exchange. However, trades are reported on the OTCQX under the symbol “FMCB”.
The following tables summarize the actual high, low, and close sale prices for the Company's common stock since the first quarter of 2019. These figures are based on activity posted on the OTCQX.
Calendar Quarter
High
Low
Close
Cash Dividends
Declared (Per Share)
Fourth quarter
$
$
$
$
7.50
Third quarter
-
Second quarter
7.25
First quarter
-
Calendar Quarter
High
Low
Close
Cash Dividends
Declared (Per Share)
Fourth quarter
$
$
$
$
7.15
Third quarter
-
Second quarter
7.05
First quarter
-
As of January 31, 2021, there were approximately 1,650 stockholders of record of the Company’s common stock. However, since approximately 30% of our common stock shares are held by brokers on behalf of stockholders, we are unable to determine the exact total number of stockholders.
The Company and, before the Company was formed, the Bank, has paid cash dividends for the past 86 consecutive years. There are limitations under Delaware corporate law as to the amounts of cash dividends that may be paid by the Company. Additionally, if we decided to defer interest on our 2003 subordinated debentures, we would be prohibited from paying cash dividends on the Company’s common stock. The Company is dependent on cash dividends paid by the Bank to fund its cash dividend payments to its stockholders. There are regulatory limitations on cash dividends that may be paid by the Bank. See “Item 1. Business - Supervision and Regulation.”
In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since then, and most recently, on November 6, 2018, the Board of Directors approved an extension of the $20 million stock repurchase program over the three-year period ending December 31, 2021.
Repurchases under the program may be made from time to time on the open market or through private transactions. The repurchase program also requires that no purchases may be made if the Bank would not remain “well-capitalized” after the repurchase.
There were no stock repurchases in 2020 or 2019 under the Common Stock Repurchase Plan. The remaining dollar value of shares that may yet be purchased under the Company’s Common Stock Repurchase Plan is approximately $20 million.
On November 23, 2020, the Board of Directors of Farmers & Merchants Bancorp approved, and all applicable regulators provided statements of non-objection regarding, the Company’s repurchase and retirement of up to $8.5 million of its outstanding common stock during the fourth quarter of 2020 and the first half of 2021. These repurchases will be done outside of the Company’s current repurchase plan. All repurchases will be made at the then prevailing market prices. In the fourth quarter of 2020, the Company repurchased $2.8 million of shares from shareholders.
On May 24, 2018, stockholders approved a proposal to increase our authorized shares of common stock from 7,500,000 to 40,000,000. In approving this proposal the stockholders also granted the Board discretionary authority (i.e., without further stockholder action) to determine whether to delay the proposed amendment. The Company has no immediate plans to effect the increase in the authorized shares of common stock.
On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights Agent, and the Company declared a dividend of a right to acquire one preferred share purchase right (a “Right”) for each outstanding share of the Company’s common stock, $0.01 par value per share, to stockholders of record at the close of business on August 15, 2008. Generally, the Rights are only triggered and become exercisable if a person or group (the “Acquiring Person”) acquires beneficial ownership of 10 percent or more of the Company’s common stock or announces a tender offer for 10 percent or more of the Company’s common stock.
The Rights Plan is similar to plans adopted by many other publicly traded companies. The effect of the Rights Plan is to discourage any potential acquirer from triggering the Rights without first convincing the Company’s Board of Directors that the proposed acquisition is fair to, and in the best interest of, all of the stockholders of the Company. The provisions of the Plan, if triggered by the Acquiring Person, will substantially dilute the equity and voting interest of any potential acquirer unless the Board of Directors approves of the proposed acquisition (under Article XV of the Company’s Certificate of Incorporation, the Board of Directors has the authority to consider any and all factors in determining whether an acquisition is in the best interests of the Company and its stockholders). Each Right, if and when exercisable, will entitle the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, no par value, at a purchase price of $1,600 for each one one-hundredth of a share, subject to adjustment. Each holder of a Right (except for the Acquiring Person, whose Rights will be null and void upon such event) shall thereafter have the right to receive, upon exercise, that number of Common Shares of the Company having a market value of two times the exercise price of the Right. At any time before a person becomes an Acquiring Person, the Rights can be redeemed, in whole, but not in part, by Farmers and Merchants Bancorp’s Board of Directors at a price of $0.001 per Right.
The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan. Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal. The Board also increased the purchase price under the Rights Plan to $1,600 per one one-hundredth of a preferred share from $1,200, to reflect the increase in the market price of the Company’s common stock over the past several years.
During 2020, the Company issued a combined total 523 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at a price of $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. See Note 14, located in “Item 8. Financial Statements and Supplementary Data.”
During 2019, the Company issued a combined total 9,312 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at prices ranging from $715.00 to $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. See Note 14, located in “Item 8. Financial Statements and Supplementary Data.”
Performance Graphs
The following graph compares the Company’s cumulative total stockholder return on common stock from December 31, 2015 to December 31, 2020 to that of: (i) the Morningstar Banks Index - Regional (US) Industry Group; and (ii) the cumulative total return of the New York Stock Exchange market index. The graph assumes an initial investment of $100 on December 31, 2015 and reinvestment of dividends. The stock price performance set forth in the following graph is not necessarily indicative of future price performance. The Company’s stock price data is based on activity posted on the OTCQX and on private transactions between individual stockholders that are reported to the Company. This data was furnished by Zacks SEC Compliance Services Group.
This graph shall not be deemed filed or incorporated by reference into any filing under the Securities Act of 1933.

---

ITEM 6. SELECTED FINANCIAL DATA
Item 6. Selected Financial Data
Farmers & Merchants Bancorp
Five Year Financial Summary of Operations
(in thousands except per share data)
Summary of Income:
Total Interest Income
$
158,652
$
153,708
$
133,453
$
114,612
$
99,266
Total Interest Expense
9,491
13,194
7,950
6,289
4,196
Net Interest Income
149,161
140,514
125,503
108,323
95,070
Provision for Credit Losses
4,500
5,533
2,850
6,335
Net Interest Income After Provision for Credit Losses
144,661
140,314
119,970
105,473
88,735
Total Non-Interest Income
15,696
17,241
15,219
16,762
15,257
Total Non-Interest Expense
82,406
82,242
75,459
67,754
58,172
Income Before Income Taxes
77,951
75,313
59,730
54,481
45,820
Provision for Income Taxes
19,217
19,277
14,203
26,111
16,097
Net Income
$
58,734
$
56,036
$
45,527
$
28,370
$
29,723
Balance Sheet Data:
Total Assets
$
4,550,453
$
3,721,830
$
3,434,243
$
3,075,452
$
2,922,121
Loans & Leases
3,099,592
2,673,027
2,571,241
2,215,295
2,177,601
Allowance for Credit Losses
58,862
55,012
55,266
50,342
47,919
Investment Securities
876,665
567,615
548,962
536,056
506,372
Goodwill
11,183
11,183
11,183
-
-
Core Deposit Intangible
4,013
4,640
5,278
Deposits
4,060,267
3,278,019
3,062,832
2,723,228
2,581,711
Shareholders' Equity
423,665
369,296
311,215
299,660
279,981
Selected Ratios:
Return on Average Assets
1.43
%
1.61
%
1.45
%
0.94
%
1.12
%
Return on Average Equity
14.60
%
16.77
%
14.80
%
9.66
%
11.17
%
Dividend Payout Ratio
19.92
%
20.02
%
24.49
%
38.71
%
35.25
%
Average Loans & Leases to Average Deposits
80.77
%
84.38
%
84.36
%
82.18
%
88.63
%
Average Equity to Average Assets
9.78
%
9.61
%
9.66
%
9.77
%
10.05
%
Period-end Shareholders' Equity to Total Assets
9.31
%
9.92
%
9.06
%
9.74
%
9.58
%
Basic and Diluted Per Share Data:
Earnings (1)
$
74.03
$
71.18
$
56.82
$
35.03
$
37.44
Cash Dividends Per Share
$
14.75
$
14.20
$
13.90
$
13.55
$
13.10
Book Value Per Share at Year End (2)
$
536.53
$
465.68
$
397.10
$
368.90
$
346.80
(1) Based on the weighted average number of shares outstanding of 793,337, 787,227, 801,229, 809,834, and 793,970 for the years ended December 31, 2020, 2019, 2018, 2017, and 2016, respectively.
(2) Based on the year-end number of shares outstanding of 789,646, 793,033, 783,721, 812,304, and 807,329 for the years ended December 31, 2020, 2019, 2018, 2017, and 2016, respectively.

---

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
Although the Company has initiated efforts to expand its geographic footprint into the East Bay area of San Francisco and Napa, California (see “Item 1. Business - Service Area”), the Company’s primary service area remains the mid Central Valley of California, a region that can be significantly impacted by the seasonal needs of the agricultural industry. Accordingly, discussion of the Company’s Financial Condition and Results of Operations is influenced by the seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and planting of crops. Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).
The Five-Year Period: 2016 through 2020
By early 2020 the Company’s primary service area had significantly recovered from the recession that began in late 2007. Then, late in the first quarter of 2020 the COVID-19 pandemic began, an event that would impact economies everywhere. Importantly, agriculture has been designated as an “essential” industry during the pandemic, helping to mitigate economic stress in the Company’s primary service area.
Despite this challenging economic environment, in management’s opinion, the Company’s operating performance over the past five years has been exceptionally strong.
We used certain non-GAAP financial measures to provide supplemental information regarding our performance in 2017. Income Tax Expense for the year ended 2017 included a one-time, non-cash $6.3 million charge related to the re-measurement of the Company’s Deferred Tax Asset (“DTA”) as a result of the passage of the Tax Cuts and Jobs Act in 2017. We believed that presenting Adjusted Net Income, excluding the impact of the DTA re-measurement charge, provides additional clarity to the users of financial statements regarding core financial performance and allows for a better year-over-year comparison of trends in core profitability.
(in thousands, except per share data)
Financial Performance Indicator
Pre Tax Income
$
77,951
$
75,313
$
59,730
$
54,481
$
45,820
Income Tax Expense
19,217
19,277
14,203
26,111
16,097
Effect of Income Tax Rate Change
DTA Re-measurement
-
-
-
(6,300
)
-
Adjusted Income Tax Expense
19,217
19,277
14,203
19,811
16,097
Non-GAAP Adjusted Net Income
58,734
56,036
45,527
34,670
29,723
Effect of Income Tax Rate Change
DTA Re-measurement
-
-
-
(6,300
)
-
Net Income (See Note 1)
$
58,734
$
56,036
$
45,527
$
28,370
$
29,723
Total Assets
4,550,453
3,721,830
3,434,243
3,075,452
2,922,121
Total Loans & Leases
3,099,592
2,673,027
2,571,241
2,215,295
2,177,601
Total Deposits
4,060,267
3,278,019
3,062,832
2,723,228
2,581,711
Total Shareholders’ Equity
423,665
369,296
311,215
299,660
279,981
Total Risk-Based Capital Ratio
12.60
%
12.40
%
11.40
%
13.07
%
12.80
%
Non-Performing Loans as a % of Total Loans
0.02
%
0.00
%
0.00
%
0.00
%
0.14
%
Substandard Loans as a % of Total Loans
0.60
%
0.61
%
0.57
%
0.40
%
0.29
%
Net Charge-Offs (Recoveries) to Average Loans
0.02
%
0.02
%
0.03
%
0.02
%
0.00
%
Loan Loss Allowance as a % of Total Loans
1.89
%
2.05
%
2.14
%
2.27
%
2.19
%
Return on Average Assets
1.43
%
1.61
%
1.45
%
0.94
%
1.12
%
Adjusted Return on Average Assets
1.43
%
1.61
%
1.45
%
1.15
%
1.12
%
Return on Average Equity
14.60
%
16.77
%
14.80
%
9.66
%
11.17
%
Adjusted Return on Average Equity
14.60
%
16.77
%
14.80
%
11.79
%
11.17
%
Earnings Per Share
74.03
71.18
56.82
35.03
37.44
Adjusted Earnings Per Share
74.03
71.18
56.82
42.81
37.44
Cash Dividends Per Share
14.75
14.20
13.90
13.55
13.10
Cash Dividends Declared
11,700
11,221
11,151
10,982
10,478
Note 1 - On December 22, 2017, the Tax Cuts and Jobs Act was signed into law by the President. Among other things, this legislation reduced the corporate tax rate from 35% to 21% beginning January 1, 2018. Although the Company believes that this reduction in the corporate tax rate will continue to have a significant positive impact on future financial performance, U.S. generally accepted accounting principles require that all companies re-measure their DTA’s using the new lower tax rate as of the date of enactment of the legislation. As a result the Company’s net income for 2017 included a $6.3 million re-measurement reflected as a one-time, non-cash increase to income tax expense in the 4th quarter. Our situation is not unique in that the majority of all financial institutions reported significant DTA re-measurements in the 4th quarter of 2017. Excluding the impact of the $6.3 million DTA re-measurement, non-GAAP adjusted net income for the year totaled $34.6 million, an increase of $5.0 million or 16.8% over the prior year, which would have resulted in an adjusted return on average assets of 1.15% and adjusted return on average equity of 11.79%.
Management believes that the Company’s performance compared very favorably to its peer banks during the five-year period ended December 31, 2020:
• Net income over the five-year period totaled $218 million.
• Return on Average Assets averaged 1.31% over the five-year period.
• Total assets increased 74% from $2.6 billion at December 31, 2015 to $4.6 billion at December 31, 2020.
• Total loans & leases increased 55.3% from $2.0 billion at December 31, 2015 to $3.1 billion at December 31, 2020.
• Total deposits increased 78.3% from $2.3 billion at December 31, 2015 to $4.1 billion at December 31, 2020.
More recently:
• In 2020, the Company earned $58.7 million for a return on average assets of 1.43%.
• In 2020, the Company increased its cash dividend per share by 3.9% over 2019 levels, and our strong financial performance has allowed us to increase dividends every year during this five-year period.
• The Company’s total risk based capital ratio was 12.60% at December 31, 2020, and the Bank achieved the highest regulatory classification of “well capitalized” in each of the previous five years. See “Financial Condition - Capital.”
• The Company’s asset quality remains very strong at the present time, when measured by: (1) net charge-offs at 0.02% of average loans & leases during 2020; (2) non-accrual loans of $495,000 at December 31, 2020; and (3) substandard loans & leases totaling 0.60% of total loans & leases at December 31, 2020. See “Results of Operations - Provision and Allowance for Credit Losses” and “Financial Condition - Classified Loans & Leases and Non-Performing Assets.”
Because of our strong earnings performance, capital position, and asset quality, stockholders have benefited from the fact that cash dividends per share have increased 14.34% since 2015, and totaled $69.50 per share over the five-year period. The 2020 dividend of $14.75 per share represents a 1.94% yield based upon the December 31, 2020 closing stock price of $760 per share (See “Part II, Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities”).
Looking Forward: 2021 and Beyond
In management’s opinion, the following key issues will continue to influence the financial results of the Company in 2021 and future years:
• The continuing impact of COVID-19.
• The Company’s earnings are heavily dependent on its net interest margin, which is sensitive to such factors as: (1) market interest rates; (2) the mix of our earning assets and interest-bearing liabilities; and (3) competitor pricing strategies. Since early 2020 market interest rates have declined and remain at very low levels. This has adversely impacted the Company’s NIM, and will, in all probability, continue to place pressure on NIM in 2021.
• The Company’s results are impacted by changes in the credit quality of its borrowers. Substandard loans & leases totaled $18.6 million or 0.60% of total loans & leases at December 31, 2020 vs. $16.2 million or 0.61% of total loans & leases at December 31, 2019. Management believes, based on information currently available, that these levels are adequately covered by the Company’s $58.9 million allowance for credit losses as of December 31, 2020. See “Results of Operations - Provision and Allowance for Credit Losses” and “Financial Condition - Classified Loans & Leases and Non-Performing Assets.” The Company’s provision for credit losses was $4.5 million in 2020, compared to $200,000 in 2019 and $5.5 million in 2018. See “Item 1A. Risk Factors.”
• Since the passage of the Dodd-Frank Act in 2010, Congress has implemented broad changes to the regulation of consumer financial products and the financial services industry as a whole. These changes have, and will continue to have, a significant effect on the Company’s product offerings, pricing and profitability in areas such as debit and credit cards, home mortgages and deposit service charges.
• The Company has: (i) expanded its geographic footprint through de novo branch expansion in Walnut Creek, Napa, Lockeford and Concord, CA and through acquisition in Manteca, Riverbank, Rio Vista, and Walnut Grove, CA; and (ii) established equipment leasing as a new line of business. Although Management believes that these initiatives will result in increased asset growth and earnings, along with reduced concentration risks, the start-up costs related to staff and facilities are significant and will take time to recoup.
• The Company benefited significantly in 2018 and 2019, and should continue to benefit in future years, from the reduction of the federal corporate tax rate from 35% to 21% pursuant to the recently enacted Tax Cuts and Jobs Act. However, if the new Biden administration increases federal corporate tax rates it will negatively impact the Company’s future financial results.
Results of Operations
The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and its subsidiaries’ performance during each of the years in the three-year period ended December 31, 2020 and the material changes in financial condition, operating income, and expense of the Company and its subsidiaries as shown in the accompanying consolidated financial statements.
Impact of Bank of Rio Vista Acquisition on Results of Operations
On October 10, 2018, Farmers & Merchants Bancorp completed the acquisition of Bank of Rio Vista. Since the acquisition took place late in the year, and Bank of Rio Vista had only $217.5 million in assets (less than 6% of Farmers & Merchants Bancorp’s total assets), the impact on the Company’s 2018 Results of Operations was limited with the exception of legal fees, contract termination costs and systems conversion costs that were booked as non-interest expense by the Company in 2018. The gross amount of such expenses were $2.93 million.
Net Interest Income/Net Interest Margin
The tables on the following pages reflect the Company's average balance sheets and volume and rate analysis for the years ended 2020, 2019 and 2018. Average balance amounts for assets and liabilities are the computed average of daily balances.
Net interest income is the amount by which the interest and fees on loans & leases and other interest-earning assets exceed the interest paid on interest-bearing sources of funds. For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes. This adjustment is referred to as “tax equivalent” adjustment and is noted wherever applicable. The presentation of net interest income and net interest margin on a tax equivalent basis is a common practice within the banking industry.
The Volume and Rate Analysis of Net Interest Income summarizes the changes in interest income and interest expense based on changes in average asset and liability balances (volume) and changes in average rates (rate). For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to: (1) changes in volume (change in volume multiplied by initial rate); (2) changes in rate (change in rate multiplied by initial volume); and (3) changes in rate/volume, also called “changes in mix” (allocated in proportion to the respective volume and rate components).
The Company’s earning assets and interest bearing liabilities are subject to repricing at different times, which exposes the Company to income fluctuations when interest rates change. In order to minimize income fluctuations, the Company attempts to match asset and liability maturities. However, some maturity mismatch is inherent in the asset and liability mix. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk.”
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
Year Ended December 31, 2020
Assets
Balance
Interest
Rate
Interest Bearing Deposits with Banks
$
326,247
$
1,207
0.37
%
Investment Securities:
U.S. Treasuries
21,249
1.68
%
U.S. Govt SBA
9,450
1.23
%
Government Agency & Government-Sponsored Entities
-
-
-
Municipals - Taxable
12,582
4.08
%
Obligations of States and Political Subdivisions - Non-Taxable (1)
52,736
2,109
4.00
%
Mortgage Backed Securities
468,306
11,193
2.39
%
Other
19,323
1.10
%
Total Investment Securities
583,646
14,500
2.48
%
Loans & Leases: (2)
Real Estate
1,921,485
95,194
4.95
%
Home Equity Lines and Loans
37,952
1,828
4.82
%
Agricultural
259,132
13,049
5.04
%
Commercial
372,344
17,941
4.82
%
Consumer (3)
12,748
6.15
%
Other
228,530
8,837
3.87
%
Leases
106,293
5,750
5.41
%
Total Loans & Leases
2,938,484
143,383
4.88
%
Total Earning Assets
3,848,377
$
159,090
4.13
%
Unrealized Gain on Securities Available-for-Sale
16,289
Allowance for Credit Losses
(55,804
)
Cash and Due From Banks
62,089
All Other Assets
241,586
Total Assets
$
4,112,537
Liabilities & Shareholders' Equity
Interest Bearing Deposits:
Interest Bearing DDA
$
787,306
$
1,618
0.21
%
Savings and Money Market
1,128,623
2,724
0.24
%
Time Deposits
489,246
4,771
0.98
%
Total Interest Bearing Deposits
2,405,175
9,113
0.38
%
Federal Home Loan Bank Advances
-
0.00
%
Subordinated Debt
10,310
3.67
%
Total Interest Bearing Liabilities
2,415,486
$
9,491
0.39
%
Interest Rate Spread (4)
3.74
%
Demand Deposits (Non-Interest Bearing)
1,232,874
All Other Liabilities
61,848
Total Liabilities
3,710,208
Shareholders' Equity
402,329
Total Liabilities & Shareholders' Equity
$
4,112,537
Impact of Non-Interest Bearing Deposits and Other Liabilities
0.15
%
Net Interest Income and Margin on Total Earning Assets (5)
149,599
3.89
%
Tax Equivalent Adjustment
(438
)
Net Interest Income
$
149,161
3.88
%
(1) Yields and interest income are calculated on an fully taxable equivalent basis using the current statutory federal tax rate.
(2) Average balances on loans & leases outstanding include non-performing loans, if any. The amortized portion of net loan origination fees is included in interest income on loans & leases, representing an adjustment to the yield.
(3) Includes CARES Act Small Business Administration Paycheck Protection Program loans.
(4) Interest rate spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(5) Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets.
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
Year Ended December 31, 2019
Assets
Balance
Interest
Rate
Interest Bearing Deposits with Banks
$
232,623
$
4,909
2.11
%
Investment Securities:
U.S. Treasuries
27,096
1.98
%
U.S. Govt SBA
13,372
2.46
%
Government Agency & Government-Sponsored Entities
2,108
2.94
%
Municipals - Taxable
6,545
5.26
%
Obligations of States and Political Subdivisions - Non-Taxable
51,872
2,079
4.01
%
Mortgage Backed Securities
321,240
8,466
2.64
%
Other
4,850
3.57
%
Total Investment Securities
427,083
11,990
2.81
%
Loans & Leases:
Real Estate
1,736,406
93,227
5.37
%
Home Equity Lines and Loans
90,423
2,316
2.56
%
Agricultural
275,472
15,423
5.60
%
Commercial
364,676
19,335
5.30
%
Consumer
16,634
1,194
7.18
%
Other
1,051
2.28
%
Leases
104,896
5,718
5.45
%
Total Loans & Leases
2,589,558
137,237
5.30
%
Total Earning Assets
3,249,264
$
154,136
4.74
%
Unrealized Gain on Securities Available-for-Sale
Allowance for Credit Losses
(55,165
)
Cash and Due From Banks
56,855
All Other Assets
225,565
Total Assets
$
3,477,457
Liabilities & Shareholders' Equity
Interest Bearing Deposits:
Interest Bearing DDA
$
668,818
$
2,360
0.35
%
Savings and Money Market
930,390
3,340
0.36
%
Time Deposits
519,848
6,940
1.34
%
Total Interest Bearing Deposits
2,119,056
12,640
0.60
%
Federal Home Loan Bank Advances
-
0.00
%
Subordinated Debt
10,310
5.37
%
Total Interest Bearing Liabilities
2,129,367
$
13,194
0.62
%
Interest Rate Spread
4.12
%
Demand Deposits
949,695
All Other Liabilities
64,274
Total Liabilities
3,143,336
Shareholders' Equity
334,121
Total Liabilities & Shareholders' Equity
$
3,477,457
Impact of Non-Interest Bearing Deposits and Other Liabilities
0.21
%
Net Interest Income and Margin on Total Earning Assets
140,942
4.34
%
Tax Equivalent Adjustment
(428
)
Net Interest Income
$
140,514
4.32
%
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan interest income includes fee income and unearned discount in the amount of $5.8 million for the year ended December 31, 2019. Non-accrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost.
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
Year Ended December 31, 2018
Assets
Balance
Interest
Rate
Interest Bearing Deposits with Banks
$
147,700
$
2,755
1.87
%
Investment Securities:
U.S. Treasuries
64,630
1.45
%
U.S. Govt SBA
22,537
1.97
%
Government Agency & Government-Sponsored Entities
3,057
2.88
%
Municipals - Taxable
0.75
%
Obligations of States and Political Subdivisions - Non-Taxable
53,143
2,024
3.81
%
Mortgage Backed Securities
314,937
7,682
2.44
%
Other
3,707
2.64
%
Total Investment Securities
462,676
11,281
2.44
%
Loans & Leases
Real Estate
1,642,005
83,131
5.06
%
Home Equity Lines and Loans
37,086
2,041
5.50
%
Agricultural
273,178
14,067
5.15
%
Commercial
291,209
15,158
5.21
%
Consumer
9,014
5.58
%
Other
1,356
2.29
%
Leases
95,968
4,906
5.11
%
Total Loans & Leases
2,349,816
119,837
5.10
%
Total Earning Assets
2,960,192
$
133,873
4.52
%
Unrealized Loss on Securities Available-for-Sale
(8,151
)
Allowance for Credit Losses
(52,012
)
Cash and Due From Banks
49,292
All Other Assets
199,526
Total Assets
$
3,148,847
Liabilities & Shareholders' Equity
Interest Bearing Deposits
Interest Bearing DDA
$
618,674
$
1,683
0.27
%
Savings and Money Market
844,729
1,798
0.21
%
Time Deposits
476,756
3,944
0.83
%
Total Interest Bearing Deposits
1,940,159
7,425
0.38
%
Federal Home Loan Bank Advances
2.78
%
Subordinated Debt
10,310
5.08
%
Total Interest Bearing Liabilities
1,950,505
$
7,950
0.41
%
Interest Rate Spread
4.11
%
Demand Deposits
845,165
All Other Liabilities
45,516
Total Liabilities
2,841,186
Shareholders' Equity
307,661
Total Liabilities & Shareholders' Equity
$
3,148,847
Impact of Non-Interest Bearing Deposits and Other Liabilities
0.14
%
Net Interest Income and Margin on Total Earning Assets
125,923
4.25
%
Tax Equivalent Adjustment
(420
)
Net Interest Income
$
125,503
4.24
%
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan interest income includes fee income and unearned discount in the amount of $5.5 million for the year ended December 31, 2018. Non-accrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost.
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Income
(Rates on a Taxable Equivalent Basis)
(in thousands)
2020 versus 2019
Amount of Increase
(Decrease) Due to Change in:
Interest Earning Assets
Volume
Rate
Net Chg.
Interest Bearing Deposits with Banks
$
3,529
$
(7,230
)
$
(3,702
)
Investment Securities:
U.S. Treasuries
(105
)
(76
)
(181
)
U.S. Govt SBA
(78
)
(135
)
(213
)
Government Agency & Government-Sponsored Entities
(31
)
(31
)
(62
)
Municipals - Taxable
(54
)
Obligations of States and Political Subdivisions - Non-Taxable
(5
)
Mortgage Backed Securities
3,423
(696
)
2,727
Other
(13
)
Total Investment Securities
3,519
(1,010
)
2,509
Loans:
Real Estate
7,147
(5,180
)
1,967
Home Equity
(1,431
)
(488
)
Agricultural
(881
)
(1,493
)
(2,374
)
Commercial
(1,811
)
(1,394
)
Consumer (1)
(254
)
(156
)
(410
)
Other
8,785
8,813
Leases
(41
)
Total Loans
16,229
(10,083
)
6,146
Total Earning Assets
23,277
(18,324
)
4,953
Interest Bearing Liabilities
Interest Bearing Deposits:
Transaction
(1,290
)
(742
)
Savings
1,147
(1,762
)
(616
)
Time Deposits
(390
)
(1,779
)
(2,169
)
Total Interest Bearing Deposits
1,304
(4,831
)
(3,527
)
Other Borrowed Funds
-
-
-
Subordinated Debt
-
(176
)
(176
)
Total Interest Bearing Liabilities
1,304
(5,007
)
(3,703
)
Total Change
$
21,973
$
(13,317
)
$
8,656
(1) Includes CARES Act Small Business Administration Paycheck Protection Program loans.
Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total "net change." The above figures have been rounded to the nearest whole number.
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Income
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
2019 versus 2018
Amount of Increase
(Decrease) Due to Change in:
Interest Earning Assets
Volume
Rate
Net Chg.
Interest Bearing Deposits with Banks
$
1,753
$
$
2,154
Investment Securities:
U.S. Treasuries
(1,078
)
(402
)
U.S. Govt SBA
(294
)
(116
)
Government Agency & Government-Sponsored Entities
(28
)
(26
)
Municipals - Taxable
Obligations of States and Political Subdivisions - Non-Taxable
(66
)
Mortgage Backed Securities
Other
Total Investment Securities
(969
)
1,679
Loans & Leases:
Real Estate
4,920
5,176
10,096
Home Equity Lines and Loans
(163
)
Agricultural
1,237
1,356
Commercial
3,890
4,177
Consumer
Other
(7
)
-
(7
)
Leases
Total Loans & Leases
10,350
7,049
17,399
Total Earning Assets
11,134
9,129
20,263
Interest Bearing Liabilities
Interest Bearing Deposits:
Interest Bearing DDA
Savings and Money Market
1,344
1,542
Time Deposits
2,612
2,996
Total Interest Bearing Deposits
4,488
5,215
Other Borrowed Funds
(1
)
-
(1
)
Subordinated Debt
-
Total Interest Bearing Liabilities
4,518
5,244
Total Change
$
10,408
$
4,611
$
15,019
Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total "net change." The above figures have been rounded to the nearest whole number.
2020 Compared to 2019
Net interest income increased 6.15% to $149.2 million during 2020. On a fully tax equivalent (TE) basis, net interest income increased 6.14% and totaled $149.6 million during 2020 compared to $141.0 million for 2019. As more fully discussed below, the increase in net interest income was due primarily to a $599.1 million increase in average earning assets offset by a 45 basis point decrease in the net interest margin.
Net interest income on a tax equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin. For 2020, the Company’s net interest margin was 3.89% compared to 4.34% in 2019. This decrease in net interest margin was due primarily to a decrease of 0.61% in the yield received on earning assets, offset somewhat by a 0.23% decrease in the cost of interest bearing liabilities.
Average loans & leases totaled $2.9 billion for the year ended December 31, 2020; an increase of $349.0 million compared to the year ended December 31, 2019. A significant portion of this increase was due to loans funded under the SBA PPP. Since April 2020, we have funded $347.4 million of loans for 1,540 of our small business customers. (See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information). Loans & leases decreased from 79.7% of average earning assets during 2019 to 76.4% in 2020. The year-to-date yield on the loan & lease portfolio decreased to 4.88% for the year ended December 31, 2020, compared to 5.30% for the year ended December 31, 2019. Some of this decrease was due to $347.4 million of PPP loans funded at a rate of 1.00% (plus accreted loan fees) with the remaining decrease due to an overall drop in market interest rates. This lower yield was offset by the positive impact of increased average loan & lease balances resulting in interest revenue from loans & leases to increase by 4.48% to $143.4 million. The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to respond in order to retain key customers. This could place negative pressure on future loan & lease yields and net interest margin.
The investment portfolio is the other main component of the Company’s earning assets. Historically, the Company invested primarily in: (1) mortgage-backed securities issued by government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans & leases, the yield earned on investments is generally less than that of loans & leases.
Average investment securities increased $156.6 million in 2020 compared to the average balance during 2019. The average yield, on a tax equivalent basis, in the investment portfolio was 2.48% in 2020 compared to 2.81% in 2019. This overall decrease in yield was caused primarily by a decrease in market interest rates. As a result, of the combined impact of mix, balance and yield changes, tax equivalent interest income on securities increased $2.5 million to $14.5 million for the year ended December 31, 2020, compared to $12.0 million for the year ended December 31, 2019. See “Financial Condition - Investment Securities” for a discussion of the Company’s investment strategy in 2020. Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates, is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.
Interest-bearing deposits with banks and overnight investments in Federal Funds Sold are additional earning assets available to the Company. Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earn interest at the Fed Funds rate, which decreased to .10% in December 2020 compared to 1.55% in December 2019. Average interest-bearing deposits with banks for the year ended December 31, 2020, was $326.2 million, an increase of $93.6 million compared to the average balance for the year ended December 31, 2019. Interest income on interest-bearing deposits with banks for the year ended December 31, 2020, decreased $3.7 million to $1.2 million from the year ended December 31, 2019.
Average interest-bearing liabilities increased $286.1 million or 13.4% during the year ended December 31, 2020 compared to the average balance during 2019. Of that increase: (1) interest-bearing transaction deposits increased $118.5 million; (2) savings and money market deposits increased $198.2 million; and (3) time deposits decreased $30.6 million (see “Financial Condition - Deposits”); (4) FHLB advances remained unchanged (see “Financial Condition - Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings”); and (5) subordinated debt remained unchanged (see “Financial Condition - Subordinated Debentures”). A significant portion of this deposit growth was a result of funds from the SBA PPP being deposited into borrower accounts until those funds will be used for their operating expenses.
Total interest expense on deposits was $9.1 million for 2020 and $12.6 million for 2019. As a result of the overall drop in market interest rates during 2020, and the decrease in higher yielding CD’s as a percentage of total deposits, the average rate paid on interest-bearing deposits was 0.38% in 2020 as compared to 0.60% in 2019. See “Overview - Looking Forward: 2021 and Beyond” for a discussion of factors influencing the Company’s future deposit rates and their impact on net interest margin.
2019 Compared to 2018
Net interest income increased 12.0% to $140.5 million during 2019. On a fully tax equivalent basis, net interest income increased 12.0% and totaled $141.0 million during 2019 compared to $125.9 million for 2018. As more fully discussed below, the increase in net interest income was due primarily to a $289.1 million increase in average earning assets, and a 9 basis point increase in the net interest margin.
Net interest income on a tax equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin. For 2019, the Company’s net interest margin was 4.34% compared to 4.25% in 2018 This increase in net interest margin was due primarily to an increase of 0.22% in the yield received on earning assets, offset somewhat by a 0.21% increase in the rates paid on interest bearing liabilities.
Average loans & leases totaled $2.6 billion for the year ended December 31, 2019; an increase of $239.7 million compared to the year ended December 31, 2018. Loans & leases increased from 79.4% of average earning assets during 2018 to 79.7% in 2019. The year-to-date yield on the loan & lease portfolio increased to 5.30% for the year ended December 31, 2019, compared to 5.10% for the year ended December 31, 2018. This higher yield combined with the impact of increased average loan & lease balances resulted in interest revenue from loans & leases increasing 14.5% to $137.2 million for 2019. The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to respond in order to retain key customers. This could place negative pressure on future loan & lease yields and net interest margin.
The investment portfolio is the other main component of the Company’s earning assets. Historically, the Company invested primarily in: (1) mortgage-backed securities issued by government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times the Company selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans & leases, the yield earned on investments is generally less than that of loans & leases.
Average investment securities decreased $35.6 million in 2019 compared to the average balance during 2018. The average yield, on a tax equivalent basis, in the investment portfolio was 2.81% in 2019 compared to 2.44% in 2018. This overall increase in yield was caused primarily by an increase in the mix of mortgage-backed securities as a percentage of total securities and an increase in market interest rates. As a result of the combined impact of these mix, balance and yield changes, tax equivalent interest income on securities increased slightly by $710,000 to $12.0 million for the year ended December 31, 2019, compared to $11.3 million for the year ended December 31, 2018. See “Financial Condition - Investment Securities” for a discussion of the Company’s investment strategy in 2019. Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.
Interest-bearing deposits with banks and overnight investments in Federal Funds Sold are additional earning assets available to the Company. Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earn interest at the Fed Funds rate, which decreased to 1.55% in December 2019. Average interest-bearing deposits with banks for the year ended December 31, 2019, was $232.6 million, an increase of $84.9 million compared to the average balance for the year ended December 31, 2018. Interest income on interest-bearing deposits with banks for the year ended December 31, 2019, increased $2.2 million to $4.9 million from the year ended December 31, 2018.
Average interest-bearing liabilities increased $178.9 million or 9.2% during the year ended December 31, 2019 compared to the average balance during 2018. Of that increase: (1) interest-bearing transaction deposits increased $50.1 million; (2) savings and money market deposits increased $85.7 million; and (3) time deposits increased $43.1 million. See “Financial Condition - Deposits” for a discussion of trends in the Company’s deposit base. Total interest expense on deposits was $12.6 million for 2019 and $7.4 million for 2018. As a result of increasing short-term market interest rates and competition, the average rate paid on interest-bearing deposits was 0.60% in 2019 and 0.38% in 2018.
Provision and Allowance for Credit Losses
As a financial institution that assumes lending and credit risks as a principal element of its business, credit losses will be experienced in the normal course of business. The Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio. The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction), and by restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk. Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. Management reports regularly to the Board of Directors regarding trends and conditions in the loan & lease portfolio and regularly conducts credit reviews of individual loans & leases. Loans & leases that are performing but have shown some signs of weakness are subject to more stringent reporting and oversight.
Allowance for Credit Losses
The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company's loan & lease portfolio as of the balance sheet date. The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan & lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary components: specific reserves related to impaired loans & leases; general reserves for inherent losses related to loans & leases that are not impaired; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors.
A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Loans & leases determined to be impaired are individually evaluated for impairment. When a loan or lease is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s or lease's effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s or lease's observable market price, or the fair value of the collateral if the loan or lease is collateral dependent. A loan or lease is collateral dependent if the repayment of the loan or lease is expected to be provided solely by the underlying collateral.
A restructuring of a loan or lease constitutes a troubled debt restructuring (“TDR”) under ASC 310-40, if the Company for economic or legal reasons related to the borrower's financial difficulties grants a more than insignificant concession to the borrower that it would not otherwise consider. Restructured loans or leases typically present an elevated level of credit risk, as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans & leases that are on nonaccrual status at the time they become TDR, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.
The determination of the general reserve for loans or leases that are collectively evaluated for impairment is based on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company's service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.
The Company maintains a separate allowance for each portfolio segment (loan & lease type). These portfolio segments include: (1) commercial real estate; (2) agricultural real estate; (3) real estate construction (including land and development loans); (4) residential 1st mortgages; (5) home equity lines and loans; (6) agricultural; (7) commercial; (8) consumer & other; and (9) equipment leases. See “Financial Condition - Loans & Leases” for examples of loans & leases made by the Company. The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans & leases and loans & leases that are not impaired, is combined to determine the Company's overall allowance, which is included on the consolidated balance sheet.
The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability. For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans or leases, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans & leases. These credit quality indicators are used to assign a risk rating to each individual loan or lease. These risk ratings are also subject to examination by independent specialists engaged by the Company. The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management’s assessment of the following for each portfolio segment: (1) inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment. See “Note 1 Significant Accounting Policies - Allowance for Credit Losses.”
The risk ratings can be grouped into five major categories, defined as follows:
Pass and Watch - A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management's close attention. This category also includes “Watch” loans, which is a loan with an emerging weakness in either the individual credit or industry that requires additional attention. A credit may also be classified Watch if cash flows have not yet stabilized, such as in the case of a development project. Included in this category are all loans in which the Bank entered into a CARES Act modification.
Special Mention - A special mention loan or lease has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease position at some future date. Special mention loans & leases are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard - A substandard loan or lease is not adequately protected by the current financial condition and paying capacity of the borrower or the value of the collateral pledged, if any. Loans or leases classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Well-defined weaknesses include a project's lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project's failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful - Loans or leases classified doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, highly questionable or improbable.
Loss - Loans or leases classified as loss are considered uncollectible. Once a loan or lease becomes delinquent and repayment becomes questionable, the Company will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Bank will estimate its probable loss and immediately charge-off some or all of the balance.
The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management's assessment of the following for each portfolio segment: (1) inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment described below:
Commercial Real Estate - Commercial real estate mortgage loans are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans. Trends in vacancy rates of commercial properties impact the credit quality of these loans. High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flow to service debt obligations.
Real Estate Construction - Real estate construction loans, including land loans, are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. A major risk arises from the necessity to complete projects within specified cost and time lines. Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.
Commercial - These loans are generally considered to possess a moderate inherent risk of loss because they are shorter-term; typically made to relationship customers; generally underwritten to existing cash flows of operating businesses; and may be collateralized by fixed assets, inventory and/or accounts receivable. Debt coverage is provided by business cash flows and economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans.
Agricultural Real Estate and Agricultural - These loans are generally considered to possess a moderate inherent risk of loss since they are typically made to relationship customers and are secured by crop production, livestock and related real estate. These loans are vulnerable to two risk factors that are outside the control of Company and borrowers: commodity prices and weather conditions.
Leases - Equipment leases are generally considered to possess a moderate inherent risk of loss. As lessor, the Company is subject to both the credit risk of the borrower and the residual value risk of the equipment. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.
Residential 1st Mortgages and Home Equity Lines and Loans - These loans are generally considered to possess a low inherent risk of loss, although this is not always true as evidenced by the correction in residential real estate values that occurred between 2007 and 2012. The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower's ability to repay in an orderly fashion. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.
Consumer & Other - A consumer installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most installment loans are made for consumer purchases. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.
In addition, the Company's and Bank's regulators, including the FRB, DFPI and FDIC, as an integral part of their examination process, review the adequacy of the allowance. These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations.
Provision for Credit Losses
Changes in the provision for credit losses between years are the result of management’s evaluation, based upon information currently available, of the adequacy of the allowance for credit losses relative to factors such as the credit quality of the loan & lease portfolio, loan & lease growth, current credit losses, and the prevailing economic climate and its effect on borrowers’ ability to repay loans & leases in accordance with the terms of the notes.
The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought conditions in California. As a result, current reservoir levels are adequate and the availability of water in our primary service area should not be an issue. However, these recent weather patterns further reinforce the fact that the long-term risks associated with the availability of water are significant. See “Item 1A. Risk Factors” for additional information.
As discussed above in “COVID-19 (Coronavirus) Disclosure,” COVID-19 has had and continues to have a material impact on the U.S. and California economies. We are monitoring the impact on our borrowers, and working closely with them using all of the tools at our disposal, including the SBA PPP program, the FRB Main Street Lending Program and other loan restructuring strategies, to help them move through this period of reduced business activity. To account for growth in our loan portfolio and the economic uncertainty created by COVID-19, our provision for credit losses increased in 2020.
The provision for credit losses totaled $4.5 million in 2020 compared to $200,000 in 2019. Net charge offs during 2020 were $650,000 compared to net charge offs of $454,000 during 2019 and net charge offs of $609,000 in 2018. The allowance for credit losses as a percentage of total loans and leases declined in 2020 from 2.05% to 1.89%. This decline was due to the increase in government guaranteed SBA loans under the PPP. Excluding these loans, the allowance for credit losses as a percentage of total loans was 2.04% at December 31, 2020. See “Critical Accounting Policies and Estimates - Allowance for Credit Losses” and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk.”
After reviewing all factors above, management concluded that the allowance for credit losses, as of December 31, 2020, and December 30, 2019 were adequate.
The following table summarizes the activity and the allocation of the allowance for credit losses for the years indicated. (in thousands)
Allowance for Credit Losses Beginning of Year
$
55,012
$
55,266
$
50,342
$
47,919
$
41,523
Provision Charged to Expense
4,500
5,533
2,850
6,335
Charge-Offs:
Commercial Real Estate
-
-
-
-
Agricultural Real Estate
-
-
-
-
-
Real Estate Construction
-
-
-
-
-
Residential 1st Mortgages
-
-
Home Equity Lines and Loans
-
Agricultural
-
-
-
-
Commercial
1,101
-
-
Consumer & Other
Total Charge-Offs
1,174
Recoveries:
Commercial Real Estate
-
-
Agricultural Real Estate
-
-
-
Real Estate Construction
-
-
-
-
-
Residential 1st Mortgages
Home Equity Lines and Loans
Agricultural
-
-
-
Commercial
Consumer & Other
Total Recoveries
Net (Charge-Offs) Recoveries
(650
)
(454
)
(609
)
(427
)
Total Allowance for Credit Losses, End of Year
$
58,862
$
55,012
$
55,266
$
50,342
$
47,919
Ratios:
Allowance for Credit Losses to:
Total Loans & Leases at Year End
1.89
%
2.05
%
2.14
%
2.27
%
2.19
%
Average Loans & Leases
2.00
%
2.12
%
2.35
%
2.31
%
2.34
%
Consolidated Net (Charge-Offs) Recoveries to:
Total Loans & Leases at Year End
(0.02
%)
(0.02
%)
(0.02
%)
(0.02
%)
0.00
%
Average Loans & Leases
(0.02
%)
(0.02
%)
(0.03
%)
(0.02
%)
0.00
%
The table below breaks out year-to-date activity by portfolio segment (in thousands):
December 31, 2020
Commercial
Real Estate
Agricultural
Real Estate
Real Estate
Construction
Residential 1st
Mortgages
Home
Equity
Lines &
Loans
Agricultural
Commercial
Consumer &
Other
Leases
Unallocated
Total
Year-To-Date Allowance for Credit Losses:
Beginning Balance- January 1, 2020
$
11,053
$
15,128
$
1,949
$
$
2,675
$
8,076
$
11,466
$
$
3,162
$
$
55,012
Charge-Offs
-
-
-
-
(7
)
-
(1,101
)
(66
)
-
-
(1,174
)
Recoveries
-
-
-
-
-
Provision
16,626
(6,576
)
(306
)
(722
)
(3,262
)
(684
)
(90
)
(1,431
)
4,500
Ending Balance- December 31, 2019
$
27,679
$
8,633
$
1,643
$
$
2,024
$
4,814
$
9,961
$
$
1,731
$
1,084
$
58,862
Overall the Allowance for Credit Losses as of December 31, 2020 increased $3.9 million from December 31, 2019. Changes to the reserve during 2020 are due to changes in the underlying credit quality of the loan portfolio. Overall: (1) reserves for “Agricultural” and “Agricultural Real Estate” loans (which are currently thought to have more limited COVID-19 loss exposure since agricultural activity has substantially continued without significant issues) have been reduced significantly; (2) reserves for Commercial Real Estate (where our COVID-19 exposure is thought to be greater since many of these borrowers have been impacted by “non-essential” designations and “shelter-in-place” orders) have been increased significantly; and (3) the “Unallocated” reserve has been increased. See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure.
Allowance Allocation at December 31,
(in thousands)
2020 Amount
Percent of Loans in Each Category to Total Loans
2019 Amount
Percent of Loans in Each Category to Total Loans
2018 Amount
Percent of Loans in Each Category to Total Loans
2017 Amount
Percent of Loans in Each Category to Total Loans
2016 Amount
Percent of Loans in Each Category to Total Loans
Commercial Real Estate
$
27,679
31.2
%
$
11,053
31.6
%
$
11,609
32.4
%
$
10,922
31.1
%
$
11,110
30.4
%
Agricultural Real Estate
8,633
20.7
%
15,128
23.3
%
14,092
22.7
%
12,085
22.5
%
9,450
21.2
%
Real Estate Construction
1,643
6.0
%
1,949
4.3
%
1,249
3.8
%
1,846
4.5
%
3,223
7.6
%
Residential 1st Mortgages
9.6
%
9.5
%
10.1
%
11.7
%
10.3
%
Home Equity Lines and Loans
2,024
1.1
%
2,675
1.5
%
2,761
1.6
%
2,324
1.6
%
2,140
1.7
%
Agricultural
4,814
8.5
%
8,076
10.9
%
8,242
11.3
%
8,159
12.3
%
7,381
14.7
%
Commercial
9,961
12.0
%
11,466
14.4
%
11,656
13.3
%
9,197
12.0
%
8,515
10.5
%
Consumer & Other
7.6
%
0.6
%
0.8
%
0.3
%
0.3
%
Leases
1,731
3.3
%
3,162
3.9
%
4,022
4.0
%
3,363
4.0
%
3,586
3.3
%
Unallocated
1,084
-
-
-
1,422
-
1,449
-
Total
$
58,862
100.0
%
$
55,012
100.0
%
$
55,266
100.0
%
$
50,342
100.0
%
$
47,919
100.0
%
As of December 31, 2020, the allowance for credit losses was $58.9 million, which represented 1.89% of the total loan & lease balance (2.04% when government guaranteed SBA loans originated under the PPP beginning in April 2020 are excluded). At December 31, 2019, the allowance for credit losses was $55.0 million or 2.05% of the total loan & lease balance. The Company believes that the current allowance provides sufficiently for our exposure at the current time.
Non-Interest Income
Non-interest income includes: (1) service charges and fees from deposit accounts; (2) net gains and losses from investment securities; (3) increases in the cash surrender value of bank owned life insurance; (4) debit card and ATM fees; (5) net gains and losses on non-qualified deferred compensation plan; and (6) fees from other miscellaneous business services. See “Overview - Looking Forward: 2021 and Beyond.”
2020 Compared to 2019
Non-interest income totaled $15.7 million for 2020, a decrease of $1.5 million or 8.96% from non-interest income of $17.2 million for 2019.
Debit card and ATM fees totaled $5.5 million in 2020, an increase of 8.13% or $416,000 from $5.1 million in 2019. This was primarily due to increased numbers of cardholders and increased account activity.
Service charges on deposit accounts totaled $2.6 million in 2020, a decrease of 28.2% or $1.0 million from $3.7 million in 2019. This decrease was primarily due to the Bank complying with the Governor of California’s request that banks not charge overdraft and other fees during the early stages of the COVID-19 crisis.
Net gains on deferred compensation plan investments were $1.8 million in 2020 compared to net gains of $2.6 million in 2019. See Note 16, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.
Other non-interest income was $3.6 million, a decrease of $173,000 or 4.6% from 2019.
2019 Compared to 2018
Non-interest income totaled $17.2 million for 2019, an increase of $2.0 million or 13.3% from non-interest income of $15.2 million for 2018.
Net (loss) gain on investment securities was a net gain of $1,000 in 2019 compared to a net loss of $1.3 million for 2018. See “Financial Condition-Investment Securities” for a discussion of the Company’s investment strategy.
Debit card and ATM fees totaled $5.1 million in 2019, an increase of 17.3% or $755,000 from $4.4 million in 2018. This was primarily due to increased numbers of cardholders and increased account activity.
Net gains on deferred compensation plan investments were $2.6 million in 2019 compared to net gains of $1.1 million in 2018. See Note 16, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.
Other non-interest income was $3.8 million, a decrease of $1.9 million or 33.2% from 2018. This decrease was primarily due to a $2.0 million decrease related to non-recurring income received in 2018 from: (1) the purchase of Bank of Rio Vista; and (2) the gain on sale of fixed assets.
Non-Interest Expense
Non-interest expense for the Company includes expenses for: (1) salaries and employee benefits; (2) net gains and losses on non-qualified deferred compensation plan; (3) occupancy; (4) equipment; (5) supplies; (6) legal fees; (7) professional services; (8) data processing; (9) marketing; (10) deposit insurance; and (11) ORE carrying costs and gains/losses on sale; and (12) other miscellaneous expenses.
2020 Compared to 2019
Overall, non-interest expense totaled $82.4 million for 2020, an increase of $164,000 or .20% from the year ended December 31, 2019.
Salaries and employee benefits increased $1.7 million or 3.1% in 2020, primarily related to: (1) general salary increases; and (2) increased contributions to retirement and profit sharing plans.
Net gains on deferred compensation plan investments were $2.6 million in 2019 compared to net gains of $1.8 million in 2020. See Note 16, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.
Occupancy expense in 2020 totaled $4.6 million, an increase of $345,000 or 8.0% from 2019. This increase was primarily related to operating expenses associated with remodeling existing branch offices.
Marketing expenses decreased $332,000 from 2019 and totaled $922,000.
Legal expenses decreased $2.2 million from 2019 and totaled $128,000.
Other non-interest expense increased $1.5 million or 14.2%, to $12.5 million in 2020 compared to $10.9 million in 2019.
2019 Compared to 2018
Overall, non-interest expense totaled $82.2 million for 2019, an increase of $6.8 million or 9.0% from the year ended December 31, 2018.
Salaries and employee benefits increased $5.2 million or 10.3% in 2019, primarily related to: (1) new staff from the acquisition of the Bank of Rio Vista; (2) general salary increases; and (3) increased contributions to retirement and profit sharing plans.
Net gains on deferred compensation plan investments were $2.6 million in 2019 compared to net gains of $1.1 million in 2018. See Note 16, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no effect on the Company’s net income.
Occupancy expense in 2019 totaled $4.3 million, an increase of $390,000 or 10.0% from 2018 and equipment expense in 2019 totaled $4.9 million, an increase of $618,000 or 14.4% from 2018. Both of these increases were primarily related to operating expenses associated with remodeling existing branch offices and adding new branches.
Legal expenses increased $1.4 million from 2018 and totaled $2.3 million.
Other non-interest expense increased $862,000, or 8.6%, to $10.9 million in 2019 compared to $10.1 million in 2018.
The preceding increases in non-interest expense were offset somewhat by non-recurring expenses from the acquisition of Bank of Rio Vista that totaled $3.0 million in 2018.
Income Taxes
The provision for income taxes decreased $60,000 for the year ended December 31, 2020. The Company’s effective tax rate for 2020 was 24.65% compared to 25.6% for the year ended December 2019. The Company’s effective tax rate fluctuates from year to year due primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to benefits regarding the cash surrender value of life insurance; credits associated with low income housing tax credit investments (LIHTC); and tax-exempt interest income on municipal securities and loans.
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law changing the Company’s Federal corporate tax rate from 35% to 21%. The Company’s provision for income taxes decreased 45.61% to $14.0 million during 2018 compared to 2017 primarily as a result of: (1) the Federal corporate tax rate change and (2) the Company having amended and planning to amend tax returns in open tax years resulting in a reduction of $990,000 in the Company’s tax provision for 2018. See “Note 1. Significant Accounting Policies - Out of Period Adjustment.” The effective tax rate for 2018 was 23.8% compared to 47.9% during 2017.
Also due to the signing of the Tax Cuts and Jobs Act, during the 4th quarter of 2017, all companies were required to re-measure their deferred tax assets (DTA) and deferred tax liabilities (DTL) at the new corporate tax rate of 21%. This one-time re-measurement resulted in a $6.3 million increase to the Company’s income tax provision in 2017. This DTA re-measurement accompanied by an 8.7% increase in pre-tax earnings resulted in the tax provision increase in 2017.
With the exception of the one-time DTA re-measurement that took place in 2017, tax law causes the Company’s taxes payable to approximate or exceed the current provision for taxes on the income statement. Three provisions have had a significant effect on the Company’s current income tax liability: (1) the restrictions on the deductibility of credit losses; (2) deductibility of pension and other long-term employee benefits only when paid; and (3) the statutory deferral of deductibility of California franchise taxes on the Company’s federal return.
Financial Condition
Investment Securities and Federal Funds Sold
The investment portfolio provides the Company with an income alternative to loans & leases. The debt securities in the Company’s investment portfolio have historically been comprised primarily of: (1) mortgage-backed securities issued by federal government-sponsored entities; (2) debt securities issued by US Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times, the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity without subjecting the Company to the interest rate risk associated with mortgage-backed securities.
The Company’s investment portfolio at December 31, 2020 was $876.7 million compared to $567.6 million at December 31, 2019, an increase of $309.1 million or 54.5%. The Company uses its investment portfolio to help balance its overall interest rate risk. Accordingly, when market rates are increasing it invests most of its funds in shorter term Treasury and Agency securities or shorter term (10, 15 and 20 year) mortgage backed securities. Conversely, when rates are falling, 30 year mortgage backed securities or longer term Treasury and Agency securities may be increased.
The Company's total investment portfolio currently represents 19.3% of the Company’s total assets as compared to 15.3% at December 31, 2019.
As of December 31, 2020, the Company held $68.9 million of municipal investments, all classified as held-to-maturity (“HTM”). Of this balance $24.4 million were bank-qualified municipal bonds, and $44.5 million were private placement municipal bonds, warrants, and CRA qualified investments in our service area. In order to comply with Section 939A of the Dodd-Frank Act, the Company performs its own credit analysis on new purchases of municipal bonds. As of December 31, 2020, all of the Company’s bank-qualified municipal bond portfolio was rated at either the issue or issuer level, and all of these ratings were “investment grade.” The Company monitors the status of all municipal investments, and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security.
Not included in the investment portfolio are interest bearing deposits with banks and overnight investments in Federal Funds Sold. Interest bearing deposits with banks consisted primarily of FRB deposits. The FRB currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest. Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB. Interest bearing deposits with banks totaled $317.5 million at December 31, 2020 and $223.2 million at December 31, 2019.
The Company classifies its investments as held-to-maturity (“HTM”), trading, or available-for-sale (“AFS”). Securities are classified as held-to-maturity and are carried at amortized cost when the Company has the intent and ability to hold the securities to maturity. Trading securities are securities acquired for short-term appreciation and are carried at fair value, with unrealized gains and losses recorded in non-interest income. As of December 31, 2020 and December 31, 2019, there were no securities in the trading portfolio. Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income taxes.
Investment Portfolio
The following table summarizes the balances and distributions of the investment securities held on the dates indicated.
Available
for Sale
Held to
Maturity
Available
for Sale
Held to
Maturity
Available
for Sale
Held to
Maturity
December 31: (in thousands)
U.S. Treasury Notes
$
15,288
$
-
$
54,995
$
-
$
164,514
$
-
U.S. Government SBA
8,160
-
10,798
-
15,447
-
Government Agency & Government Sponsored Entities
-
-
-
-
3,039
-
Obligations of States and Political Subdivisions
-
68,933
-
60,229
-
53,566
Mortgage Backed Securities
737,873
-
441,078
-
307,045
-
Corporate Securities
45,919
-
-
-
-
-
Other
-
-
5,351
-
Total Book Value
$
807,732
$
68,933
$
507,386
$
60,229
$
495,396
$
53,566
Fair Value
$
807,732
$
70,049
$
507,386
$
61,097
$
495,396
$
53,738
Analysis of Investment Securities Available-for-Sale
The following table is a summary of the relative maturities and yields of the Company's investment securities Available-for-Sale as of December 31, 2020.
December 31, 2020 (in thousands)
Fair
Value
Average
Yield
U.S. Treasury
One year or less
$
5,020
2.19
%
After one year through five years
10,268
2.36
%
Total U.S. Treasury Securities
15,288
2.30
%
U.S. Government Agency SBA
After one year through five years
2.12
%
After five years through ten years
1.34
%
After ten years
7,339
1.28
%
Total U.S. Government Agency SBA Securities
8,160
1.31
%
Corporate Securities
After one year through five years
15,495
1.51
%
After five years through ten years
30,424
2.12
%
Total Corporate Securities
45,919
1.92
%
Other
One year or less
2.24
%
Total Other Securities
2.24
%
Mortgage Backed Securities
737,873
1.91
%
Total Investment Securities Available-for-Sale
$
807,732
1.91
%
Note: The average yield for floating rate securities is calculated using the current stated yield.
Analysis of Investment Securities Held-to-Maturity
The following table is a summary of the relative maturities and yields of the Company's investment securities Held-to-Maturity as of December 31, 2020. Non-taxable Obligations of States and Political Subdivisions have been calculated on a fully taxable equivalent basis.
December 31, 2020 (in thousands)
Book
Value
Average
Yield
Obligations of States and Political Subdivisions
One year or less
$
8,309
3.99
%
After one year through five years
5,137
3.55
%
After five years through ten years
23,493
3.49
%
After ten years
31,994
4.74
%
Total Obligations of States and Political Subdivisions
68,933
4.13
%
Total Investment Securities Held-to-Maturity
$
68,933
4.13
%
Loans & Leases
Loans & leases can be categorized by borrowing purpose and use of funds. Common examples of loans & leases made by the Company include:
Commercial and Agricultural Real Estate - These are loans secured by farmland, commercial real estate, multifamily residential properties, and other non-farm, non-residential properties generally within our market area. Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing, and the income will be the Bank's primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; generally do not exceed 15 years (and may have pricing adjustments on a shorter timeframe); have debt service coverage ratios of 1.00 or better with a target of greater than 1.25; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Real Estate Construction - These are loans for development and construction (the Company generally requires the borrower to fund the land acquisition) and are secured by commercial or residential real estate. These loans are generally made only to experienced local developers with whom the Bank has a successful track record; for projects in our service area; with Loan To Value (LTV) below 75%; and where the property can be developed and sold within 2 years. Commercial construction loans are made only when there is a written take-out commitment from the Bank or an acceptable financial institution or government agency. Most acquisition, development and construction loans are tied to the prime rate or LIBOR with an appropriate spread based on the amount of perceived risk in the loan.
Residential 1st Mortgages - These are loans primarily made on owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC; however, we will make loans on rural residential properties up to 40 acres. Most residential loans have terms from ten to twenty years and carry fixed rates priced off of treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income.”
Home Equity Lines and Loans - These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $250,000; Combined Loan To Value (CLTV) does not exceed 80%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1st lien position.
Agricultural - These are loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on livestock, crops, crop proceeds and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Commercial - These are loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations. Lines of credit are extended to finance the seasonal working capital needs of customers during peak business periods; are usually established for periods no longer than 12 to 24 months; are often secured by general filing liens on accounts receivable, inventory and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a plant or purchase of a business; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Consumer - These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit. The Company has a very minimal consumer loan portfolio, and loans are primarily made as an accommodation to deposit customers.
Leases - These are leases to businesses or individuals, for the purpose of financing the acquisition of equipment. They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases; or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains the tax benefits of ownership. Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.
The Company accounts for leases with Investment Tax Credits (ITC) under the deferred method as established in ASC 740-10. ITC are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement.
See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” for a discussion about the credit risks the Company assumes and its overall credit risk management practices.
Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan & lease structure. See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan & lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan & lease type. The Company’s policies require that loans & leases are approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting procedures for all loan & lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease.
Most loans & leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan is made.
In order to be responsive to borrower needs, the Company prices loans & leases: (1) on both a fixed rate and adjustable rate basis; (2) over different terms; and (3) based upon different rate indices; as long as these structures are consistent with the Company’s interest rate risk management policies and procedures. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Interest Rate Risk” for further details.
Overall, the Company's loan & lease portfolio at December 31, 2020 totaled $3.1 billion, an increase of $426.6 million or 16.0% over December 31, 2019. This increase occurred as a result of: (1) the Company’s business development efforts directed toward credit-qualified borrowers; and (2) expansion of our service area into the East Bay of San Francisco and Napa; and (3) the origination of $347.4 million of PPP loans, of which $224.3 million remain outstanding at December 31, 2020 (See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure). No assurances can be made that this growth in the loan & lease portfolio will continue, and it is anticipated that the remainder of the PPP loans will be forgiven by the SBA in early 2021. However, the Company does anticipate that it will participate in the 2021 PPP which may add some additional loans.
The following table sets forth the distribution of the loan & lease portfolio by type and percent as of December 31 of the years indicated.
(in thousands)
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Commercial Real Estate
$
971,326
31.2
%
$
846,486
31.6
%
$
834,476
32.4
%
$
691,639
31.1
%
$
674,445
30.9
%
Agricultural Real Estate
643,014
20.7
%
625,767
23.3
%
584,625
22.7
%
499,231
22.5
%
467,685
21.4
%
Real Estate Construction
185,741
6.0
%
115,644
4.3
%
98,568
3.8
%
100,206
4.5
%
176,462
8.1
%
Residential 1st Mortgages
299,379
9.6
%
255,253
9.5
%
259,736
10.1
%
260,751
11.7
%
242,247
11.1
%
Home Equity Lines and Loans
34,239
1.1
%
39,270
1.5
%
40,789
1.6
%
34,525
1.6
%
31,625
1.4
%
Agricultural
264,372
8.5
%
292,904
10.9
%
290,463
11.3
%
273,582
12.3
%
295,325
13.5
%
Commercial
374,816
12.0
%
384,795
14.4
%
343,834
13.3
%
265,703
12.0
%
217,577
10.0
%
Consumer & Other (1)
235,529
7.6
%
15,422
0.6
%
19,412
0.8
%
6,656
0.3
%
6,913
0.3
%
Leases
103,117
3.3
%
104,470
3.9
%
106,217
4.0
%
88,957
4.0
%
70,986
3.3
%
Total Gross Loans & Leases
3,111,533
100.0
%
2,680,011
100.0
%
2,578,120
100.0
%
2,221,250
100.0
%
2,183,265
100.0
%
Less: Unearned Income
11,941
6,984
6,879
5,955
5,664
Subtotal
3,099,592
2,673,027
2,571,241
2,215,295
2,177,601
Less: Allowance for Credit Losses
58,862
55,012
55,266
50,342
47,919
Net Loans & Leases
$
3,040,730
$
2,618,015
$
2,515,975
$
2,164,953
$
2,129,682
(1) Includes PPP loans. There were no concentrations of loans exceeding 10% of total loans which were not otherwise disclosed as a category of loans in the above table.
The following table shows the maturity distribution and interest rate sensitivity of the loan portfolio of the Company on December 31, 2020.
(in thousands)
One Year
or Less
Over One
Year to
Five
Years
Over
Five
Years
Total
Commercial Real Estate
$
42,313
$
275,256
$
641,411
$
958,980
Agricultural Real Estate
22,811
150,752
469,451
643,014
Real Estate Construction
94,364
87,484
3,893
185,741
Residential 1st Mortgages
1,180
4,229
293,970
299,379
Home Equity Lines and Loans
33,873
34,239
Agricultural
155,485
97,736
11,151
264,372
Commercial
120,994
199,704
54,118
374,816
Consumer & Other
230,443
4,387
235,529
Leases
8,517
50,720
44,285
103,522
Total
$
446,376
$
1,096,677
$
1,556,539
$
3,099,592
Rate Sensitivity:
Fixed Rate
$
66,042
$
593,253
$
1,027,705
$
1,687,000
Variable Rate
380,334
503,424
528,834
1,412,592
Total
$
446,376
$
1,096,677
$
1,556,539
$
3,099,592
Percent
14.40
%
35.38
%
50.22
%
100.00
%
Classified Loans & Leases and Non-Performing Assets
All loans & leases are assigned a credit risk grade using grading standards developed by bank regulatory agencies. See “Results of Operations - Provision and Allowance for Credit Losses” for more detail on risk grades. The Company utilizes the services of a third-party independent loan & lease review firm to perform evaluations of individual loans & leases and review the credit risk grades the Company places on loans & leases. Loans & leases that are judged to exhibit a higher risk profile are referred to as “classified” and these loans & leases receive increased management attention. As of December 31, 2020, classified loans & leases totaled $18.6 million compared to $16.2 million at December 31, 2019.
Classified loans & leases with higher levels of credit risk can be further designated as “impaired” loans & leases. A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. See “Results of Operations - Provision and Allowance for Credit Losses” for further details. Impaired loans & leases consist of: (1) non-accrual loans & leases; and/or (2) restructured loans & leases that are still performing (i.e., accruing interest).
Non-Accrual Loans & Leases - Accrual of interest on loans & leases is generally discontinued when a loan or lease becomes contractually past due by 90 days or more with respect to interest or principal. When loans & leases are 90 days past due, but in management's judgment are well secured and in the process of collection, they may not be classified as non-accrual. When a loan or lease is placed on non-accrual status, all interest previously accrued but not collected is reversed. Income on such loans & leases is then recognized only to the extent that cash is received and where the future collection of principal is probable. At December 31, 2020, non-accrual loans & leases totaled $495,000. There were no non-accrual loans & leases at December 2019.
Restructured Loans & Leases - A restructuring of a loan or lease constitutes a TDR under ASC 310-40, if the Company for economic or legal reasons related to the debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider, except when subject to the CARES Act and H.R. 133. Restructured loans or leases typically present an elevated level of credit risk, as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans & leases that are on nonaccrual status at the time they become TDR loans or leases, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.
At December 31, 2020, restructured loans totaled $7.9 million all of which were performing and at December 31, 2019, restructured loans totaled $12.1 million all of which were performing.
Other Real Estate - Loans where the collateral has been repossessed are classified as other real estate ("ORE") or, if the collateral is personal property, the loan is classified as other assets on the Company's financial statements.
Not included in the table below, but relevant to a discussion of asset quality are loans that were granted some form of relief because of COVID-19 and are not considered TDRs because of the CARES Act and H.R. 133. Since April 2020 we have restructured $277.6 million of loans under the CARES Act and H.R. 133 guidelines (see “Part I, Introduction - COVID-19 (Coronavirus) Disclosure”).
The following table sets forth the amount of the Company's non-performing loans & leases (defined as non-accrual loans & leases plus accruing loans & leases past due 90 days or more) and ORE as of December 31 of the years indicated.
December 31,
(in thousands)
Non-Accrual Loans & Leases
Commercial Real Estate
$
-
$
-
$
-
$
-
$
-
Agricultural Real Estate
-
-
-
1,304
Real Estate Construction
-
-
-
-
-
Residential 1st Mortgages
-
-
-
-
Home Equity Lines and Loans
-
-
-
-
-
Agricultural
-
-
-
-
Commercial
-
-
-
-
1,426
Consumer & Other
-
-
-
-
Total Non-Accrual Loans & Leases
-
-
-
3,074
Accruing Loans & Leases Past Due 90 Days or More
Commercial Real Estate
-
-
-
-
-
Agricultural Real Estate
-
-
-
-
-
Real Estate Construction
-
-
-
-
-
Residential 1st Mortgages
-
-
-
-
-
Home Equity Lines and Loans
-
-
-
-
-
Agricultural
-
-
-
-
-
Commercial
-
-
-
-
-
Consumer & Other
-
-
-
-
-
Total Accruing Loans & Leases Past Due 90 Days or More
-
-
-
-
-
Total Non-Performing Loans & Leases
$
$
-
$
-
$
-
$
3,074
Other Real Estate Owned
$
$
$
$
$
3,745
Total Non-Performing Assets
$
1,368
$
$
$
$
6,819
Restructured Loans & Leases (Performing)
$
7,868
$
12,105
$
13,577
$
6,301
$
4,462
Non-Performing Loans & Leases as a Percent of Total Loans & Leases
0.02
%
0.00
%
0.00
%
0.00
%
0.14
%
Although management believes that non-performing loans & leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. See Note 6, located in “Item 8. Financial Statements and Supplementary Data” for an allocation of the allowance classified to impaired loans & leases.
The Company reported $873,000 of ORE at December 31, 2020, and at December 31, 2019. ORE at December 31, 2020 consisted of commercial land.
Except for: (i) those classified and non-performing loans & leases discussed above; and (ii) those loans modified under the COVID-19 guidelines of the CARES Act and H.R. 133, the Company’s management is not aware of any loans & leases as of December 31, 2020, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date. However:
• The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought conditions in California. As a result, current reservoir levels are adequate and the availability of water in our primary service area should not be an issue. However, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.
• The agricultural industry is facing challenges associated with: (1) downward pressures on commodity prices (somewhat offset by higher yields); and (2) tight labor markets and higher wages due to legislative changes at the state and federal levels.
• In an attempt to slow the accelerating spread of COVID-19, on March 16, 2020 the first cities and counties in Northern California were placed under “shelter-in-place” orders. By March 19th, the Governor had placed the entire state under these orders. Since that time most California counties have been in various levels of lockdown, including those in which the Company operates. The Governor has developed guidance as to when a given county can re-open certain business and other activities, but all counties in which the Company operates remain under some level of restriction. Businesses have been designated as “essential” or “non-essential.” Non-essential businesses have either been closed or had the scope of their activities significantly reduced. Unemployment has increased. The economic impact of this situation has already been severe, and continuing restrictions will only exacerbate the situation. The duration of these restrictions is not known at this time nor is the pace of recovery once they are lifted, therefore, the Company cannot determine the ultimate impact on classified and non-performing loans and leases (see “Part I, Introduction - COVID-19 (Coronavirus) Disclosure”).
Deposits
One of the key sources of funds to support earning assets is the generation of deposits from the Company’s customer base. The ability to grow the customer base and subsequently deposits is a significant element in the performance of the Company.
The following table sets forth, by time remaining to maturity, the Company’s time deposits in amounts of $250,000 or more at December 31, 2020.
(in thousands)
Time Deposits of $250,000 or More
Three Months or Less
$
63,183
Over Three Months Through Six Months
50,761
Over Six Months Through Twelve Months
51,854
Over Twelve Months
20,146
Total Time Deposits of $250,000 or More
$
185,944
Refer to the Year-To-Date Average Balances and Rate Schedules located in this "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for information on separate deposit categories.
At December 31, 2020, deposits totaled $4.06 billion. This represents an increase of 23.9% or $782.2 million from December 31, 2019. In addition to the Company’s ongoing business development activities for deposits, the following factors positively impacted year-over-year deposit growth: (1) the Company’s strong financial results and position and F&M Bank’s reputation as one of the most safe and sound banks in its market area; and (2) the Company’s expansion of its service area into Walnut Creek, Concord and Napa; and (3) borrowers under the PPP depositing loan proceeds into their deposit accounts until those funds are used for operating expenses.
Although total deposits have increased 23.9% since December 31, 2019, importantly, low cost transaction accounts have grown at a strong pace as well as:
• Demand and interest-bearing transaction accounts increased $612.8 million or 34.7% since December 31, 2019.
• Savings and money market accounts have increased $265.5 million or 26.7% since December 31, 2019.
• Time deposit accounts have decreased $96.1 million or 18.6% since December 31, 2019.
Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings
Lines of Credit with the Federal Reserve Bank and Federal Home Loan Bank are other key sources of funds to support earning assets. These sources of funds are also used to manage the Company’s interest rate risk exposure; and, as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB advances at December 31, 2020 or 2019. There were no Federal Funds purchased or advances from the FRB at December 31, 2020 or 2019.
Long-Term Subordinated Debentures
On December 17, 2003, the Company raised $10.0 million through the sale of subordinated debentures to an off-balance sheet trust and its sale of trust-preferred securities. See Note 13, located in “Item 8. Financial Statements and Supplementary Data.” Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our TPS will continue to qualify as regulatory capital. These securities accrue interest at a variable rate based upon 3-month London InterBank Offered Rate (“LIBOR”) plus 2.85%. Interest rates reset quarterly (the next reset is March 17, 2021) and the rate was 3.08% as of December 31, 2020. The average rate paid for these securities was 3.66% in 2020 and 5.37% in 2019. Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock.
Capital
The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders’ Equity totaled $423.7 million at December 31, 2020, and $369.3 million at the end of 2019.
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a material effect on the Company and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The minimum capital level requirements applicable to the Company and the Bank are: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets (“RWA”); (ii) a Tier 1 capital ratio of 6% of RWA; (iii) a total capital ratio of 8% of RWA; and (iv) a Tier 1 leverage ratio of 4% of total assets. A "capital conservation buffer" of 2.5% above each of the regulatory minimum capital ratios, which would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0% of RWA; (ii) a Tier 1 capital ratio of 8.5% of RWA; and (iii) a total capital ratio of 10.5% of RWA. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. The Company’s subordinated debentures issued in 2003 continue to be counted as Tier 1 capital.
As previously discussed, in order to supplement its regulatory capital base, during December 2003, the Company issued $10.0 million of trust preferred securities. In accordance with the provisions of the “Consolidation” topic of the FASB Accounting Standards Codification (“ASC”), the Company does not consolidate the subsidiary trust, which has issued the trust-preferred securities.
In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since then, and most recently, on November 6, 2018, the Board of Directors approved an extension of the $20 million stock repurchase program over the three-year period ending December 31, 2021. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”
There were no stock repurchases in 2020 or 2019 under the Common Stock Repurchase Plan. The remaining dollar value of shares that may yet be purchased under the Company’s Common Stock Repurchase Plan is approximately $20 million.
On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights Agent. The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan. Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for further explanation.
On November 23, 2020, the Board of Directors of Farmers & Merchants Bancorp approved, and all applicable regulators provided statements of non-objection regarding, the Company’s repurchase and retirement of up to $8.5 million of its outstanding common stock during the fourth quarter of 2020 and the first half of 2021. These repurchases will be done outside of the Company’s current repurchase plan. All repurchases have been and will continue to be made at the then prevailing market prices. In the fourth quarter of 2020 the Company repurchased $2.8 million of shares from shareholders.
During the first quarter of 2020, the Company issued a combined total 523 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at a price of $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. See Note 14, located in “Item 8. Financial Statements and Supplementary Data.”
During 2019, the Company issued a combined total 9,312 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at prices ranging from $715.00 to $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. See Note 14, located in “Item 8. Financial Statements and Supplementary Data.”
During 2018, the Company issued a combined total 13,520 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. There were also 2,400 shares issued to individuals during 2018. All of the shares were issued at prices ranging from $635.00 to $690.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital.
Critical Accounting Policies and Estimates
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the Company’s financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. Management believes that the most significant subjective judgments that it makes include the following:
Allowance for Credit Losses - As a financial institution, which assumes lending and credit risks as a principal element in its business, the Company anticipates that credit losses will be experienced in the normal course of business. Accordingly, the allowance for credit losses is maintained at a level considered adequate by management to provide for losses that are inherent in the portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Management employs a systematic methodology for determining the allowance for credit losses. On a quarterly basis, management reviews the credit quality of the loan & lease portfolio and considers problem loans & leases, delinquencies, internal credit reviews, current economic conditions, loan & lease loss experience, and other factors in determining the adequacy of the allowance balance.
While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates. The estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. For additional information, see Note 6, located in “Item 8. Financial Statements and Supplementary Data.”
Fair Value Measurements - The Company discloses the fair value of financial instruments and the methods and significant assumptions used to estimate those fair values. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization. For additional information, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Credit Risk” and Notes 17 and 18 located in “Item 8. Financial Statements and Supplementary Data.”
Income Taxes - The Company uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year. For additional information, see Note 1, located in “Item 8. Financial Statements and Supplementary Data.”
Off-Balance-Sheet Arrangements
Off-balance-sheet arrangements are any contractual arrangement to which an unconsolidated entity is a party, under which the Company has: (1) any obligation under a guarantee contract; (2) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to that entity for such assets; (3) any obligation under certain derivative instruments; or (4) any obligation under a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services with the Company. The Company had the following off balance sheet commitments as of the dates indicated.
(in thousands)
December 31,
December 31,
Commitments to Extend Credit
$
1,040,844
$
919,982
Letters of Credit
18,846
20,346
Performance Guarantees Under Interest Rate Swap Contracts Entered Into Between Our Borrowing Customers and Third Parties
2,786
1,513
The Company's exposure to credit loss in the event of nonperformance by the other party with regard to standby letters of credit, undisbursed loan commitments, and financial guarantees is represented by the contractual notional amount of those instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded balance sheet items. The Company may or may not require collateral or other security to support financial instruments with credit risk. Evaluations of each customer's creditworthiness are performed on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third party. Most standby letters of credit are issued for 12 months or less. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Additionally, the Company maintains a reserve for off balance sheet commitments, which totaled $315,000 at December 31, 20120 and 2019. We do not anticipate any material losses as a result of these transactions.
Aggregate Contractual Obligations and Commitments
The following table presents, as of December 31, 2020, our significant and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts, or other similar carrying value adjustments. For further information on the nature of each obligation type, see applicable note disclosures located in “Item 8. Financial Statements and Supplementary Data.”
(in thousands)
Total
1 Year or Less
2-3 Years
4-5 Years
More Than 5 Years
Long-Term Subordinated Debentures
10,310
-
-
-
10,310
Deferred Compensation (1)
68,077
1,315
2,118
1,058
63,586
Total
$
78,387
$
1,315
$
2,118
$
1,058
$
73,896
(1) These amounts represent obligations to participants under the Company's various non-qualified deferred compensation plans. All amounts have been fully funded in to a Rabbi Trust as of December 31, 2020. See Note 16 located in “Item 8. Financial Statements and Supplementary Data.”

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Risk Management
The Company has adopted risk management policies and procedures, which aim to ensure the proper control and management of all risk factors inherent in the operation of the Company, most importantly credit risk, interest rate risk and liquidity risk. These risk factors are not mutually exclusive. It is recognized that any product or service offered by the Company may expose the Company to one or more of these risk factors.
Credit Risk
Credit risk is the risk to earnings or capital arising from an obligor’s failure to meet the terms of any contract or otherwise fail to perform as agreed. Credit risk is found in all activities where success depends on counterparty, issuer, or borrower performance.
Credit risk in the investment portfolio and correspondent bank accounts is addressed through defined limits in the Company’s policy statements. In addition, certain securities carry insurance to enhance credit quality of the bond.
In order to control credit risk in the loan & lease portfolio the Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio. The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower, and by restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk. Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. However, as a financial institution that assumes credit risks as a principal element of its business, credit losses will be experienced in the normal course of business. The allowance for credit losses is maintained at a level considered by management to be adequate to provide for risks inherent in the loan & lease portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs.
The Company’s methodology for assessing the appropriateness of the allowance is applied on a regular basis and considers all loans & leases. The systematic methodology consists of three parts.
Part 1 - includes a detailed analysis of the loan & lease portfolio in two phases. The first phase is conducted in accordance with the “Receivables” topic of the FASB ASC. Individual loans & leases are reviewed to identify them for impairment. A loan or lease is impaired when principal and interest are deemed uncollectible in accordance with the original contractual terms of the loan or lease. Impairment is measured as either the expected future cash flows discounted at each loan’s or lease’s effective interest rate, the fair value of the loan’s or lease’s collateral if the loan or lease is collateral dependent, or an observable market price of the loan or lease, if one exists. Upon measuring the impairment, the Company will ensure an appropriate level of allowance is present or established.
Central to the first phase of the analysis of the loan & lease portfolio is the risk rating system. The originating credit officer assigns each borrower an initial risk rating, which is based primarily on a thorough analysis of that borrower’s financial position in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior credit administration personnel. Credits are monitored by credit administration personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary. Risk ratings are reviewed by both the Company’s independent third-party credit examiners and bank examiners from the DFPI and FDIC.
Based on the risk rating system, specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicates that the loan or lease is impaired and there is a probability of loss. Management performs a detailed analysis of these loans & leases, including, but not limited to, cash flows, appraisals of the collateral, conditions of the marketplace for liquidating the collateral, and assessment of the guarantors. Management then determines the inherent loss potential and allocates a portion of the allowance for losses as a specific allowance for each of these credits.
The second phase is conducted by segmenting the loan & lease portfolio by risk rating and into groups of loans & leases with similar characteristics in accordance with the “Contingency” topic of the FASB ASC. In this second phase, groups of loans & leases with similar characteristics are reviewed and the appropriate allowance factor is applied based on the historical average charge-off rate for each particular group of loans or leases.
Part 2 - considers qualitative internal and external factors that may affect a loan or lease’s collectability, is based upon management’s evaluation of various conditions, the effects of which are not directly measured in the determination of the historical and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the second element of the analysis of the allowance include, but are not limited to the following conditions that existed as of the balance sheet date:
• general economic and business conditions affecting the key service areas of the Company;
• credit quality trends (including trends in collateral values, delinquencies and non-performing loans & leases);
• loan & lease volumes, growth rates and concentrations;
• loan & lease portfolio seasoning;
• specific industry and crop conditions;
• recent loss experience; and
• duration of the current business cycle.
Part 3 - An unallocated allowance generally occurs due to the imprecision in estimating and allocating allowance balances associated with macro factors such as: (1) economic conditions in the Central Valley; and (2) the long-term risks associated with the availability of water in the Central Valley.
Management reviews all of these conditions in discussion with the Company’s senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable impaired credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable impaired credit or portfolio segment as of the evaluation date, management’s evaluation of the inherent loss related to such condition is reflected in the second element of the allowance or in the unallocated allowance.
Management believes, that based upon the preceding methodology, and using information currently available, the allowance for credit losses at December 31, 2020 was adequate. No assurances can be given that future events may not result in increases in delinquencies, non-performing loans & leases, or net loan & lease charge-offs that would require increases in the provision for credit losses and thereby adversely affect the results of operations.
Interest Rate Risk
The mismatch between maturities of interest sensitive assets and liabilities results in uncertainty in the Company’s earnings and economic value and is referred to as interest rate risk. The Company does not attempt to predict interest rates and positions the balance sheet in a manner, which seeks to minimize, to the extent possible, the effects of changing interest rates.
The Company measures interest rate risk in terms of potential impact on both its economic value and earnings. The methods for governing the amount of interest rate risk include: (1) analysis of asset and liability mismatches (Gap analysis); (2) the utilization of a simulation model; and (3) limits on maturities of investment, loan & lease, and deposit products, which reduces the market volatility of those instruments.
The Gap analysis measures, at specific time intervals, the divergence between earning assets and interest bearing liabilities for which repricing opportunities will occur. A positive difference, or Gap, indicates that earning assets will reprice faster than interest-bearing liabilities. This will generally produce a greater net interest margin during periods of rising interest rates and a lower net interest margin during periods of declining interest rates. Conversely, a negative Gap will generally produce a lower net interest margin during periods of rising interest rates and a greater net interest margin during periods of decreasing interest rates.
The interest rates paid on deposit accounts do not always move in unison with the rates charged on loans & leases. In addition, the magnitude of changes in the rates charged on loans & leases is not always proportionate to the magnitude of changes in the rate paid for deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solely as a result of the differences between repricing opportunities of earning assets or interest bearing liabilities.
The Company also utilizes the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The sensitivity of the Company’s net interest income is measured over a rolling one-year horizon.
The simulation model estimates the impact of changing interest rates on interest income from all interest earning assets and the interest expense paid on all interest bearing liabilities reflected on the Company’s balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given a 200 basis point upward and a 100 basis point downward shift in interest rates. A shift in rates over a 12-month period is assumed. Results that exceed policy limits, if any, are analyzed for risk tolerance and reported to the Board with appropriate recommendations. At December 31, 2020, the Company’s estimated net interest income sensitivity to changes in interest rates, as a percent of net interest income was a slight decrease in net interest income of .03% if rates increase by 200 basis points and a decrease in net interest income of 0.2% if rates decline 100 basis points.
The estimated sensitivity does not necessarily represent a Company forecast and the results may not be indicative of actual changes to the Company’s net interest income. These estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape; prepayments on loans & leases and securities; pricing strategies on loans & leases and deposits; replacement of asset and liability cash flows; and other assumptions. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change.
Liquidity Risk
Liquidity risk is the risk to earnings or capital resulting from the Company’s inability to meet its obligations when they come due without incurring unacceptable losses. It includes the ability to manage unplanned decreases or changes in funding sources and to recognize or address changes in market conditions that affect the Company’s ability to liquidate assets or acquire funds quickly and with minimum loss of value. The Company endeavors to maintain a cash flow adequate to fund operations, handle fluctuations in deposit levels, respond to the credit needs of borrowers, and to take advantage of investment opportunities as they arise.
The Company’s principal operating sources of liquidity include (see “Item 8. Financial Statements and Supplementary Data - Consolidated Statements of Cash Flows”) cash and cash equivalents, cash provided by operating activities, principal payments on loans & leases, proceeds from the maturity or sale of investments, and growth in deposits. To supplement these operating sources of funds the Company maintains Federal Funds credit lines of $118 million and repurchase lines of $112 million with major banks. As of December 31, 2020, the Company has additional borrowing capacity of $630.5 million with the Federal Home Loan Bank and $438 million with the Federal Reserve Bank. Borrowings under these lines are collateralized with loans or securities that have been accepted for pledging at the FHLB and FRB.
At December 31, 2020, the Company had available sources of liquidity, which included cash and cash equivalents and unpledged investment securities available-for-sale of approximately $583.4 million, which represents 13% of total assets.

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Consolidated Balance Sheets - December 31, 2020, and 2019
Consolidated Statements of Income - Years ended December 31, 2020, 2019 and 2018
Consolidated Statements of Comprehensive Income - Years Ended December 31, 2020, 2019 and 2018
Consolidated Statements of Changes in Shareholders' Equity - Years ended December 31, 2020, 2019 and 2018
Consolidated Statements of Cash Flows - Years Ended December 31, 2020, 2019 and 2018
Notes to the Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of
Farmers & Merchants Bancorp
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Farmers & Merchants Bancorp and subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020 and 2019, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, 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 of Management on Internal Control over Financial Reporting included in Item 9A. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting 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 audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s 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 company’s 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 Company’s assets that could have a material effect on the consolidated 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.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses
As described in Notes 1 and 6 to the consolidated financial statements, the Company’s consolidated allowance for credit losses balance was $58.8 million at December 31, 2020. The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company’s loan & lease portfolio as of the balance sheet date. The overall allowance consists of three primary components: specific reserves related to impaired loans & leases; general reserves for inherent losses related to loans & leases that are not impaired; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors. The determination of the general reserve for loans & leases that are collectively evaluated for impairment is based on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company's service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.
We identified management’s risk ratings of loans and the estimation of qualitative factors, both of which are used in the allowance for credit losses calculation, as a critical audit matter. The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability. For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans & leases. The qualitative factors are used to estimate losses related to factors that are not captured in the historical loss rates such as economic trends in the Company's service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, and the character of the loan & lease portfolio, and are based on management’s evaluation of available internal and external data and involves significant management judgement. Auditing management’s judgments regarding the determination of risk ratings and qualitative factors applied to the allowance for credit losses involved a high degree of subjectivity.
The primary procedures we performed to address this critical audit matter included:
• Testing the design, implementation, and operating effectiveness of controls relating to management’s calculation of the allowance for credit losses, including controls over the accuracy of risk ratings of loans and the determination of the qualitative factors used.
• Testing a risk-based targeted selection of loans to gain substantive evidence that the Company is appropriately rating these loans in accordance with its policies, and that the risk ratings for the loans are reasonable.
• Performing a loan grade analysis by loan type to determine whether any large fluctuations occurred that could not be reasonably explained.
• Obtaining management’s analysis and supporting documentation related to the qualitative factors, and testing whether the qualitative factors used in the calculation of the allowance for credit losses are supported by the analysis provided by management and are used in a manner consistent with management’s established policies and procedures.
• Performing an independent sensitivity analysis to evaluate the reasonableness of the qualitative factors used by management to account for inherent losses that are not captured in the calculation of the allowance for credit losses based on historical loss rates alone.
/s/ Moss Adams LLP
San Francisco, California
March 15, 2021
We have served as the Company’s auditor since 2013.
Farmers & Merchants Bancorp
Consolidated Balance Sheets
(in thousands except share and per share data)
December 31,
Assets
Cash and Cash Equivalents:
Cash and Due from Banks
$
66,327
$
71,564
Interest Bearing Deposits with Banks
317,510
223,194
Total Cash and Cash Equivalents
383,837
294,758
Investment Securities:
Available-for-Sale, amortized cost $789,175, and $502,693, respectively
807,732
507,386
Held-to-Maturity, fair value $70,049 and $61,097, respectively
68,933
60,229
Total Investment Securities
876,665
567,615
Loans & Leases:
3,099,592
2,673,027
Less: Allowance for Credit Losses
58,862
55,012
Loans& Leases, Net
3,040,730
2,618,015
Premises and Equipment, Net
50,147
45,271
Bank Owned Life Insurance, Net
69,235
67,148
Interest Receivable and Other Assets
129,839
129,023
Total Assets
$
4,550,453
$
3,721,830
Liabilities
Deposits:
Demand
$
1,475,425
$
1,067,187
Interest-Bearing Transaction
902,487
697,952
Savings and Money Market
1,260,487
994,958
Time
421,868
517,922
Total Deposits
4,060,267
3,278,019
Subordinated Debentures
10,310
10,310
Interest Payable and Other Liabilities
56,211
64,205
Total Liabilities
4,126,788
3,352,534
Commitments & Contingencies (See Note 19)
Shareholders’ Equity
Preferred Stock: No Par Value, 1,000,000 Shares Authorized, None Issued or Outstanding
-
-
Common Stock: Par Value $0.01, 7,500,000 Shares Authorized, 789,646 and 793,033
Shares Issued and Outstanding at December 31, 2020 and 2019, respectively.
Additional Paid-In Capital
77,516
79,947
Retained Earnings
333,070
286,036
Accumulated Other Comprehensive Income, Net of Taxes
13,071
3,305
Total Shareholders’ Equity
423,665
369,296
Total Liabilities and Shareholders’ Equity
$
4,550,453
$
3,721,830
The accompanying notes are an integral part of these consolidated financial statements
Farmers & Merchants Bancorp
Consolidated Statements of Income
(in thousands except per share data)
Year Ended December 31,
Interest Income
Interest and Fees on Loans & Leases
$
143,383
$
137,237
$
119,837
Interest on Deposits with Banks
1,207
4,909
2,755
Interest on Investment Securities:
Taxable
12,391
9,911
9,257
Exempt from Federal Tax
1,671
1,651
1,604
Total Interest Income
158,652
153,708
133,453
Interest Expense
Deposits
9,113
12,640
7,425
Borrowed Funds
-
-
Subordinated Debentures
Total Interest Expense
9,491
13,194
7,950
Net Interest Income
149,161
140,514
125,503
Provision for Credit Losses
4,500
5,533
Net Interest Income After Provision for Credit Losses
144,661
140,314
119,970
Non-Interest Income
Service Charges on Deposit Accounts
2,637
3,673
3,479
Net Gain (Loss) on Sales Investment Securities
(1,260
)
Increase in Cash Surrender Value of Bank Owned Life Insurance
2,088
2,031
1,900
Debit Card and ATM Fees
5,536
5,120
4,365
Net Gain on Deferred Compensation Investments
1,777
2,625
1,088
Other
3,618
3,791
5,647
Total Non-Interest Income
15,696
17,241
15,219
Non-Interest Expense
Salaries and Employee Benefits
56,950
55,250
50,054
Net Gain on Deferred Compensation Plan Investments
1,777
2,625
1,088
Occupancy
4,640
4,295
3,905
Equipment
4,994
4,921
4,303
Marketing
1,254
1,232
Legal
2,347
FDIC Insurance
Acquisition Expenses
-
-
2,933
Other
12,478
10,926
10,064
Total Non-Interest Expense
82,406
82,242
75,459
Income Before Provision for Income Taxes
77,951
75,313
59,730
Provision for Income Taxes
19,217
19,277
14,203
Net Income
$
58,734
$
56,036
$
45,527
Basic and Diluted Earnings Per Common Share
$
74.03
$
71.18
$
56.82
The accompanying notes are an integral part of these consolidated financial statements
FARMERS & MERCHANTS BANCORP
Consolidated Statements of Comprehensive Income
(in thousands)
Year Ended December 31,
Net Income
$
58,734
$
56,036
$
45,527
Other Comprehensive Loss
Net Unrealized Gain (Loss) on Available-for-Sale Securities
13,905
8,936
(4,343
)
Deferred Tax (Benefit) Expense Related to Unrealized (Gain) Losses
(4,099
)
(2,642
)
1,284
Reclassification Adjustment for Realized (Gain) Loss on Sales of Available-for-Sale Securities Included in Net Income
(40
)
(1
)
1,260
Deferred Tax Related to Reclassification Adjustment
-
-
(372
)
Total Other Comprehensive Income (Loss)
9,766
6,293
(2,171
)
Comprehensive Income
$
68,500
$
62,329
$
43,356
The accompanying notes are an integral part of these consolidated financial statements
Farmers & Merchants Bancorp
Consolidated Statements of Changes in Shareholders’ Equity
(in thousands except share and per share data)
Common
Shares
Outstanding
Common
Stock
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
(Loss) Income
Total
Shareholders’
Equity
Balance, January 1, 2018
812,304
$
$
93,624
$
206,845
$
(817
)
$
299,660
Net Income
45,527
45,527
Cash Dividends Declared on Common Stock ($13.90 per share)
(11,151
)
(11,151
)
Repurchase of Common Stock
(44,503
)
(31,152
)
(31,152
)
Issuance of Common Stock
15,920
10,502
10,502
Change in Net Unrealized Loss on Securities Available-for-Sale
(2,171
)
(2,171
)
Balance, December 31, 2018
783,721
$
$
72,974
$
241,221
$
(2,988
)
$
311,215
Net Income
56,036
56,036
Cash Dividends Declared on Common Stock ($14.20 per share)
(11,221
)
(11,221
)
Issuance of Common Stock
9,312
6,973
6,973
Change in Net Unrealized Gain on Securities Available-for-Sale
6,293
6,293
Balance, December 31, 2019
793,033
$
$
79,947
$
286,036
$
3,305
$
369,296
Net Income
58,734
58,734
Cash Dividends Declared on Common Stock ($14.75 per share)
(11,700
)
(11,700
)
Repurchase of Common Stock
(3,910
)
(2,834
)
(2,834
)
Issuance of Common Stock
Change in Net Unrealized Gain on Securities Available-for-Sale
9,766
9,766
Balance, December 31, 2020
789,646
$
$
77,516
$
333,070
$
13,071
$
423,665
The accompanying notes are an integral part of these consolidated financial statements
Farmers & Merchants Bancorp
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31,
Operating Activities
Net Income
$
58,734
$
56,036
$
45,527
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Provision for Credit Losses
4,500
5,533
Depreciation and Amortization
2,769
2,756
2,421
(Benefit) Provision for Deferred Income Taxes
(1,962
)
(3,254
)
5,462
Net Amortization of Investment Security Premiums & Discounts
1,159
Amortization of Core Deposit Intangible
Accretion of Discount on Acquired Loans
(166
)
(47
)
(153
)
Net (Gain) Loss on Sale of Investment Securities
(40
)
(1
)
1,260
Net Loss (Gain) on Sale of Property & Equipment
(32
)
(273
)
Earnings from Equity Investment
-
-
(66
)
Dividends from Equity Investment
-
-
Gain on Remeasurement of Previously Held Equity Investment
-
-
(997
)
Net Change in Operating Assets & Liabilities:
Net (Increase) Decrease in Interest Receivable and Other Assets
(3,333
)
18,949
(2,098
)
Net (Decrease) Increase in Interest Payable and Other Liabilities
(4,136
)
4,983
Net Cash Provided by Operating Activities
58,119
80,858
57,774
Investing Activities:
Purchase of Investment Securities Available-for-Sale
(670,550
)
(652,280
)
(465,414
)
Proceeds from Sold, Matured, or Called Securities Available-for-Sale
383,257
644,244
550,727
Purchase of Investment Securities Held-to-Maturity
(22,020
)
(16,376
)
(9,813
)
Proceeds from Matured, or Called Securities Held-to-Maturity
13,299
10,871
10,647
Net Loans & Leases Paid, Originated or Acquired
(427,573
)
(102,413
)
(276,066
)
Principal Collected on Loans & Leases Previously Charged Off
Cash Paid for Acquisition, Net
-
-
(5,987
)
Additions to Premises and Equipment, Net
(7,709
)
(15,537
)
(4,577
)
Purchase of Other Investments
(6,063
)
(4,400
)
(5,750
)
Proceeds from Sale of Property & Equipment
Net Cash Used in Investing Activities
(736,754
)
(135,630
)
(205,089
)
Financing Activities:
Net Increase in Deposits
782,248
215,187
148,033
Stock Repurchases
(2,834
)
-
(31,152
)
Cash Dividends
(11,700
)
(11,221
)
(11,151
)
Net Cash Provided by Financing Activities
767,714
203,966
105,730
Net Change in Cash and Cash Equivalents
89,079
149,194
(41,585
)
Cash and Cash Equivalents at Beginning of Year
294,758
145,564
187,149
Cash and Cash Equivalents at End of Year
$
383,837
$
294,758
$
145,564
Supplementary Data
Cash Payments Made for Income Taxes
$
9,581
$
7,342
$
7,971
Issuance of Common Stock to the Bank’s Non-Qualified Retirement Plans
$
$
6,973
$
10,502
Interest Paid
$
10,903
$
11,755
$
7,731
Supplementary Noncash Disclosure
Lease Liabilities Arising from Obtaining Right-of-Use Assets
$
-
$
5,645
$
-
Acquisitions:
Fair Value of Assets Acquired
$
-
$
-
$
234,456
Fair Value of Liabilities Acquired
$
-
$
-
$
192,809
The accompanying notes are an integral part of these consolidated financial statements
Notes to Consolidated Financial Statements
1. Significant Accounting Policies
Farmers & Merchants Bancorp (the “Company”) was organized March 10, 1999. Primary operations are related to traditional banking activities through its subsidiary Farmers & Merchants Bank of Central California (the “Bank”) which was established in 1916. The Bank’s wholly owned subsidiaries include Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. Farmers & Merchants Investment Corporation has been dormant since 1991. Farmers/Merchants Corp. acts as trustee on deeds of trust originated by the Bank.
The Company’s other wholly owned subsidiaries include F & M Bancorp, Inc. and FMCB Statutory Trust I. F & M Bancorp, Inc. was created in March 2002 to protect the name F & M Bank. During 2002, the Company completed a fictitious name filing in California to begin using the streamlined name “F & M Bank” as part of a larger effort to enhance the Company’s image and build brand name recognition. In December 2003, the Company formed a wholly owned subsidiary, FMCB Statutory Trust I, for the sole purpose of issuing Trust Preferred Securities and related subordinated debentures, in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). FMCB Statutory Trust I is a non-consolidated subsidiary.
On October 10, 2018, Farmers & Merchants Bancorp completed the acquisition of the Bank of Rio Vista, headquartered in Rio Vista, California, a locally owned and operated community bank established in 1904. As of the acquisition date, Bank of Rio Vista had approximately $217.5 million in assets and three branch locations in the communities of Rio Vista, Walnut Grove, and Lodi. Since the Company had a 39.65% interest in Bank of Rio Vista prior to the acquisition of the remaining interest, the transaction was accounted for as a business combination achieved in stages or a step acquisition. The Company, through an independent valuation, remeasured its previously held equity interest in Bank of Rio Vista at fair value, which resulted in a gain for the excess of the acquisition-date fair value over its carrying value of $997,000 which is included in other non-interest income in the consolidated statements of income. At the effective time of the acquisition, Bank of Rio Vista was merged into Farmers & Merchants Bank of Central California.
Basis of Presentation
The accounting and reporting policies of the Company conform to U.S. GAAP and prevailing practice within the banking industry.
The accompanying consolidated financial statements and notes thereto have been prepared in accordance with accounting principles generally accepted in the United States of America for financial information.
The accompanying consolidated financial statements include the accounts of the Company and the Company’s wholly owned subsidiaries, F & M Bancorp, Inc. and the Bank, along with the Bank’s wholly owned subsidiaries, Farmers & Merchants Investment Corporation and Farmers/Merchants Corp. Significant inter-company transactions have been eliminated in consolidation.
The preparation of consolidated financial statements in conformity with U.S. GAAP and under the rules and regulations of U.S. Securities and Exchange Commission, requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Certain amounts in the prior years' financial statements and related footnote disclosures have been reclassified to conform to the current-year presentation. These reclassifications had no effect on previously reported net income or total shareholders’ equity.
Accounting Guidance Pending Adoption at December 31, 2020
The following paragraphs provide descriptions of newly issued but not yet effective accounting standards that could have a material effect on the Company’s financial position or results of operations.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU will require the earlier recognition of credit losses on loans and other financial instruments based on an expected loss model, replacing the incurred loss model that is currently in use. Under the new guidance, an entity will measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The expected loss model will apply to loans and leases, unfunded lending commitments, held-to-maturity debt securities and other debt instruments measured at amortized cost. The impairment model for available-for-sale debt securities will require the recognition of credit losses through a valuation allowance when fair value is less than amortized cost, regardless of whether the impairment is considered to be other-than-temporary. During 2019, the Company completed an assessment of its CECL data and system needs, and engaged a third-party vendor to assist in developing a CECL model. The Company, in conjunction with this vendor, researched and analyzed modeling standards, loan segmentation, as well as potential external inputs to supplement our historical loss history. Model validation began in the third quarter, enabling the Company to complete parallel runs using data beginning with the second quarter of 2019.
The new guidance had been effective on January 1, 2020. However, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) and H.R. 133, resulted in federal banking regulators issuing an interim final rule allowing banks the option of delaying the implementation of CECL until January 1, 2022. In addition, the national banking regulators have issued a joint statement allowing financial institutions to mitigate the effects of CECL in their regulatory capital calculations for up to two years. The Company has elected to delay CECL adoption, but continues to run its CECL model quarterly to accumulate data for the ultimate implementation. Management is currently evaluating the impact that the standard will have on its consolidated financial statements.
Out of Period Adjustment
During the quarter ended September 30, 2018, while preparing 2017 tax returns, the Company identified certain items related to IRS Code Section 162(m) that were not appropriately reflected in the 2014 through 2017 Provision for Income Taxes. To reflect this change, the cumulative impact of $990,000 was recognized by reducing the Company’s Provision for Income Taxes in the third quarter of 2018. After evaluating the quantitative and qualitative aspects of the adjustment, the Company concluded that its 2017 financial statements were not materially misstated and, therefore, no restatement was required.
Cash and Cash Equivalents
For purposes of the Consolidated Statements of Cash Flows, the Company has defined cash and cash equivalents as those amounts included in the balance sheet captions Cash and Due from Banks, Interest Bearing Deposits with Banks and Federal Funds Sold, which have original maturity dates of 3 months or less. For these instruments, the carrying amount is a reasonable estimate of fair value.
Investment Securities
Investment securities are classified at the time of purchase as held-to-maturity (“HTM”) if it is management’s intent and the Company has the ability to hold the securities until maturity. These securities are carried at cost, adjusted for amortization of premium over the term through the earliest call date and accretion of discount using a level yield of interest over the estimated remaining period until maturity. Losses, reflecting a decline in value judged by the Company to be other than temporary, are recognized in the period in which they occur.
Securities are classified as available-for-sale (“AFS”) if it is management’s intent, at the time of purchase, to hold the securities for an unstated period of time and may be used as part of the Company’s asset/liability management strategy. These securities are reported at fair value with aggregate unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income taxes. Fair values are based on quoted market prices or broker/dealer price quotations on a specific identification basis. Gains or losses on the sale of these securities are computed using the specific identification method.
Trading securities, if any, are acquired for short-term appreciation and are recorded in a trading portfolio and are carried at fair value, with unrealized gains and losses recorded in earnings.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement; and (2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Equity securities, are carried at fair value, with unrealized and realized gains recognized through earnings.
Loans & Leases
Loans & leases are reported at the principal amount outstanding net of unearned discounts and deferred loan & lease fees and costs. Interest income on loans & leases is accrued daily on the outstanding balances using the simple interest method. Loan & lease origination fees are deferred and recognized over the contractual life of the loan or lease as an adjustment to the yield. Loans & leases are placed on non-accrual status when the collection of principal or interest is in doubt or when they become past due for 90 days or more unless they are both well-secured and in the process of collection. For this purpose, a loan or lease is considered well-secured if it is collateralized by property having a net realizable value in excess of the amount of the loan or lease or is guaranteed by a financially capable party. When a loan or lease is placed on non-accrual status, the accrued and unpaid interest receivable is reversed and charged against current income; thereafter, interest income is recognized only as it is collected in cash. Additionally, cash would be applied to principal if all principal was not expected to be collected. Loans & leases placed on non-accrual status are returned to accrual status when the loans or leases are paid current as to principal and interest and future payments are expected to be made in accordance with the contractual terms of the loan or lease.
A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Impaired loans & leases are either: (1) non-accrual loans & leases; or (2) restructured loans & leases that are still accruing interest. Loans or leases determined to be impaired are individually evaluated for impairment. When a loan or lease is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan or lease's effective interest rate, except that as a practical expedient, it may measure impairment based on a loan or lease's observable market price, or the fair value of the collateral if the loan or lease is collateral dependent. A loan or lease is collateral dependent if the repayment of the loan or lease is expected to be provided solely by the underlying collateral.
A restructuring of a loan or lease constitutes a troubled debt restructuring (TDR) if the Company for economic or legal reasons related to the borrower’s (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction) financial difficulties grants a concession to the borrower that it would not otherwise consider. Restructured loans & leases typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans & leases that are on nonaccrual status at the time they become TDR, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment as described above.
Generally, the Company will not restructure loans or leases for borrowers unless: (1) the existing loan or lease is brought current as to principal and interest payments; and (2) the restructured loan or lease can be underwritten to reasonable underwriting standards. If these standards are not met other actions will be pursued (e.g., foreclosure) to collect outstanding loan or lease amounts. After restructure, a determination is made whether the loan or lease will be kept on accrual status based upon the underwriting and historical performance of the restructured credit.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law, and was amended and extended by the Consolidated Appropriations Act of 2021 (“H.R. 133”) on December 21, 2020. The CARES Act and H.R. 133 provide financial institutions, under specific circumstances, the opportunity to temporarily suspend certain requirements under generally accepted accounting principles related to modifications for a limited period of time to account for the effects of COVID-19. In March 2020, a joint statement was issued by federal and state regulatory agencies, after consultation with the FASB, to clarify that short-term loan modifications are not TDRs if made on a good-faith basis in response to COVID-19 to borrowers who were current prior to any relief. Under this guidance, six months is provided as an example of short-term, and current is defined as less than 30 days past due at the time the modification program is implemented. The guidance also provides that these modified loans generally will not be classified as nonaccrual during the term of the modification. See “Note 2 - Risks and Uncertainties” for additional information on the CARES Act, H.R. 133 and the impact of COVID-19 on the Company.
Allowance for Credit Losses
The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company's loan & lease portfolio as of the balance sheet date. The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan & lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary components: specific reserves related to impaired loans & leases; general reserves for inherent losses related to loans & leases that are not impaired; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors.
The determination of the general reserve for loans & leases that are collectively evaluated for impairment is based on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, qualitative factors that include economic trends in the Company's service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.
The Company maintains a separate allowance for each portfolio segment (loan & lease type). These portfolio segments include: (1) commercial real estate; (2) agricultural real estate; (3) real estate construction (including land and development loans); (4) residential 1st mortgages; (5) home equity lines and loans; (6) agricultural; (7) commercial; (8) consumer and other; and (9) equipment leases. The allowance for credit losses attributable to each portfolio segment, which includes both individually evaluated impaired loans & leases and loans & leases that are collectively evaluated for impairment, is combined to determine the Company's overall allowance, which is included on the consolidated balance sheet.
The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability. For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans & leases. These credit quality indicators are used to assign a risk rating to each individual loan or lease. These risk ratings are also subject to examination by independent specialists engaged by the Company. The risk ratings can be grouped into five major categories, defined as follows:
Pass and Watch - A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management's close attention. This category also includes “Watch” loans, which is a loan with an emerging weakness in either the individual credit or industry that requires additional attention. A credit may also be classified Watch if cash flows have not yet stabilized, such as in the case of a development project. Included in this category are all loans in which the Bank entered into a CARES Act modification.
Special Mention - A special mention loan or lease has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease or in the Company's credit position at some future date. Special mention loans & leases are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard - A substandard loan or lease is not adequately protected by the current financial condition and paying capacity of the borrower or the value of the collateral pledged, if any. Loans or leases classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Well-defined weaknesses include a project's lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project's failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful - Loans or leases classified doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, highly questionable or improbable.
Loss - Loans or leases classified as loss are considered uncollectible. Once a loan or lease becomes delinquent and repayment becomes questionable, the Company will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Company will estimate its probable loss and immediately charge-off some or all of the balance.
The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management's assessment of the following for each portfolio segment: (1) inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment described below:
Commercial Real Estate - Commercial real estate mortgage loans are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans. Trends in vacancy rates of commercial properties impact the credit quality of these loans. High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flow to service debt obligations.
Real Estate Construction - Real estate construction loans, including land loans, are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. A major risk arises from the necessity to complete projects within specified cost and time lines. Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.
Commercial - These loans are generally considered to possess a moderate inherent risk of loss because they are shorter-term; typically made to relationship customers; generally underwritten to existing cash flows of operating businesses; and may be collateralized by fixed assets, inventory and/or accounts receivable. Debt coverage is provided by business cash flows and economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans.
Agricultural Real Estate and Agricultural - These loans are generally considered to possess a moderate inherent risk of loss since they are typically made to relationship customers and are secured by crop production, livestock and related real estate. These loans are vulnerable to two risk factors that are largely outside the control of Company and borrowers: commodity prices and weather conditions.
Leases - Equipment leases are generally considered to possess a moderate inherent risk of loss. As lessor, the Company is subject to both the credit risk of the borrower and the residual value risk of the equipment. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.
Residential 1st Mortgages and Home Equity Lines and Loans - These loans are generally considered to possess a lower inherent risk of loss. The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower's ability to repay in an orderly fashion. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.
Consumer & Other - A consumer installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most installment loans are made for consumer purchases. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.
At least quarterly, the Board of Directors reviews the adequacy of the allowance, including consideration of the relative risks in the portfolio, current economic conditions and other factors. If the Board of Directors and management determine that changes are warranted based on those reviews, the allowance is adjusted. In addition, the Company's and Bank's regulators, including the Federal Reserve Board (“FRB”), the Department of Financial Protection and Innovation (“DFPI”) and the Federal Deposit Insurance Corporation (“FDIC”), as an integral part of their examination process, review the adequacy of the allowance. These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations.
Acquired Loans
Loans acquired through purchase or through a business combination are recorded at their fair value at the acquisition date. Credit discounts, which reflect estimates of credit losses, expected to be incurred over the life of the loan, are included in the determination of fair value; therefore, an allowance for loan losses is not recorded at the acquisition date.
Allowance for Credit Losses on Off-Balance-Sheet Credit Exposures
The Company also maintains a separate allowance for off-balance-sheet commitments. Management estimates anticipated losses using historical data and utilization assumptions. The allowance for off-balance-sheet commitments is included in Interest Payable and Other Liabilities on the Company’s Consolidated Balance Sheet.
Right of Use Lease Asset & Lease Liability
The Company leases retail space and office space under operating leases. Most leases require the Company to pay real estate taxes, maintenance, insurance and other similar costs in addition to the base rent. Certain leases also contain lease incentives, such as tenant improvement allowances and rent abatement. Variable lease payments are recognized as lease expense as they are incurred. We record an operating lease right of use (ROU) asset and an operating lease liability (lease liability) for operating leases with a lease term greater than 12 months. The ROU asset and lease liability are recorded in other assets and other liabilities, respectively, in the consolidated statement of financial condition. 12 ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term. Accordingly, ROU assets are reduced by tenant improvement allowances from landlords plus any prepaid rent. We do not separate lease and non-lease components of contracts. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. Many of our leases contain various provisions for increases in rental rates, based either on changes in the published Consumer Price Index or a predetermined escalation schedule, which are factored into our determination of lease payments when appropriate. A majority of the leases provide the Company with the option to extend the lease term one or more times following expiration of the initial term. The ROU asset and lease liability terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
Revenue from Contracts with Customers
The Company records revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the Company satisfies a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.
The Company’s primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606. The Company has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is limited judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
Premises and Equipment
Premises, equipment, and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation is computed principally by the straight-line method over the estimated useful lives of the assets. Estimated useful lives of buildings range from 30 to 40 years, and for furniture and equipment from 3 to 7 years. Leasehold improvements are amortized over the lesser of the terms of the respective leases, or their useful lives, which are generally 5 to 10 years. Remodeling and capital improvements are capitalized while maintenance and repairs are charged directly to occupancy expense.
Other Real Estate
Other real estate, which is included in other assets, is expected to be sold and is comprised of properties no longer utilized for business operations and property acquired through foreclosure in satisfaction of indebtedness. These properties are recorded at fair value less estimated selling costs upon acquisition. Revised estimates to the fair value less cost to sell are reported as adjustments to the carrying amount of the asset, provided that such adjusted value is not in excess of the carrying amount at acquisition. Initial losses on properties acquired through full or partial satisfaction of debt are treated as credit losses and charged to the allowance for credit losses at the time of acquisition. Subsequent declines in value from the recorded amounts, routine holding costs, and gains or losses upon disposition, if any, are included in non-interest expense as incurred.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law, and was amended and extended by H.R. 133 on December 21, 2020. The CARES Act and H.R. 133 restrict the ability of financial institutions to exercise their foreclosure rights on residential and multi-family properties backed by federally guaranteed mortgage loans. The State of California has gone further and temporarily suspended all residential and commercial foreclosures through June 30, 2021. The Company is working with its borrowers when they make requests to defer payments on their mortgage loans. See “Note 2 - Risks and Uncertainties” for additional information on the CARES Act and the impact of COVID-19 on the Company.
Income Taxes
The Company uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year.
The Company follows the standards set forth in the “Income Taxes” topic of the Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. This standard prescribes a recognition threshold and measurement standard for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
The Company accounts for leases with Investment Tax Credits (ITC) under the deferred method as established in ASC 740-10. ITC are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement.
The Company accounts for its interest in LIHTC using the cost method as established in ASC 323-740. As an investor, the Company obtains income tax credits and deductions from the operating losses of these tax credit entities. The income tax credits and deductions are allocated to the investors based on their ownership percentages and are recorded as a reduction of income tax expense (or an increase to income tax benefit) and a reduction of federal income taxes payable.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the consolidated financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
At December 31, 2020 and 2019, the Company has no material uncertain tax positions and recognized no interest or penalties. The Company's policy is to recognize interest and penalties related to income taxes in the provision for income taxes in the Consolidated Statement of Income.
Basic and Diluted Earnings Per Common Share
The Company’s common stock is not traded on any exchange. However, trades are reported on the OTCQX under the symbol "FMCB". The shares are primarily held by local residents and are not actively traded. Basic earnings per common share amounts are computed by dividing net income by the weighted average number of common shares outstanding for the period. There are no common stock equivalent shares. Therefore, there is no difference between presentation of diluted and basic earnings per common share. See Note 15 - “Dividends and Basic and Diluted Earnings Per Common Share” for additional information.
Segment Reporting
The “Segment Reporting” topic of the FASB ASC requires that public companies report certain information about operating segments. It also requires that public companies report certain information about their products and services, the geographic areas in which they operate, and their major customers. The Company is a holding company for a community bank, which offers a wide array of products and services to its customers. Pursuant to its banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, the Company is not organized around discernible lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change.
Comprehensive Income
The “Comprehensive Income” topic of the FASB ASC establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Other comprehensive income refers to revenues, expenses, gains, and losses that U.S. GAAP recognize as changes in value to an enterprise but are excluded from net income. For the Company, comprehensive income includes net income and changes in fair value of its available-for-sale investment securities.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the consolidated financial statements.
Business Combinations And Related Matters
Business combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method, the acquiring entity in a business combination recognizes 100 percent of the acquired assets and assumed liabilities, regardless of the percentage owned, at their estimated fair values as of the date of acquisition. Any excess of the fair value over the purchase price of net assets and other identifiable intangible assets acquired is recorded as bargain purchase gain. Assets acquired and liabilities assumed from contingencies must also be recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the statement of operations from the date of acquisition. Acquisition-related costs, including conversion charges, are expensed as incurred.
Goodwill and Other Intangible Assets: Goodwill is determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill that arises from a business combination is periodically evaluated for impairment at the reporting unit level, at least annually. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Core deposit intangible ("CDI") represents the estimated future benefit of deposits related to an acquisition and is booked separately from the related deposits and evaluated periodically for impairment. The CDI asset is amortized on a straight-line method over its estimated useful life of ten years. At December 31, 2020, the future estimated amortization expense for the CDI arising from our past acquisitions is as follows:
(in thousands)
Thereafter
Total
Core Deposit Intangible Amortization
$
$
$
$
$
$
1,165
$
4,013
We make a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit where goodwill is assigned is less than its carrying amount. If we conclude that it is more likely than not that the fair value is more than its carrying amount, no impairment is recorded. Goodwill is tested for impairment on an interim basis if circumstances change or an event occurs between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The qualitative assessment includes adverse events or circumstances identified that could negatively affect the reporting units’ fair value as well as positive and mitigating events. Such indicators may include, among others, a significant change in legal factors or in the general business climate, significant change in our stock price and market capitalization, unanticipated competition, and an action or assessment by a regulator. If the fair value of a reporting unit is less than its carrying amount, an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value is recognized. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.
2. Risks and Uncertainties
The COVID-19 pandemic has affected all of us. Designated as an “essential business”, the Company’s subsidiary, Farmers & Merchants Bank of Central California, has kept all branches open and maintained regular business hours during these difficult times. Our staffing levels have remained stable during the COVID-19 crisis. We have taken what we believe are prudent measures to protect our employees and customers, while still providing core banking services.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law, and was amended and extended by the Consolidated Appropriations Act of 2021 (“H.R. 133”) on December 21, 2020. Through this legislation, as well as related federal and state regulatory actions, the federal government has taken extraordinary efforts to provide financial assistance to individuals and companies to help them move through these difficult times. However, there are no guarantees how long the COVID-19 virus may continue to impact our economy, and therefore, the Company.
While we expect the effects of COVID-19 could have an adverse future impact on our business, financial condition and results of operations, we are unable to predict the full extent or nature of these impacts at the current time.
3. Investment Securities
The amortized cost, fair values, and unrealized gains and losses of the securities available-for-sale are as follows:
(in thousands)
Amortized
Gross Unrealized
Fair/Book
December 31, 2020
Cost
Gains
Losses
Value
US Treasury Notes
$
14,859
$
$
-
$
15,288
US Government Agency SBA
8,252
8,160
Mortgage Backed Securities (1)
720,562
17,359
737,873
Corporate Securities
45,010
45,919
Other
-
-
Total
$
789,175
$
18,716
$
$
807,732
Amortized
Gross Unrealized
Fair/Book
December 31, 2019
Cost
Gains
Losses
Value
US Treasury Notes
$
54,745
$
$
-
$
54,995
US Government Agency SBA
10,902
10,798
Mortgage Backed Securities (1)
436,531
4,646
441,078
Other
-
-
Total
$
502,693
$
4,905
$
$
507,386
(1) All Mortgage Backed Securities were issued by an agency or government sponsored entity of the U.S. government.
The book values, estimated fair values and unrealized gains and losses of investments classified as held-to-maturity are as follows: (in thousands)
Amortized
Gross Unrealized
Fair
December 31, 2020
Cost
Gains
Losses
Value
Obligations of States and Political Subdivisions
$
68,933
$
1,116
$
-
$
70,049
Total
$
68,933
$
1,116
$
-
$
70,049
Amortized
Gross Unrealized
Fair
December 31, 2019
Cost
Gains
Losses
Value
Obligations of States and Political Subdivisions
$
60,229
$
$
$
61,097
Total
$
60,229
$
$
$
61,097
Fair values are based on quoted market prices or dealer quotes. If a quoted market price or dealer quote is not available, fair value is estimated using quoted market prices for similar securities.
The amortized cost and estimated fair values of investment securities at December 31, 2020 by contractual maturity are shown in the following tables. (in thousands)
Available-for-Sale
Held-to-Maturity
December 31, 2020
Amortized
Cost
Fair/Book
Value
Amortized
Cost
Fair
Value
Within One Year
$
5,479
$
5,512
$
8,309
$
8,309
After One Year Through Five Years
25,427
26,096
5,137
5,179
After Five Years Through Ten Years
30,281
30,912
23,493
24,451
After Ten Years
7,426
7,339
31,994
32,110
68,613
69,859
68,933
70,049
Investment Securities Not Due at a Single Maturity Date:
Mortgage Backed Securities
720,562
737,873
-
-
Total
$
789,175
$
807,732
$
68,933
$
70,049
Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
The following tables show those investments with gross unrealized losses and their market value aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at the dates indicated. (in thousands)
Less Than 12 Months
12 Months or More
Total
December 31, 2020
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Securities Available-for-Sale
US Government Agency SBA
$
1,741
$
$
6,126
$
$
7,867
$
Mortgage Backed Securities
20,142
20,319
Corporate Securities
4,041
-
-
4,041
Total
$
25,924
$
$
6,303
$
$
32,227
$
There were no HTM investments with gross unrealized losses at December 31, 2020.
Less Than 12 Months
12 Months or More
Total
December 31, 2019
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Securities Available-for-Sale
US Government Agency SBA
$
2,693
$
$
5,198
$
$
7,891
$
Mortgage Backed Securities
131,005
131,718
Total
$
133,698
$
$
5,911
$
$
139,609
$
Securities Held-to-Maturity
Obligations of States and Political Subdivisions
$
$
$
-
$
-
$
$
Total
$
$
$
-
$
-
$
$
As of December 31, 2020, the Company held 649 investment securities of which 13 were in an unrealized loss position for less than twelve months and 83 securities were in an unrealized loss position for twelve months or more. Management periodically evaluates each investment security for other-than-temporary impairment relying primarily on industry analyst reports and observations of market conditions and interest rate fluctuations. Management believes it will be able to collect all amounts due according to the contractual terms of the underlying investment securities.
Securities of Government Agency and Government Sponsored Entities - At December 31, 2020 and December 31, 2019, no securities of government agency and government sponsored entities were in a loss position.
U.S. Treasury Notes - At December 31, 2020 and December 31, 2019, no U.S. Treasury Note security investments were in a loss position.
U.S. Government SBA - At December 31, 2020, 8 U.S. Government SBA security investments were in a loss position for less than 12 months and 65 were in a loss position for 12 months or more. The unrealized losses on the Company's investment in U.S. Government SBA were $93,000 at December 31, 2020 and $113,000 at December 31, 2019. The unrealized losses were caused by interest rate fluctuations. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the securities and it is more likely than not that the Company will not have to sell the securities before recovery of their cost basis, the Company did not consider these investments to be other-than-temporarily impaired at December 31, 2020 and December 31, 2019.
Mortgage Backed Securities - At December 31, 2020, 3 mortgage backed security investments were in a loss position for less than 12 months and 18 were in a loss position for 12 months or more. The unrealized losses on the Company's investment in mortgage-backed securities were $48,000 at December 31, 2020 and $99,000 at December 31, 2019. The unrealized losses were caused by interest rate fluctuations. The contractual cash flows of these investments are guaranteed by an agency or government sponsored entity of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company's investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the securities and it is more likely than not that the Company will not have to sell the securities before recovery of their cost basis, the Company did not consider these investments to be other-than-temporarily impaired at December 31, 2020 or 2019.
Corporate Securities - At December 30, 2020, 2 corporate securities were in an unrealized loss position for less than 12 months and none were in a loss position for 12 months or more. The unrealized losses on the Company’s investment in corporate securities were $18,000. Changes in the prices of corporate securities are primarily influenced by: (1) changes in market interest rates; (2) changes in perceived credit risk in the general economy or in particular industries; (3) changes in the perceived credit risk of a particular company; and (4) day to day trading supply, demand and liquidity. The Company monitors the status of each of our corporate securities and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security. Because the Company does not intend to sell the securities and it is more likely than not that the Company will not have to sell the securities before recovery of their cost basis, the Company does not consider these investments to be other-than-temporarily impaired at December 30, 2020.
Obligations of States and Political Subdivisions - At December 31, 2020, no obligations of states and political subdivisions were in a loss position for less than 12 months. None were in a loss position for 12 months or more. As of December 31, 2020, one-hundred percent of the Company’s bank-qualified municipal bond portfolio is rated at either the issue or the issuer level, and all of these ratings are “investment grade.” The Company monitors the status of all municipal investments in the portfolio, and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security.
The unrealized losses on the Company’s investment in obligation of states and political subdivisions were $0 at December 31, 2020 and $12,000 at December 31, 2019. Management believes that any unrealized losses on the Company's investments in obligations of states and political subdivisions were caused by interest rate fluctuations. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the Company does not intend to sell the securities and it is more likely than not that the Company would not have to sell the securities before recovery of their cost basis, the Company did not consider these investments to be other-than-temporarily impaired at December 31, 2020 and December 31, 2019.
Proceeds from sales and calls of these securities were as follows:
(in thousands)
Gross Proceeds
Gross Gains
Gross Losses
$
5,080
$
$
-
$
5,300
$
$
-
$
99,323
$
$
1,338
Pledged Securities
As of December 31, 2020, securities carried at $439.7 million were pledged to secure public deposits, Federal Home Loan Bank (“FHLB”) borrowings, and other government agency deposits as required by law. This amount was $352.5 million at December 31, 2019.
4. Federal Home Loan Bank Stock and Other Equity Securities, at Cost
The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock and other equity securities are carried at cost, classified as restricted securities, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. FHLB stock and other equity securities are reported in Interest Receivable and Other Assets on the Company’s Consolidated Balance Sheets and totaled $12.7 million at December 31, 2020 and 2019.
5. Loans & Leases
Loans & leases as of December 31 consisted of the following:
(in thousands)
Commercial Real Estate
$
971,326
$
846,486
Agricultural Real Estate
643,014
625,767
Real Estate Construction
185,741
115,644
Residential 1st Mortgages
299,379
255,253
Home Equity Lines and Loans
34,239
39,270
Agricultural
264,372
292,904
Commercial
374,816
384,795
Consumer & Other (1)
235,529
15,422
Leases
103,117
104,470
Total Gross Loans & Leases
3,111,533
2,680,011
Less: Unearned Income
11,941
6,984
Subtotal
3,099,592
2,673,027
Less: Allowance for Credit Losses
58,862
55,012
Loans & Leases, Net
$
3,040,730
$
2,618,015
(1) Includes CARES Act Small Business Administration Paycheck Protection Program loans of $224,309 as of December 31, 2020.
Paycheck Protection Program (“PPP”) … Under the CARES Act and H.R. 133 (see “Note 2 - Risks and Uncertainties”) the Small Business Administration (“SBA”) was directed by Congress to provide loans to small businesses with less than 500 employees to assist these businesses in meeting their payroll and other financial obligations during the COVID-19 pandemic. These government guaranteed loans are made with an interest rate of 1%, a risk weight of 0% under risk-based capital rules, have a term of 2 years, and under certain conditions the SBA will forgive them. The Bank actively participated in the PPP, and since April 2020, the Bank has funded $347.4 million of loans for 1,540 small business customers.
At December 31, 2020, the portion of loans that were approved for pledging as collateral on borrowing lines with the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank (“FRB”) were $808.9 million and $706.2 million, respectively. The borrowing capacity on these loans was $630.5 million from FHLB and $438.1 million from the FRB.
6. Allowance for Credit Losses
The Company was originally scheduled to implement ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (“CECL”) as of January 1, 2020. The CARES Act and H.R. 133 provide the election to defer CECL implementation until January 1, 2022. The Company has elected to delay CECL implementation.
The following tables show the allocation of the allowance for credit losses at December 31, 2020 and December 31, 2019 by portfolio segment and by impairment methodology (in thousands):
December 31, 2020
Commercial
Real Estate
Agricultural
Real Estate
Real Estate
Construction
Residential 1st
Mortgages
Home Equity
Lines & Loans
Agricultural
Commercial
Consumer
& Other
Leases
Unallocated
Total
Year-To-Date Allowance for Credit Losses:
Beginning Balance- January 1, 2020
$
11,053
$
15,128
$
1,949
$
$
2,675
$
8,076
$
11,466
$
$
3,162
$
$
55,012
Charge-Offs
-
-
-
-
(7
)
-
(1,101
)
(66
)
-
-
(1,174
)
Recoveries
-
-
-
-
-
Provision
16,626
(6,576
)
(306
)
(722
)
(3,262
)
(684
)
(90
)
(1,431
)
4,500
Ending Balance- December 31, 2020
$
27,679
$
8,633
$
1,643
$
$
2,024
$
4,814
$
9,961
$
$
1,731
$
1,084
$
58,862
Ending Balance Individually Evaluated for Impairment
-
-
-
-
-
Ending Balance Collectively Evaluated for Impairment
27,679
8,633
1,643
2,016
4,722
9,941
1,731
1,084
58,573
Loans & Leases:
Ending Balance
$
958,980
$
643,014
$
185,741
$
299,379
$
34,239
$
264,372
$
374,816
$
235,529
$
103,522
$
-
$
3,099,592
Ending Balance Individually Evaluated for Impairment
5,629
-
2,365
-
-
9,238
Ending Balance Collectively Evaluated for Impairment
958,876
637,385
185,741
297,014
34,081
263,877
374,583
235,275
103,522
-
3,090,354
December 31, 2019
Commercial
Real Estate
Agricultural
Real Estate
Real Estate
Construction
Residential 1st
Mortgages
Home Equity
Lines & Loans
Agricultural
Commercial
Consumer
& Other
Leases
Unallocated
Total
Year-To-Date Allowance for Credit Losses:
Beginning Balance- January 1, 2019
$
11,609
$
14,092
$
1,249
$
$
2,761
$
8,242
$
11,656
$
$
4,022
$
$
55,266
Charge-Offs
-
-
-
-
-
-
(592
)
(83
)
-
-
(675
)
Recoveries
-
-
-
-
-
Provision
(556
)
(38
)
(114
)
(166
)
(7
)
(860
)
(69
)
Ending Balance- December 31, 2019
$
11,053
$
15,128
$
1,949
$
$
2,675
$
8,076
$
11,466
$
$
3,162
$
$
55,012
Ending Balance Individually Evaluated for Impairment
-
-
-
-
Ending Balance Collectively Evaluated for Impairment
10,819
15,128
1,949
2,663
7,977
11,329
3,162
54,351
Loans & Leases:
Ending Balance
$
838,570
$
625,767
$
115,644
$
255,253
$
39,270
$
292,904
$
384,795
$
15,422
$
105,402
$
-
$
2,673,027
Ending Balance Individually Evaluated for Impairment
4,524
5,654
-
2,368
1,528
-
-
14,691
Ending Balance Collectively Evaluated for Impairment
834,046
620,113
115,644
252,885
39,041
292,716
383,267
15,222
105,402
-
2,658,336
The ending balance of loans individually evaluated for impairment includes restructured loans in the amount of $876,000 and $2.6 million at December 31, 2020 and 2019, respectively, which are no longer disclosed or classified as TDR’s, since they were restructured at market terms.
The following tables show the loan & lease portfolio, including unearned income allocated by management’s internal risk ratings at December 31, 2020 and December 31, 2019 (in thousands):
December 31, 2020
Pass(1)
Special
Mention
Substandard
Total Loans
Loans & Leases:
Commercial Real Estate
$
946,621
$
7,849
$
4,510
$
958,980
Agricultural Real Estate
631,043
11,571
643,014
Real Estate Construction
185,741
-
-
185,741
Residential 1st Mortgages
298,689
-
299,379
Home Equity Lines and Loans
34,058
-
34,239
Agricultural
263,781
264,372
Commercial
373,038
1,060
374,816
Consumer & Other
235,063
-
235,529
Leases
103,522
-
-
103,522
Total
$
3,071,556
$
9,405
$
18,631
$
3,099,592
(1) Includes “Watch” loans of $958.2 million.
December 31, 2019
Pass(1)
Special
Mention
Substandard
Total Loans
Loans & Leases:
Commercial Real Estate
$
831,941
$
6,629
$
-
$
838,570
Agricultural Real Estate
611,792
1,136
12,839
625,767
Real Estate Construction
115,644
-
-
115,644
Residential 1st Mortgages
254,459
-
255,253
Home Equity Lines and Loans
39,092
-
39,270
Agricultural
289,276
2,617
1,011
292,904
Commercial
380,650
3,239
384,795
Consumer & Other
14,934
-
15,422
Leases
105,402
-
-
105,402
Total
$
2,643,190
$
13,621
$
16,216
$
2,673,027
(1) Includes “Watch” loans of $744.7 million.
See Note 1. “Significant Accounting Policies - Allowance for Credit Losses” for a description of the internal risk ratings used by the Company. There were no loans & leases outstanding at December 31, 2020 and 2019 rated doubtful or loss.
The following tables show an aging analysis of the loan & lease portfolio, including unearned income, by the time past due at December 31, 2020 and December 31, 2019 (in thousands):
December 31, 2020
30-59 Days
Past Due
60-89 Days
Past Due
90 Days and
Still Accruing
Nonaccrual
Total Past
Due
Current
Total
Loans & Leases
Loans & Leases:
Commercial Real Estate
$
-
$
-
$
-
$
-
$
-
$
958,980
$
958,980
Agricultural Real Estate
-
-
-
642,519
643,014
Real Estate Construction
-
-
-
-
-
185,741
185,741
Residential 1st Mortgages
-
-
-
-
-
299,379
299,379
Home Equity Lines and Loans
-
-
-
-
-
34,239
34,239
Agricultural
-
-
-
-
-
264,372
264,372
Commercial
-
-
-
-
-
374,816
374,816
Consumer & Other
-
-
-
235,518
235,529
Leases
-
-
-
-
-
103,522
103,522
Total
$
$
-
$
-
$
$
$
3,099,086
$
3,099,592
December 31, 2019
30-59 Days
Past Due
60-89 Days
Past Due
90 Days and
Still Accruing
Nonaccrual
Total Past
Due
Current
Total
Loans & Leases
Loans & Leases:
Commercial Real Estate
$
-
$
-
$
-
$
-
$
-
$
838,570
$
838,570
Agricultural Real Estate
-
-
-
-
-
625,767
625,767
Real Estate Construction
-
-
-
115,404
115,644
Residential 1st Mortgages
-
-
-
-
-
255,253
255,253
Home Equity Lines and Loans
-
-
-
-
-
39,270
39,270
Agricultural
-
-
-
-
-
292,904
292,904
Commercial
-
-
-
384,718
384,795
Consumer & Other
-
-
-
15,387
15,422
Leases
-
-
-
-
-
105,402
105,402
Total
$
$
-
$
-
$
-
$
$
2,672,675
$
2,673,027
Non-accrual loans & leases at December 31, 2020 were $495,000. There were no non-accrual loans & leases at December 31, 2019. Foregone interest income on non-accrual loans & leases, which would have been recognized during the period, if all such loans & leases had been current in accordance with their original terms, totaled $22,000, $0, and $0 at December 31, 2020, 2019, and 2018 respectively.
The following tables show information related to impaired loans & leases at and for the year ended December 31, 2020 and December 31, 2019 (in thousands):
December 31, 2020
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
With no related allowance recorded:
Commercial Real Estate
$
$
$
-
$
$
Agricultural Real Estate
5,629
5,629
-
5,629
Agricultural
-
-
Commercial
-
-
-
$
5,716
$
5,716
$
-
$
6,772
$
With an allowance recorded:
Commercial Real Estate
$
-
$
-
$
-
$
$
Agricultural Real Estate
-
-
-
-
Residential 1st Mortgages
1,671
1,895
1,652
Home Equity Lines and Loans
Agricultural
Commercial
Consumer & Other
$
2,651
$
2,929
$
$
2,603
$
Total
$
8,367
$
8,645
$
$
9,375
$
December 31, 2019
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
With no related allowance recorded:
Commercial Real Estate
$
$
$
-
$
$
Agricultural Real Estate
5,654
5,654
-
6,069
Commercial
-
-
-
$
5,740
$
5,740
$
-
$
6,167
$
With an allowance recorded:
Commercial Real Estate
$
2,822
$
2,822
$
$
2,853
$
Residential 1st Mortgages
1,562
1,770
1,601
Home Equity Lines and Loans
Agricultural
Commercial
1,528
1,528
1,554
Consumer & Other
-
$
6,368
$
6,587
$
$
6,328
$
Total
$
12,108
$
12,327
$
$
12,495
$
Total recorded investment shown in the prior table will not equal the total ending balance of loans & leases individually evaluated for impairment on the allocation of allowance table. This is because this table does not include impaired loans that were previously modified in a troubled debt restructuring, are currently performing and are no longer disclosed or classified as TDR’s, since they were restructured at market terms.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law, and was amended and extended by the Consolidated Appropriations Act 2021 (“H.R. 133”) on December 21, 2020. The CARES Act and H.R. 133 provide financial institutions, under specific circumstances, the opportunity to temporarily suspend certain requirements under generally accepted accounting principles related to TDR’s for a limited period of time to account for the effects of COVID-19. In March 2020, a joint statement was issued by federal and state regulatory agencies, after consultation with the FASB, to clarify that short-term loan modifications are not TDRs if made on a good-faith basis in response to COVID-19 to borrowers who were current prior to any relief. Under this guidance, six months is provided as an example of short-term, and current is defined as less than 30 days past due at the time the modification program is implemented. The guidance also provides that these modified loans generally will not be classified as nonaccrual during the term of the modification. Since April 2020, we have restructured $277.6 million of loans under the CARES Act and H.R. 133 guidelines. As of December 31, 2020, $3.7 million of these loans remain in a deferral status, the other loans having returned to making principal and/or interest payments. We believe that these actions will assist these borrowers in getting through these difficult times, but no guaranties can be made that at some time in the future these loans will not be required to be accounted for as a TDR. For borrowers who are 30 days or more past due when enrolling in a loan modification program related to the COVID-19 pandemic, we evaluate the loan modifications under our existing TDR framework, and where such a loan modification would result in a more than insignificant concession to a borrower experiencing financial difficulty, the loan will be accounted for as a TDR and will generally not accrue interest. See “Note 2 - Risks and Uncertainties” for additional information on the CARES Act, H.R. 133 and the impact of COVID-19 on the Company.
At December 31, 2020, there were no formal foreclosure proceedings in process for consumer mortgage loans secured by residential real estate properties.
At December 31, 2020, the Company allocated $158,000 of specific reserves to $7.9 million of troubled debt restructured loans, all of which were performing. At December 31, 2019, the Company allocated $612,000 of specific reserves to $12.1 million of troubled debt restructured loans, all of which were performing. The Company had no commitments at December 31, 2020 and December 31, 2019 to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.
Modifications involving a reduction of the stated interest rate of the loan were for 5 years. Modifications involving an extension of the maturity date range from 3 months to 10 years.
The following table presents loans by class modified as troubled debt restructured loans for the year ended December 31, 2020 (in thousands):
December 31, 2020
Troubled Debt Restructurings
Number of
Loans
Pre-Modification
Outstanding
Recorded
Investment
Post-Modification
Outstanding
Recorded
Investment
Residential 1st Mortgages
$
$
Agricultural
Commercial
Total
$
$
The troubled debt restructurings described above increased the allowance for credit losses by $120,000. There were no charge-offs for the twelve months ended December 31, 2020.
During the year ended December 31, 2020, there were no payment defaults on loans modified as troubled debt restructurings within twelve months following the modification.
The following table presents loans by class modified as troubled debt restructured loans for the year ended December 31, 2019 (in thousands):
December 31, 2019
Troubled Debt Restructurings
Number of
Loans
Pre-Modification
Outstanding
Recorded
Investment
Post-Modification
Outstanding
Recorded
Investment
Agricultural
$
$
Consumer & Other
Total
$
$
The troubled debt restructurings described above increased the allowance for credit losses by $101,000. There were no charge-offs for the twelve months ended December 31, 2019.
During the year ended December 31, 2019, there were no payment defaults on loans modified as troubled debt restructurings within twelve months following the modification.
7. Premises and Equipment
Premises and equipment as of December 31 consisted of the following:
(in thousands)
Land and Buildings
$
60,246
$
53,997
Furniture, Fixtures and Equipment
21,750
21,058
Leasehold Improvement
3,753
3,745
Subtotal
85,749
78,800
Less: Accumulated Depreciation and Amortization
35,602
33,529
Total
$
50,147
$
45,271
Depreciation and amortization on premises and equipment included in occupancy and equipment expense amounted to $2,769,000, $2,756,000, and $2,421,000 for the years ended December 31, 2020, 2019 and 2018, respectively. Rental income was $434,000, $183,000, and $173,000 for the years ended December 31, 2020, 2019, and 2018, respectively.
8. Other Real Estate
The Bank reported $873,000 in other real estate at December 31, 2020, and December 31, 2019. Other real estate includes property no longer utilized for business operations and property acquired through foreclosure proceedings. These properties are carried at fair value less selling costs determined at the date acquired. Losses, if any, arising from properties acquired through foreclosure are charged against the allowance for loan losses at the time of foreclosure. Subsequent declines in value, periodic holding costs, and net gains or losses on disposition are included in other operating expense as incurred. Other real estate is reported in Interest Receivable and Other Assets on the Company’s Consolidated Balance Sheets.
9. Time Deposits
Time Deposits of $250,000 or more as of December 31 were as follows:
(in thousands)
Balance
$
185,944
$
257,392
At December 31, 2020, the scheduled maturities of time deposits were as follows:
(in thousands)
Scheduled Maturities
$
373,332
38,620
7,571
1,630
Total
$
421,868
10. Income Taxes
Current and deferred income tax expense (benefit) provided for the years ended December 31 consisted of the following:
(in thousands)
Current
Federal
$
12,174
$
14,798
$
2,517
State
9,005
7,733
6,224
Total Current
21,179
22,531
8,741
Deferred
Federal
(1,115
)
(3,500
)
5,622
State
(847
)
(160
)
Total Deferred
(1,962
)
(3,254
)
5,462
Total Provision for Taxes
$
19,217
$
19,277
$
14,203
The total provision for income taxes differs from the federal statutory rate as follows:
(in thousands)
Amount
Rate
Amount
Rate
Amount
Rate
Tax Provision at Federal Statutory Rate
$
16,370
21.0
%
$
15,816
21.0
%
$
12,543
21.0
%
Interest on Obligations of States and Political Subdivisions exempt from Federal Taxation
(350
)
(0.4
%)
(358
)
(0.5
%)
(338
)
(0.5
%)
State and Local Income Taxes, Net of Federal Income Tax Benefit
6,445
8.3
%
6,304
8.4
%
4,791
7.9
%
Bank Owned Life Insurance
(444
)
(0.6
%)
(460
)
(0.6
%)
(434
)
(0.7
%)
Low-Income Housing Tax Credit
(2,655
)
(3.4
%)
(2,078
)
(2.8
%)
(1,624
)
(2.7
%)
Out of Period Adjustment
-
0.0
%
-
0.0
%
(802
)
(1.3
%)
Other, Net
(149
)
(0.2
%)
0.1
%
0.1
%
Total Provision for Taxes
$
19,217
24.7
%
$
19,277
25.6
%
$
14,203
23.8
%
The components of net deferred tax assets as of December 31 are as follows: The net deferred tax assets are reported in Interest Receivable and Other Assets on the Company’s Consolidated Balance Sheet.
(in thousands)
Deferred Tax Assets
Allowance for Credit Losses
$
17,248
$
15,925
Accrued Liabilities
8,526
8,452
Deferred Compensation
13,707
14,200
State Franchise Tax
1,891
1,624
Tax Credit Carry Forward
-
1,266
Lease Liability
1,454
1,487
Acquired Net Operating Loss
Fair Value Adjustment on Loans Acquired
Fair Value Adjustment on ORE Acquired
PPP Loan Service Fee Income
1,367
-
Low-Income Housing Investment
Other
Total Deferred Tax Assets
$
45,572
$
44,309
Deferred Tax Liabilities
Premises and Equipment
(1,684
)
(1,974
)
Securities Accretion
(588
)
(370
)
Unrealized Gain on Securities Available-for-Sale
(5,156
)
(935
)
Leasing Activities
(17,183
)
(19,226
)
Core Deposit Intangible Asset
(1,186
)
(1,372
)
ROU Lease Asset
(1,428
)
(1,471
)
Prepaid
(45
)
(66
)
Other
(1,209
)
(898
)
Total Deferred Tax Liabilities
(28,479
)
(26,312
)
Net Deferred Tax Assets
$
17,093
$
17,997
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The CARES Act provides options for accelerating refunds associated with previously paid alternative minimum taxes. The Company benefited from the alternative minimum tax refund provisions of the CARES Act and submitted accelerated refund claims during the year ended December 31, 2020. Based upon the level of historical taxable income and projections for future taxable income over the periods during which the deferred tax assets are expected to be deductible, Management believes it is more likely than not we will realize the benefit of the remaining deferred tax assets.
The Company and its subsidiaries file income tax returns in the U.S. federal and California jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by the tax authorities for the years before 2016.
11. Short Term Borrowings
The Company had unused lines of credit available for short-term liquidity purposes of $1.3 billion at December 31, 2020 and 2019. Federal Funds purchased and advances are generally issued on an overnight basis. There were no advances from the FHLB at December 31, 2020 or 2019. There were no Federal Funds purchased or advances from the FRB at December 31, 2020 or 2019.
12. Federal Home Loan Bank Advances
The Company had no short-term or long-term advances from the Federal Home Loan Bank of San Francisco at December 31, 2020 or 2019.
In accordance with the Collateral Pledge and Security Agreement, advances are secured by all FHLB stock held by the Company. At December 31, 2020, $808.9 million in loans were approved for pledging as collateral on borrowing lines with the FHLB. The borrowing capacity on these loans was $630.5 million.
13. Long-term Subordinated Debentures
In December 2003, the Company formed a wholly owned Connecticut statutory business trust, FMCB Statutory Trust I (“Statutory Trust I”), which issued $10.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures (the “Trust Preferred Securities”). The Company is not considered the primary beneficiary of the trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. These debentures qualify as Tier 1 capital under current regulatory guidelines. All of the common securities of Statutory Trust I are owned by the Company. The proceeds from the issuance of the common securities and the Trust Preferred Securities were used by FMCB Statutory Trust to purchase $10.3 million of junior subordinated debentures of the Company, which carry a floating rate based on three-month LIBOR plus 2.85%. The debentures represent the sole asset of Statutory Trust I. The Trust Preferred Securities accrue and pay distributions at a floating rate of three-month LIBOR plus 2.85% per annum of the stated liquidation value of $1,000 per capital security. The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment to the extent that Statutory Trust I has funds available therefore of: (i) accrued and unpaid distributions required to be paid on the Trust Preferred Securities; (ii) the redemption price with respect to any Trust Preferred Securities called for redemption by Statutory Trust I; and (iii) payments due upon a voluntary or involuntary dissolution, winding up, or liquidation of Statutory Trust I. The Trust Preferred Securities are mandatorily redeemable upon maturity of the subordinated debentures on December 17, 2033, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the subordinated debentures purchased by Statutory Trust I, in whole or in part, on or after December 17, 2008. As specified in the indenture, if the subordinated debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest. Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock.
14. Shareholders’ Equity
In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since then, and most recently, on November 6, 2018, the Board of Directors approved an extension of the $20 million stock repurchase program to December 31, 2021.
Repurchases under the program may be made from time to time on the open market or through private transactions. The repurchase program also requires that no repurchases may be made if the Bank would not remain “well-capitalized” after the repurchase. There were no stock repurchases made in 2020 or 2019 under the Common Stock Repurchase Plan.
On November 23, 2020, the Board of Directors of Farmers & Merchants Bancorp approved, and all applicable regulators provided statements of non-objection regarding, the Company’s repurchase and retirement of up to $8.5 million of its outstanding common stock during the fourth quarter of 2020 and the first half of 2021. These repurchases will be done outside of the Company’s current repurchase plan. All repurchases will be made at the then prevailing market prices. In the fourth quarter of 2020 the Company repurchased $2.8 million of shares from shareholders.
On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights Agent, and the Company declared a dividend of a right to acquire one preferred share purchase right (a “Right”) for each outstanding share of the Company’s common stock, $0.01 par value per share, to stockholders of record at the close of business on August 15, 2008. Generally, the Rights are only triggered and become exercisable if a person or group (the “Acquiring Person”) acquires beneficial ownership of 10 percent or more of the Company’s common stock or announces a tender offer for 10 percent or more of the Company’s common stock.
The Rights Plan is similar to plans adopted by many other publicly traded companies. The effect of the Rights Plan is to discourage any potential acquirer from triggering the Rights without first convincing the Company’s Board of Directors that the proposed acquisition is fair to, and in the best interest of, all of the stockholders of the Company. The provisions of the Plan, if triggered by the Acquiring Person, will substantially dilute the equity and voting interest of any potential acquirer unless the Board of Directors approves of the proposed acquisition (under Article XV of the Company’s Certificate of Incorporation, the Board of Directors has the authority to consider any and all factors in determining whether an acquisition is in the best interests of the Company and its stockholders). Each Right, if and when exercisable, will entitle the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, no par value, at a purchase price of $1,600 for each one one-hundredth of a share, subject to adjustment. Each holder of a Right (except for the Acquiring Person, whose Rights will be null and void upon such event) shall thereafter have the right to receive, upon exercise, that number of Common Shares of the Company having a market value of two times the exercise price of the Right. At any time before a person becomes an Acquiring Person, the Rights can be redeemed, in whole, but not in part, by Farmers and Merchants Bancorp’s Board of Directors at a price of $0.001 per Right.
The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan. Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal. The Board also increased the purchase price under the Rights Plan to $1,600 per one one-hundredth of a preferred share from $1,200, to reflect the increase in the market price of the Company’s common stock over the past several years.
Dividends from the Bank constitute the principal source of cash to the Company. The Company is a legal entity separate and distinct from the Bank. Under regulations controlling California state chartered banks, the Bank is, to some extent, limited in the amount of dividends that can be paid to the Company without prior approval of the California DFPI. These regulations require approval if total dividends declared by a state chartered bank in any calendar year exceed the Bank’s net profits for that year combined with its retained net profits for the preceding two calendar years.
During 2020, the Company issued a combined total 523 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at a price of $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital.
During 2019, the Company issued a combined total 9,312 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at prices ranging from $715.00 to $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital.
During 2018, the Company issued a combined total 13,520 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. There were also 2,400 shares issued to individuals during 2018. All of the shares were issued at prices ranging from $635.00 to $690.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital.
The Company and the Bank are subject to various federal regulatory capital requirements under the Basel III Capital Rules. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The implementation of Basel III requirements increased the required capital levels that the Company and the Bank must maintain. The final rules included new minimum risk-based capital and leverage ratios, which have been fully phased in. The new minimum capital level requirements applicable to the Company and the Bank under the final rules are: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets (“RWA”); (ii) a Tier 1 capital ratio of 6% of RWA; (iii) a total capital ratio of 8% of RWA; and (iv) a Tier 1 leverage ratio of 4% of total assets. The final rules also established a “capital conservation buffer” of 2.5% above each of the new regulatory minimum capital ratios, which resulted in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0% of RWA; (ii) a Tier 1 capital ratio of 8.5% of RWA; and (iii) a total capital ratio of 10.5% of RWA. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. The final rules also permit the Company’s subordinated debentures issued in 2003 to continue to be counted as Tier 1 capital.
The Company believes that it is currently in compliance with all of these capital requirements and that they will not result in any restrictions on the Company’s business activity.
In addition, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since that notification that management believes have changed the Bank’s category.
(in thousands)
Actual
Minimum
Regulatory Capital
Requirements
Well Capitalized
Under Prompt
Corrective Action
December 31, 2020
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total Bank Capital to Risk Weighted Assets
$
446,251
12.46
%
$
286,462
8.00
%
$
358,077
10.00
%
Total Consolidated Capital to Risk Weighted Assets
$
450,890
12.59
%
$
286,539
8.00
%
N/A
N/A
Total Bank Common Equity Tier 1 Capital Ratio
$
401,313
11.21
%
$
161,135
4.50
%
$
232,750
6.50
%
Total Consolidated Common Equity Tier 1 Capital Ratio
$
395,941
11.05
%
$
161,178
4.50
%
N/A
N/A
Tier 1 Bank Capital to Risk Weighted Assets
$
401,313
11.21
%
$
214,846
6.00
%
$
286,462
8.00
%
Tier 1 Consolidated Capital to Risk Weighted Assets
$
405,941
11.33
%
$
214,904
6.00
%
N/A
N/A
Tier 1 Bank Capital to Average Assets
$
401,313
9.04
%
$
177,605
4.00
%
$
222,006
5.00
%
Tier 1 Consolidated Capital to Average Assets
$
405,941
9.13
%
$
177,820
4.00
%
N/A
N/A
(in thousands)
Actual
Minimum
Regulatory Capital
Requirements
Well Capitalized
Under Prompt
Corrective Action
December 31, 2019
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total Bank Capital to Risk Weighted Assets
$
399,230
12.33
%
$
259,012
8.00
%
$
323,765
10.00
%
Total Consolidated Capital to Risk Weighted Assets
$
400,258
12.36
%
$
259,028
8.00
%
N/A
N/A
Total Bank Common Equity Tier 1 Capital Ratio
$
358,576
11.08
%
$
145,694
4.50
%
$
210,447
6.50
%
Total Consolidated Common Equity Tier 1 Capital Ratio
$
349,601
10.80
%
$
145,703
4.50
%
N/A
N/A
Tier 1 Bank Capital to Risk Weighted Assets
$
358,576
11.08
%
$
194,259
6.00
%
$
259,012
8.00
%
Tier 1 Consolidated Capital to Risk Weighted Assets
$
359,601
11.11
%
$
194,271
6.00
%
N/A
N/A
Tier 1 Bank Capital to Average Assets
$
358,576
9.89
%
$
145,079
3.00
%
$
181,349
5.00
%
Tier 1 Consolidated Capital to Average Assets
$
359,601
9.90
%
$
145,255
3.00
%
N/A
N/A
15. Dividends and Basic and Diluted Earnings Per Common Share
Total cash dividends during 2020 were $11,700,000 or $14.75 per share of common stock, an increase of 3.9% per share from $11,221,000 or $14.20 per share in 2019. In 2018, cash dividends totaled $11,151,000 or $13.90 per share.
Basic earnings per common share amounts are computed by dividing net income by the weighted average number of common shares outstanding for the period. The Company has no securities or other contracts, such as stock options, that could require the issuance of additional common stock. Accordingly, diluted earnings per share are equal to basic earnings per share. The following table calculates the basic and diluted earnings per common share for the periods indicated.
(net income in thousands)
Net Income
$
58,734
$
56,036
$
45,527
Weighted Average Number of Common Shares Outstanding
793,337
787,227
801,229
Basic and Diluted Earnings Per Common Share
$
74.03
$
71.18
$
56.82
16. Employee Benefit Plans
Profit Sharing Plan
The Company, through the Bank, sponsors a Profit Sharing Plan for substantially all full-time employees of the Company with one or more years of service. Participants receive up to two annual employer contributions, one is discretionary and the other is mandatory. The discretionary contributions to the Profit Sharing Plan are determined annually by the Board of Directors. The discretionary contributions totaled $1.5 million, $1.4 million, and $1.2 million for the years ended December 31, 2020, 2019, and 2018, respectively. The mandatory contributions to the Profit Sharing Plan are made according to a predetermined set of criteria. Mandatory contributions totaled $1.7 million, $1.6 million, and $1.4 million for the years ended December 31, 2020, 2019, and 2018, respectively. Company employees are permitted, within limitations imposed by tax law, to make pretax contributions and after tax (Roth) contributions to the 401(k) feature of the Profit Sharing Plan. The Company does not match employee contributions within the 401(k) feature of the Profit Sharing Plan and the Company can terminate the Profit Sharing Plan at any time. Benefits pursuant to the Profit Sharing Plan vest 0% during the first year of participation, 25% per full year thereafter and after five years such benefits are fully vested.
Executive Retirement Plan and Life Insurance Arrangements
The Company, through the Bank, sponsors an Executive Retirement Plan (“ERP”) for certain executive level employees. The ERP is a non-qualified deferred compensation plan and was developed to supplement the Company’s Profit Sharing Plan, which, as a qualified retirement plan, has a ceiling on benefits as set by the Internal Revenue Service. The ERP is comprised of: (1) a Performance Component which makes contributions based upon long-term cumulative profitability and increase in market value of the Company; (2) a Salary Component which makes contributions based upon participant salary levels; and (3) an Equity Component for which contributions are discretionary and subject to Board of Directors approval. The Company maintains a Rabbi Trust to fund, in part, the ERP. The Rabbi Trust is an irrevocable grantor trust to which the Company may contribute assets for the limited purpose of funding a nonqualified deferred compensation plan. The Company may not use the assets of the Rabbi Trust for any purpose other than meeting its obligations under the ERP, however, the assets of the Rabbi Trust remain subject to the claims of its creditors and are included in the consolidated financial statements. The Company contributes cash to the Rabbi Trust from time to time for the sole purpose of funding the ERP. The Rabbi Trust will use any cash the Company contributes to purchase shares of common stock of the Company, and other financial instruments, on the open market. ERP contributions are invested in a mix of financial instruments; however, the Equity Component contributions are invested primarily in common stock of the Company.
The Company expensed $6.8 million to the ERP during the year ended December 31, 2020, $6.6 million during the year ended December 31, 2019 and $6.2 million during the year ended December 31, 2018. The Company’s carrying value of the liability under the ERP was $56.7 million as of December 31, 2020 and $50.5 million as of December 31, 2019. The Company’s shares of common stock held as investments in the Rabbi Trust of the ERP as of December 31, 2020 and 2019 totaled 52,980 and 48,133 with an historical cost basis of $31.2 million and $29.1 million, respectively. All amounts have been fully funded into the Rabbi Trust as of December 31, 2020 and 2019. The consolidated investments held in the Rabbi Trust are recorded at fair value with changes in unrealized gains or losses recorded within non-interest income and the equal and offsetting charges in the related liability are recorded in non-interest expense in the consolidated statements of income.
Net gains on ERP plan investments were $1.8 million in 2020 compared to net gains of $2.6 million in 2019. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices.
The Company has purchased single premium life insurance policies on the lives of certain key employees of the Company. These policies provide: (1) financial protection to the Company in the event of the death of a key employee; and (2) significant income to the Company to offset the expense associated with the Executive Retirement Plan and other employee benefit plans, since the interest earned on the cash surrender value of the policies is tax exempt as long as the policies are used to finance employee benefits. As compensation to each employee for agreeing to allow the Company to purchase an insurance policy on his or her life, split dollar agreements have been entered into with those employees. These agreements provide for a division of the life insurance death proceeds between the Company and each employee’s designated beneficiary or beneficiaries.
The Company earned tax-exempt interest on the life insurance policies of $2.1 million for the year ended December 31, 2020, $2.0 million for the year ended December 31, 2019, and $1.9 million for the year ended December 31, 2018. As of December 31, 2020 and 2019, the total cash surrender value of the insurance policies was $69.2 million and $67.1 million, respectively.
Senior Management Retention Plan
The Company, through the Bank, sponsors a Senior Management Retention Plan (“SMRP”) for certain senior level employees. The SMRP is a non-qualified deferred compensation plan and was developed to supplement the Company’s Profit Sharing Plan, which, as a qualified retirement plan, has a ceiling on benefits as set by the Internal Revenue Service. All contributions are discretionary and subject to the Board of Directors approval. The Company maintains a Rabbi Trust to fund, in part, the SMRP. The Rabbi Trust is an irrevocable grantor trust to which the Company may contribute assets for the limited purpose of funding a nonqualified deferred compensation plan. The Company may not use the assets of the Rabbi Trust for any purpose other than meeting its obligations under the SMRP, however, the assets of the Rabbi Trust remain subject to the claims of its creditors and are included in the consolidated financial statements. The Company contributes cash to the Rabbi Trust from time to time for the sole purpose of funding the SMRP. The Rabbi Trust will use any cash the Company contributes to purchase shares of common stock of the Company, and other financial instruments, on the open market. Contributions to the SMRP are invested primarily in common stock of the Company.
The Company expensed $2.3 million to the SMRP during the year ended December 31, 2020, $1.3 million during the year ended December 31, 2019 and $1.5 million during the year ended December 31, 2018. The Company’s carrying value of the liability under the SMRP was $8.6 million as of December 31, 2020 and $6.3 million as of December 31, 2019. The Company’s shares of stock held as investments in the Rabbi Trust of the SMRP as of December 31, 2020 and December 31, 2019 totaled 12,548 and 9,822 shares with an historical cost basis of $7.9 million and $5.8 million, respectively. All amounts have been fully funded into the Rabbi Trust as of December 31, 2020 and 2019. The consolidated investments held in the Rabbi Trust are recorded at fair value with changes in unrealized gains or losses recorded within non-interest income and the equal and offsetting charges in the related liability are recorded in non-interest expense in the consolidated statements of income.
Net gains on SMRP plan investments were $0.1 million in 2020 compared to zero in 2019. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices.
17. Fair Value Measurements
The Company follows the “Fair Value Measurement and Disclosures” topic of the FASB ASC, which establishes a framework for measuring fair value in U.S. GAAP and expands disclosures about fair value measurements. This standard applies whenever other standards require, or permit, assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, this standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:
Level 1 inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.
Level 2 inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, the transfer is reported at the beginning of the reporting period.
Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings.
Securities classified as available-for-sale are reported at fair value on a recurring basis utilizing Level 1, 2 and 3 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.
The Company does not record all loans & leases at fair value on a recurring basis. However, from time to time, a loan or lease is considered impaired and an allowance for credit losses is established. Once a loan or lease is identified as individually impaired, management measures impairment in accordance with the “Receivable” topic of the FASB ASC. The fair value of impaired loans or leases is estimated using one of several methods, including collateral value when the loan is collateral dependent, market value of similar debt, enterprise value, and discounted cash flows. Impaired loans & leases not requiring an allowance represent loans & leases for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans & leases. Impaired loans & leases where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The fair value of collateral dependent impaired loans is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including sales comparison, cost and the income approach. Adjustments are often made in the appraisal process by the appraisers to take in to account differences between the comparable sales and income and other available data. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for Level 3 nonrecurring impaired loans is primarily the sales comparison approach less selling costs of 10%.
Other Real Estate (“ORE”) is reported at fair value on a non-recurring basis. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including sales comparison, cost and the income approach. Adjustments are often made in the appraisal process by the appraisers to take in to account differences between the comparable sales and income and other available data. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for Level 3 nonrecurring ORE is primarily the sales comparison approach less selling costs of 10%.
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value for the periods indicated.
Fair Value Measurements
At December 31, 2020, Using
(in thousands)
Fair Value
Total
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Available-for-Sale Securities:
US Treasury Notes
$
15,288
$
15,288
$
-
$
-
US Government Agency SBA
8,160
-
8,160
-
Mortgage Backed Securities
737,873
-
737,873
-
Corporate Securities
45,919
-
45,919
-
Other
-
Total Assets Measured at Fair Value On a Recurring Basis
$
807,732
$
15,470
$
792,262
$
-
Fair Value Measurements
At December 31, 2019, Using
(in thousands)
Fair Value
Total
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Available-for-Sale Securities:
US Treasury Notes
$
54,995
$
54,995
$
-
$
-
US Government Agency SBA
10,798
-
10,798
-
Mortgage Backed Securities
441,078
-
441,078
-
Other
-
Total Assets Measured at Fair Value On a Recurring Basis
$
507,386
$
55,200
$
452,186
$
-
Fair values for Level 2 available-for-sale investment securities are based on quoted market prices for similar securities. During the year ended December 31, 2020, there were no transfers in or out of level 1, 2, or 3.
The following tables present information about the Company’s impaired loans & leases and other real estate, classes of assets or liabilities that the Company carries at fair value on a non-recurring basis, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value for the periods indicated. Not all impaired loans & leases are carried at fair value. Impaired loans & leases are only included in the following tables when their fair value is based upon an appraisal of the collateral, and if that appraisal results in a partial charge-off or the establishment of a specific reserve.
Fair Value Measurements
At December 31, 2020, Using
(in thousands)
Fair Value
Total
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired Loans:
Residential 1st Mortgage
$
1,584
$
-
$
-
$
1,584
Home Equity Lines and Loans
-
-
Agricultural
-
-
Commercial
-
-
Consumer
-
-
Total Impaired Loans
2,396
-
-
2,396
Other Real Estate:
Real Estate Construction
-
-
Total Other Real Estate
-
-
Total Assets Measured at Fair Value On a Non-Recurring Basis
$
3,269
$
-
$
-
$
3,269
Fair Value Measurements
At December 31, 2019, Using
(in thousands)
Fair Value
Total
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired Loans:
Commercial Real Estate
$
2,588
$
-
$
-
$
2,588
Residential 1st Mortgage
1,403
-
-
1,403
Home Equity Lines and Loans
-
-
Agricultural
-
-
Commercial
1,391
-
-
1,391
Consumer
-
-
Total Impaired Loans
5,751
-
-
5,751
Other Real Estate:
Real Estate Construction
-
-
Total Other Real Estate
-
-
Total Assets Measured at Fair Value On a Non-Recurring Basis
$
6,624
$
-
$
-
$
6,624
The Company’s property appraisals are primarily based on the sales comparison approach and the income approach methodologies, which consider recent sales of comparable properties, including their income generating characteristics, and then make adjustments to reflect the general assumptions that a market participant would make when analyzing the property for purchase. These adjustments may increase or decrease an appraised value and can vary significantly depending on the location, physical characteristics and income producing potential of each property. Additionally, the quality and volume of market information available at the time of the appraisal can vary from period to period and cause significant changes to the nature and magnitude of comparable sale adjustments. Given these variations, comparable sale adjustments are generally not a reliable indicator for how fair value will increase or decrease from period to period. Under certain circumstances, management discounts are applied based on specific characteristics of an individual property.
The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at December 31, 2020 and 2019:
December 31, 2020
(in thousands)
Fair Value
Valuation Technique
Unobservable Inputs
Range, Weighted Avg.
Impaired Loans:
Residential 1st Mortgage
$
1,584
Sales Comparison Approach
Adjustment for Difference
Between Comparable Sales
0.72% - 4.13%, 2.57
%
Home Equity Lines and Loans
$
Sales Comparison Approach
Adjustment for Difference
Between Comparable Sales
1.1% - 1.4%, 1.25
%
Agricultural
$
Income Approach
Capitalization Rate
10%, 10
%
Commercial
$
Income Approach
Capitalization Rate
10%, 10
%
Consumer
$
Income Approach
Adjustment for Difference
Between Comparable Sales
10%, 10
%
Other Real Estate:
Real Estate Construction
$
Sales Comparison Approach
Adjustment for Difference
Between Comparable Sales
10%, 10
%
December 31, 2019
(in thousands)
Fair Value
Valuation Technique
Unobservable Inputs
Range, Weighted Avg.
Impaired Loans:
Commercial Real Estate
$
2,588
Income Approach
Capitalization Rate
3.3
%
Residential 1st Mortgages
$
1,403
Sales Comparison Approach
Adjustment for Difference
Between Comparable Sales
0.8% - 6.4%, 3
%
Home Equity Lines and Loans
$
Sales Comparison Approach
Adjustment for Difference
Between Comparable Sales
1% - 2%, 1.3
%
Agricultural
$
Income Approach
Capitalization Rate
4.3
%
Commercial
$
1,391
Income Approach
Capitalization Rate
3.3
%
Consumer
$
Sales Comparison Approach
Adjustment for Difference
Between Comparable Sales
40.6
%
Other Real Estate:
Real Estate Construction
$
Sales Comparison Approach
Adjustment for Difference
Between Comparable Sales
%
18. Fair Value of Financial Instruments
U.S. GAAP requires disclosure of fair value information about financial instruments, whether or not recognized on the balance sheet, for which it is practical to estimate that value. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization. The fair value of loans held for investment, excluding previously presented impaired loans measured at fair value on a non-recurring basis, is estimated using discounted cash flow analyses consistent with ASC 820. The discount rates used to determine fair value use interest rate spreads that reflect factors such as liquidity, risk premium, credit, and nonperformance risk of the loans. Loans are considered a Level 3 classification.
The following tables summarize the carrying value and estimated fair value of financial instruments for the periods indicated:
Fair Value of Financial Instruments Using
December 31, 2020
(in thousands)
Carrying
Amount
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Estimated
Fair Value
Assets:
Cash and Cash Equivalents
$
383,837
$
383,837
$
-
$
-
$
383,837
Investment Securities Available-for-Sale
807,732
15,470
792,262
-
807,732
Investment Securities Held-to-Maturity
68,933
-
26,262
43,787
70,049
Loans & Leases, Net
3,040,730
-
-
3,045,911
3,045,911
Accrued Interest Receivable
20,333
-
20,333
-
20,333
Liabilities:
Deposits
4,060,267
3,638,400
-
422,840
4,061,240
Subordinated Debentures
10,310
-
6,888
-
6,888
Accrued Interest Payable
1,383
-
1,383
-
1,383
Fair Value of Financial Instruments Using
December 31, 2019
(in thousands)
Carrying
Amount
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Estimated
Fair Value
Assets:
Cash and Cash Equivalents
$
294,758
$
294,758
$
-
$
-
$
294,758
Investment Securities Available-for-Sale
507,386
55,200
452,186
-
507,386
Investment Securities Held-to-Maturity
60,229
-
31,253
29,844
61,097
Loans & Leases, Net
2,618,015
-
-
2,584,805
2,584,805
Accrued Interest Receivable
16,733
-
16,733
-
16,733
Liabilities:
Deposits
3,278,019
2,760,097
-
517,172
3,277,269
Subordinated Debentures
10,310
-
7,325
-
7,325
Accrued Interest Payable
2,795
-
2,795
-
2,795
19. Commitments and Contingencies
In the normal course of business, the Company enters into financial instruments with off balance sheet risk in order to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These instruments include commitments to extend credit, letters of credit, and other types of financial guarantees. The Company had the following off balance sheet commitments as of the dates indicated.
(in thousands)
December 31, 2020
December 31, 2019
Commitments to Extend Credit
$
1,040,844
$
919,982
Letters of Credit
18,846
20,346
Performance Guarantees Under Interest Rate Swap Contracts Entered Into Between Our Borrowing Customers and Third Parties
2,786
1,513
The Company’s exposure to credit loss in the event of nonperformance by the other party with regard to standby letters of credit, undisbursed loan commitments, and financial guarantees is represented by the contractual notional amount of those instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded balance sheet items. The Company may or may not require collateral or other security to support financial instruments with credit risk. Evaluations of each customer’s creditworthiness are performed on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third party. Outstanding standby letters of credit have maturity dates ranging from 1 to 25 months with final expiration in January 2022. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.
In the ordinary course of business, the Company becomes involved in litigation arising out of its normal business activities. Management, after consultation with legal counsel, believes that the ultimate liability, if any, resulting from the disposition of such claims would not be material in relation to the financial position of the Company.
The Company may be required to maintain average reserves on deposit with the Federal Reserve Bank primarily based on deposits outstanding. Reserve requirements are offset by the Company’s vault cash and deposit balances maintained with the Federal Reserve Bank.
20. Leases
Lessee - Operating Leases
Effective January 1, 2019, the Company adopted the provisions of Accounting Standards Update (“ASU”) No. 2016-02, “Leases (Topic 842),” for all open leases with a term greater than one year as of the adoption date, using the modified retrospective approach. Prior comparable periods are presented in accordance with previous guidance under Accounting Standards Codification ASC 840.
Operating leases in which we are the lessee are recorded as operating lease right-of-use (“ROU”) assets and operating lease liabilities, included in other assets and other liabilities, respectively, on our consolidated balance sheets. We do not currently have any significant finance leases in which we are the lessee.
Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate at the lease commencement date. ROU assets are further adjusted for lease incentives. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded net in occupancy expense in the consolidated statements of income.
Our leases relate primarily to office space and bank branches with remaining lease terms of generally 1 to 10 years. Certain lease arrangements contain extension options which typically range from 5 to 10 years at the then fair market rental rates. ASC 842 requires lessees to evaluate whether option periods, if available, will be exercised in order to determine the full life of the lease. The Company used the first option period, unless it is a relatively new lease that has a long initial lease term or other extenuating circumstances.
As of December 31, 2020, operating lease ROU assets and liabilities were $4.80 million and $4.92 million, respectively. Operating lease expenses totaled $833,000 for the year ended December 31, 2020. As of December 31, 2019, operating lease ROU assets and liabilities were $4.98 million and $5.03 million, respectively. Operating leases totaled $836,000 for the year ended December 31, 2019. In the 4th quarter of 2020, the lease term and payment of one lease was modified resulting in additional ROU assets and liabilities of $542,000.
The table below summarizes the information related to our operating leases:
(in thousands except for percent and period data)
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Cash Paid for Amounts Included in the Measurement of Lease Liabilities Operating Cash Flow from Operating Leases
$
$
Right-of-Use Assets Obtained in Exchange for New Operating Lease Liabilities
$
-
$
5,645
Weighted-Average Remaining Lease Term - Operating Leases, in Years
7.33
7.88
Weighted-Average Discount Rate - Operating Leases
2.9
%
3.2
%
The table below summarizes the maturity of remaining lease liability:
(in thousands)
December 31, 2020
2026 and thereafter
1,907
Total Lease Payments
5,486
Less: Interest
(568
)
Present Value of Lease Liabilities
$
4,918
As of December 31, 2020, we have no additional operating leases for office space that have not yet commenced or that are anticipated to commence during the first quarter of 2021.
Lessor - Direct Financing Leases
The Company is the lessor in direct finance lease arrangements. Leases are recorded at the principal balance outstanding, net of unearned income and charge-offs. Interest income is recognized using the interest method. Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease. The impact of adopting Topic 842 for lessor accounting was not significant.
Lease payments due to the Company are typically fixed and paid in equal installments over the lease term. Variable lease payments that do not depend on an index or a rate (e.g., property taxes) that are paid directly by the Company are minimal. The majority of property taxes are paid directly by the client to a third party and are not considered part of variable payments and therefore are not recorded by the Company.
As a lessor, the Company leases certain types of agriculture equipment, solar equipment, construction equipment and other equipment to its customers. The Company’s net investment in direct financing leases was $103.5 million at December 31, 2020 and $105.4 million at December 31, 2019.
21. Recent Accounting Pronouncements
Accounting Guidance Pending Adoption at December 31, 2020
The following paragraphs provide descriptions of newly issued but not yet effective accounting standards that could have a material effect on the Company’s financial position or results of operations.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740). The updated guidance simplifies the accounting for income taxes by removing certain exceptions and improves the consistent application of GAAP by clarifying and amending other existing guidance. ASU 2019-012 will be effective for us on January 1, 2021 and is not expected to have any material impact on our consolidated financial statements.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments in this ASU may be elected as of March 12, 2020 through December 31, 2022. An entity may choose to elect the amendments in this update at an interim period subsequent to March 12, 2020 with adoption methods varying based on transaction type. We have not elected to apply these amendments. However, we will assess the applicability of the ASU to us and continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.
22. Parent Company Financial Information
The following financial information is presented as of December 31 for the periods indicated.
Farmers & Merchants Bancorp
Condensed Balance Sheets
(in thousands)
Cash
$
4,551
$
1,341
Investment in Farmers & Merchants Bank of Central California
429,037
378,271
Investment Securities
Other Assets
Total Assets
$
434,854
$
380,125
Subordinated Debentures
$
10,310
$
10,310
Liabilities
Shareholders’ Equity
423,665
369,296
Total Liabilities and Shareholders’ Equity
$
434,854
$
380,125
Farmers & Merchants Bancorp
Condensed Statements of Income
Year Ended December 31,
(in thousands)
Equity (Loss) in Undistributed Earnings in Farmers & Merchants Bank of Central California
$
40,597
$
44,571
$
(26,488
)
Dividends from Subsidiary
19,874
13,166
73,010
Interest Income
Other Expenses, Net
(2,477
)
(2,416
)
(1,527
)
Tax Benefit
Net Income
$
58,734
$
56,036
$
45,527
Farmers & Merchants Bancorp
Condensed Statements of Cash Flows
Year Ended December 31,
(in thousands)
Cash Flows from Operating Activities:
Net Income
$
58,734
$
56,036
$
45,527
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
(Equity) Loss in Undistributed Net Earnings from Subsidiary
(40,597
)
(44,571
)
26,488
Net (Increase) in Other Assets
(753
)
(160
)
(125
)
Net Increase (Decrease) in Liabilities
(942
)
Net Cash Provided by Operating Activities
17,744
11,527
70,948
Investing Activities:
Payments for Business Acquisition
-
-
(28,642
)
Payments for Investments in Non-Qualified Retirement Plan
(403
)
(6,273
)
(10,503
)
Net Cash Used by Investing Activities
(403
)
(6,273
)
(39,145
)
Financing Activities:
Stock Repurchased
(2,834
)
-
(31,152
)
Issuance of Common Stock
6,973
10,503
Cash Dividends
(11,700
)
(11,221
)
(11,151
)
Net Cash Used by Financing Activities
(14,131
)
(4,248
)
(31,800
)
Increase in Cash and Cash Equivalents
3,210
1,006
Cash and Cash Equivalents at Beginning of Year
1,341
Cash and Cash Equivalents at End of Year
$
4,551
$
1,341
$
23. Quarterly Unaudited Financial Data
The following tables set forth certain unaudited historical quarterly financial data for each of the eight consecutive quarters in 2020 and 2019. This information is derived from unaudited consolidated financial statements that include, in management’s opinion, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation when read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Form 10-K.
(in thousands except per share data)
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Total
Total Interest Income
$
38,689
$
37,967
$
39,793
$
42,203
$
158,652
Total Interest Expense
3,263
2,552
2,094
1,582
9,491
Net Interest Income
35,426
35,415
37,699
40,621
149,161
Provision for Credit Losses
-
1,700
2,500
4,500
Net Interest Income After
Provision for Credit Losses
35,426
35,115
35,999
38,121
144,661
Total Non-Interest Income
2,927
3,514
4,539
4,716
15,696
Total Non-Interest Expense
19,790
19,787
20,783
22,046
82,406
Income Before Income Taxes
18,563
18,842
19,755
20,791
77,951
Provision for Income Taxes
4,441
4,533
4,945
5,298
19,217
Net Income
$
14,122
$
14,309
$
14,810
$
15,493
$
58,734
Basic and Diluted Earnings Per Common Share
$
17.80
$
18.03
$
18.66
$
19.54
$
74.03
(in thousands except per share data)
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Total
Total Interest Income
$
37,173
$
38,626
$
38,810
$
39,099
$
153,708
Total Interest Expense
2,966
3,253
3,530
3,445
13,194
Net Interest Income
34,207
35,373
35,280
35,654
140,514
Provision for Credit Losses
-
-
-
Net Interest Income After
Provision for Credit Losses
34,207
35,173
35,280
35,654
140,314
Total Non-Interest Income
4,464
4,400
3,974
4,403
17,241
Total Non-Interest Expense
20,445
20,565
20,856
20,376
82,242
Income Before Income Taxes
18,226
19,008
18,398
19,681
75,313
Provision for Income Taxes
4,677
4,903
4,660
5,037
19,277
Net Income
$
13,549
$
14,105
$
13,738
$
14,644
$
56,036
Basic and Diluted Earnings Per Common Share
$
17.27
$
17.92
$
17.45
$
18.54
$
71.18

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
The Company maintains controls and procedures designed to ensure that all relevant information is recorded and reported in all filings of financial reports. Such information is reported to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer to allow timely and accurate disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e). In accordance with Rule 13a-15(b) of the Exchange Act, we carried out an evaluation as of December 31, 2019, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of December 31, 2020.
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Company completed its evaluation.
Farmers & Merchants Bancorp
Report of Management on Internal Control Over Financial Reporting
Management of Farmers & Merchants Bancorp and Subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2020. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
The Company’s system of internal control over financial reporting includes policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management recognizes that there are inherent limitations in the effectiveness of any system of internal control, and accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation and fair presentation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020 as described in “Internal Control-Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations of the Treadway Commission. As a result of this assessment, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2020.
Moss Adams LLP, the independent registered public accounting firm that audited the financial statements included in this Annual Report, was engaged to express an opinion as to the fairness of presentation of such financial statements. Moss Adams LLP was also engaged to audit the effectiveness of the Company’s internal control over financial reporting.
/s/ Kent A. Steinwert
/s/ Stephen W. Haley
Kent A. Steinwert
Stephen W. Haley
Chairman, President & Chief Executive Officer
Executive Vice President & Chief Financial Officer

---

ITEM 9B. OTHER INFORMATION
Item 9B. Other Information
None
PART III

---

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors, Executive Officers and Corporate Governance
Set forth below is certain information regarding the Executive Officers of the Company and/or Bank:
Name and Position(s)
Age
Principal Occupation during the Past Five Years
Kent A. Steinwert
Chairman, President
& Chief Executive Officer
of the Company and Bank
Chairman, President & Chief Executive Officer of the Company and Bank.
Deborah E. Skinner
Executive Vice President & Chief Administrative Officer of the Bank
Executive Vice President & Chief Administrative Officer of the Bank.
Stephen W. Haley
Executive Vice President
& Chief Financial Officer & Secretary of the Company and
Bank
Executive Vice President & Chief Financial Officer of the Company and Bank.
Kenneth W. Smith
Executive Vice President
& Senior Credit Officer
of the Company and Bank
Executive Vice President & Senior Credit Officer of the Company and Bank.
David M. Zitterow
Executive Vice President,
Wholesale Banking Division
of the Bank
Executive Vice President, Wholesale Banking Division of the Bank since May 2017.
Senior Vice President - Northern California Regional Executive - Umpqua Bank, April 2014 - May 2017.
Jay J. Colombini
Executive Vice President,
Wholesale Banking Division
of the Bank
Executive Vice President, Wholesale Banking Division of the Bank.
Ryan J. Misasi
Executive Vice President,
Retail Banking Division of the Bank
Executive Vice President, Retail Banking Division of the Bank.
Also, see “Election of Directors” and “Compliance with Section 16(a) of the Exchange Act” in the Company’s definitive proxy statement for the 2021 Annual Meeting of Stockholders which will be filed with the SEC and which is incorporated herein by reference. During 2020, there were no changes in procedures for the election of directors.
The Company has adopted a Code of Conduct, which complies with the Code of Ethics requirements of the SEC. A copy of the Code of Conduct is posted on the Company’s website. The Company intends to disclose promptly any amendment to, or waiver from any provision of, the Code of Conduct applicable to senior financial officers, and any waiver from any provision of the Code of Conduct applicable to directors, on its website on the About Us page. The Company’s website address is www.fmbonline.com. This website address is for information only and is not intended to be an active link, or to incorporate any website information into this document.

---

ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation
The information required by Item 11 of Form 10-K is incorporated by reference from the information contained in the Company’s definitive proxy statement for the 2021 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A.

---

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 of Form 10-K is incorporated by reference from the information contained in the Company’s definitive proxy statement for the 2021 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A. The Company does not have any equity compensation plans, which require disclosure under Item 201(d) of Regulation S-K.

---

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 of Form 10-K is incorporated by reference from the information contained in the Company’s definitive proxy statement for the 2021 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A.

---

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accounting Fees and Services
The information required by Item 14 of Form 10-K is incorporated by reference from the information contained in the Company’s definitive proxy statement for the 2021 Annual Meeting of Stockholders, which will be filed pursuant to Regulation 14A.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits, Financial Statement Schedules
(a) (1) Financial Statements. Incorporated herein by reference, are listed in Item 8 hereof.
(2) Financial Statement Schedules. Not applicable.
(3) Exhibits.
Exhibit
Number
Description
3.1
Amended Certificate of Incorporation (incorporated by reference to Proposal #2 in the Registrant’s Definitive Proxy Statement on Schedule 14A for its 2012 Annual Meeting of Stockholders, Appendices 1 and 2 to the Registrant's Definitive Proxy Statement on Schedule 14A for its 2007 Annual Meeting of Stockholders, and Exhibit 3(i) to the Registrant's Current Report on Form 8-K dated April 30, 1999).
3.2
Amended By-Laws (incorporated by reference to the Registrant’s Current Report on Form 8-K dated April 4, 2016, the Registrant’s Current Report on Form 8-K dated September 19, 2008, Appendix 3 to the Registrant's Definitive Proxy Statement on Schedule 14A for its 2007 Annual Meeting of Stockholders, Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated June 7, 2005, and Exhibit 3(ii) to the Registrant's Current Report on Form 8-K dated April 30, 1999).
3.3
Certificate of Designation for the Series A Junior Participating Preferred Stock (included as Exhibit A to the Rights Agreement between Farmers & Merchants Bancorp and Registrar and Transfer Company, dated as of August 5, 2008, filed as Exhibit 4.1 below), filed on the Registrant’s Form 10-Q for the quarter ended June 30, 2008, is incorporated herein by reference.
4.1
Rights Agreement between Farmers & Merchants Bancorp and Registrar and Transfer Company, dated as of August 5, 2008, including Form of Right Certificate attached thereto as Exhibit B, filed on the Registrant’s Form 10-Q for the quarter ended June 30, 2008, is incorporated herein by reference.
4.2
Amendment No. 1 to Rights Agreement between Farmers & Merchants Bancorp and Computershare Trust, N.A., as Rights Agent, dated as of February 18, 2016, incorporated herein by reference to Exhibit 4.2 of the Registrant’s Form 8-A/A filed on February 19, 2016.
4.3
Description of F&M Bancorp Capital Stock, filed on Registrant’s Form 10-K for the year ended December 31, 2019.
10.1
Amended and Restated Employment Agreement effective August 1, 2019, between Farmers & Merchants Bank of Central California and Kent A. Steinwert, filed on Registrant’s Form 10-Q for the quarter ended June 30, 2019, is incorporated herein by reference.
10.3
Amended and Restated Employment Agreement effective August 1, 2019, between Farmers & Merchants Bank of Central California and Deborah E. Skinner, filed on Registrant’s Form 10-Q for the quarter ended June 30, 2019, is incorporated herein by reference.
10.4
Amended and Restated Employment Agreement effective August 1, 2019, between Farmers & Merchants Bank of Central California and Kenneth W. Smith, filed on Registrant’s Form 10-Q for the quarter ended June 30, 2019, is incorporated herein by reference.
10.6
Amended and Restated Employment Agreement effective August 1, 2019, between Farmers & Merchants Bank of Central California and Stephen W. Haley, filed on Registrant’s Form 10-Q for the quarter ended June 30, 2019, is incorporated herein by reference.
10.8
Amended and Restated Employment Agreement effective August 1, 2019, between Farmers & Merchants Bank of Central California and Jay J. Colombini, filed on Registrant’s Form 10-Q for the quarter ended June 30, 2019, is incorporated herein by reference.
10.10
Amended and Restated Employment Agreement effective August 1, 2019, between Farmers & Merchants Bank of Central California and Ryan J. Misasi, filed on Registrant’s Form 10-Q for the quarter ended June 30, 2019, is incorporated herein by reference.
10.11
Employment Agreement effective May 1, 2017, between Farmers & Merchants Bank of Central California and David M. Zitterow, filed on the Registrant’s Current Report on Form 8-K dated June 30, 2017, is incorporated herein by reference.
10.15
Executive Retirement Plan - Performance Component as amended on November 5, 2010, filed on Registrant’s Form 10-Q for the period ended September 30, 2010, is incorporated herein by reference.
10.16
Executive Retirement Plan - Retention Component as amended on November 5, 2010, filed on Registrant’s Form 10-Q for the period ended September 30, 2010, is incorporated herein by reference.
10.17
Executive Retirement Plan - Salary Component, amended and restated on November 29, 2014, filed on Registrant’s Form 10-K for the year ended December 31, 2014, is incorporated herein by reference.
10.19
Executive Retirement Plan - Equity Component, amended and restated on November 29, 2014, filed on Registrant’s Form 10-K for the year ended December 31, 2014, is incorporated herein by reference.
10.20
Senior Management Retention Plan, amended and restated on November 29, 2014, filed on Registrant’s Form 10-K for the year ended December 31, 2014, is incorporated herein by reference.
Code of Conduct of Farmers & Merchants Bancorp, filed on Registrant’s Form 10-K for the year ended December 31, 2003, is incorporated herein by reference.
Subsidiaries of the Registrant, filed on Registrant’s Form 10-K for the year ended December 31, 2003, is incorporated herein by reference.
31(a)
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31(b)
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
101.INS
Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document).
101.SCH
Inline XBRL Taxonomy Extension Schema Document.
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document.
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
*Filed herewith