FMCB 10-Q Quarterly Report March 31, 2020

FARMERS & MERCHANTS BANCORP

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10-Q 1 form10q.htm 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission File Number: 000-26099

FARMERS & MERCHANTS BANCORP

(Exact name of registrant as specified in its charter)

Delaware		94-332782
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

111 W. Pine Street, Lodi, California		95240
(Address of principal executive offices)		(Zip Code)

Registrant's telephone number, including area code (209) 367-2300

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically, if any, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐

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

Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐
Smaller reporting company ☐	Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Y es ☐ No ☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	FMCB	OTCQX

Number of shares of common stock of the registrant 793,556 outstanding as of May 8, 2020.

FARMERS & MERCHANTS BANCORP

FORM 10-Q

TABLE OF CONTENTS

PART I. - FINANCIAL INFORMATION			Page

	Item 1 - Financial Statements

		Consolidated Balance Sheets (Unaudited) as of March 31, 2020, December 31, 2019 and March 31, 2019.	3

		Consolidated Statements of Income (Unaudited) for the Three Months Ended March 31, 2020 and 2019.	4

		Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months Ended March 31, 2020 and 2019.	5

		Consolidated Statements of Changes in Shareholders' Equity (Unaudited) for the Three Months Ended March 31, 2020 and 2019.	6

		Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2020 and 2019.	7

		Notes to the Consolidated Financial Statements (Unaudited)	8

	Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations		35

	Item 3 - Quantitative and Qualitative Disclosures About Market Risk		53

	Item 4 - Controls and Procedures		56

PART II. - OTHER INFORMATION

	Item 1 - Legal Proceedings		57

	Item 1A – Risk Factors		57

	Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds		57

	Item 3 - Defaults Upon Senior Securities		57

	Item 4 – Mine Safety Disclosures		57

	Item 5 - Other Information		57

	Item 6 - Exhibits		58

Signatures			59

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

FARMERS & MERCHANTS BANCORP

Consolidated Balance Sheets

(in thousands except share data)

Assets	March 31, 2020 (Unaudited)		December 31, 2019		March 31, 2019 (Unaudited)
Cash and Cash Equivalents:
Cash and Due from Banks	$	57,304	$	71,564	$	54,444
Interest Bearing Deposits with Banks		225,656		223,194		43,366
Total Cash and Cash Equivalents		282,960		294,758		97,810

Investment Securities:
Available-for-Sale, at Fair Value		532,246		507,386		491,289
Held-to-Maturity		58,701		60,229		54,412
Total Investment Securities		590,947		567,615		545,701

Loans & Leases:		2,670,109		2,673,027		2,563,968
Less: Allowance for Credit Losses		54,824		55,012		54,907
Loans & Leases, Net		2,615,285		2,618,015		2,509,061

Premises and Equipment, Net		45,910		45,271		32,380
Bank Owned Life Insurance, Net		67,657		67,148		65,609
Interest Receivable and Other Assets		117,682		129,023		145,354
Total Assets	$	3,720,441	$	3,721,830	$	3,395,915

Liabilities
Deposits:
Demand	$	1,009,561	$	1,067,187	$	915,164
Interest Bearing Transaction		695,283		697,952		655,117
Savings and Money Market		1,028,681		994,958		912,977
Time		521,748		517,922		524,782
Total Deposits		3,255,273		3,278,019		3,008,040

Subordinated Debentures		10,310		10,310		10,310
Interest Payable and Other Liabilities		60,628		64,205		47,247
Total Liabilities		3,326,211		3,352,534		3,065,597

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, 793,556, 793,033 and 787,307, Shares Issued and Outstanding at March 31, 2020, December 31, 2019 and March 31, 2019, Respectively		8		8		8
Additional Paid-In Capital		80,350		79,947		75,538
Retained Earnings		300,158		286,036		254,770
Accumulated Other Comprehensive Income		13,714		3,305		2
Total Shareholders' Equity		394,230		369,296		330,318
Total Liabilities and Shareholders' Equity	$	3,720,441	$	3,721,830	$	3,395,915

The accompanying notes are an integral part of these unaudited consolidated financial statements

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FARMERS & MERCHANTS BANCORP Consolidated Statements of Income (Unaudited)
(in thousands except per share data)	Three Months Ended March 31,
	2020			2019
Interest Income
Interest and Fees on Loans & Leases	$	34,160		$	33,177
Interest on Deposits with Banks		947			1,125
Interest on Investment Securities:
Taxable		3,152			2,427
Exempt from Federal Tax		430			444
Total Interest Income		38,689			37,173

Interest Expense
Deposits		3,144			2,821
Subordinated Debentures		119			145
Total Interest Expense		3,263			2,966

Net Interest Income		35,426			34,207
Provision for Credit Losses		-			-
Net Interest Income After Provision for Credit Losses		35,426			34,207

Non-Interest Income
Service Charges on Deposit Accounts		920			876
Net Gain on Sale of Investment Securities		13			-
Increase in Cash Surrender Value of Life Insurance		509			492
Debit Card and ATM Fees		1,277			1,177
Net (Loss) Gain on Deferred Compensation Investments		(662	)		1,045
Other		870			874
Total Non-Interest Income		2,927			4,464

Non-Interest Expense
Salaries and Employee Benefits		14,880			13,424
Net (Loss) Gain on Deferred Compensation Investments		(662	)		1,045
Occupancy		1,106			1,040
Equipment		1,168			1,177
Marketing		245			380
Legal		30			869
FDIC Insurance		-			241
Other		3,023			2,269
Total Non-Interest Expense		19,790			20,445

Income Before Provision for Income Taxes		18,563			18,226
Provision for Income Taxes		4,441			4,677
Net Income	$	14,122		$	13,549
Basic and Diluted Earnings Per Common Share	$	17.80		$	17.27

The accompanying notes are an integral part of these unaudited consolidated financial statements

Table of Contents

FARMERS & MERCHANTS BANCORP

Consolidated Statements of Comprehensive Income (Unaudited)

(in thousands)

	Three Months Ended March 31,
	2020			2019
Net Income	$	14,122		$	13,549

Other Comprehensive Income
Increase in Net Unrealized Gain on Available-for-Sale Securities		14,790			4,246
Deferred Tax Benefit Related to Unrealized Gains		(4,372	)		(1,256	)
Reclassification Adjustment for Realized Gains on Available-for-Sale Securities Included in Net Income		(13	)		-
Deferred Tax Benefit Related to Reclassification Adjustment		4			-
Change in Net Unrealized Gain on Available-for-Sale Securities, Net of Tax		10,409			2,990
Total Other Comprehensive Income		10,409			2,990
Comprehensive Income	$	24,531		$	16,539

The accompanying notes are an integral part of these unaudited consolidated financial statements

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Farmers & Merchants Bancorp

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)

(in thousands except share data)

	Common Shares Outstanding		Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Loss, net			Total Shareholders' Equity
Balance, January 1, 2019		783,721	$	8	$	72,974	$	241,221	$	(2,988	)	$	311,215
Net Income				-		-		13,549		-			13,549
Issuance of Common Stock		3,586		-		2,564		-		-			2,564
Change in Net Unrealized Gain on Securities Available-for-Sale, net of tax				-		-		-		2,990			2,990
Balance, March 31, 2019		787,307	$	8	$	75,538	$	254,770	$	2		$	330,318

Balance, January 1, 2020		793,033	$	8	$	79,947	$	286,036	$	3,305		$	369,296
Net Income				-		-		14,122		-			14,122
Issuance of Common Stock		523		-		403		-		-			403
Change in Net Unrealized Gain on Securities Available-for-Sale, net of tax				-		-		-		10,409			10,409
Balance, March 31, 2020		793,556	$	8	$	80,350	$	300,158	$	13,714		$	394,230

The accompanying notes are an integral part of these unaudited consolidated financial statements

Table of Contents

FARMERS & MERCHANTS BANCORP

Consolidated Statements of Cash Flows (Unaudited)

	Three Months Ended
(in thousands)	March 31, 2020			March 31, 2019
Operating Activities:
Net Income	$	14,122		$	13,549
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Depreciation and Amortization		709			692
Net Amortization of Investment Security Premiums & Discounts		125			115
Amortization of Core Deposit Intangible		157			160
Accretion of Discount on Acquired Loans		(90	)		(5	)
Net Gain on Sale of Investment Securities		(13	)		-
Net Change in Operating Assets & Liabilities:
Net Decrease in Interest Receivable and Other Assets		8,718			6,456
Net Decrease in Interest Payable and Other Liabilities		(3,417	)		(2,080	)
Net Cash Provided by Operating Activities		20,311			18,887
Investing Activities:
Purchase of Investment Securities Available-for-Sale		(67,661	)		(155,798	)
Proceeds from Sold, Matured or Called Securities Available-for-Sale		57,595			138,952
Purchase of Investment Securities Held-to-Maturity		(2,380	)		(2,025	)
Proceeds from Matured or Called Securities Held-to-Maturity		3,904			1,160
Net Loans & Leases Paid, Originated or Acquired		2,743			6,877
Principal Collected on Loans & Leases Previously Charged Off		77			42
Additions to Premises and Equipment, Net		(1,352	)		(449	)
Purchase of Other Investments		(2,289	)		(608	)
Net Cash Used in Investing Activities		(9,363	)		(11,849	)
Financing Activities:
Net Decrease in Deposits		(22,746	)		(54,792	)
Net Cash Used in Financing Activities		(22,746	)		(54,792	)
Net Change in Cash and Cash Equivalents		(11,798	)		(47,754	)
Cash and Cash Equivalents at Beginning of Period		294,758			145,564
Cash and Cash Equivalents at End of Period	$	282,960		$	97,810
Supplementary Data
Cash Payments Made for Income Taxes	$	3		$	-
Issuance of Common Stock to the Bank's Non-Qualified Retirement Plans	$	403		$	2,564
Interest Paid	$	3,628		$	2,128
Supplementary Noncash Disclosure
Lease Liabilities Arising from Obtaining Right-of-Use Assets	$	-		$	4,729
Security (purchases) sales settled in subsequent period	$	-		$	25,000

The accompanying notes are an integral part of these unaudited consolidated financial statements

Table of Contents

FARMERS & MERCHANTS BANCORP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

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.

The accounting and reporting policies of the Company conform to U.S. GAAP and prevailing practice within the banking industry. The following is a summary of the significant accounting and reporting policies used in preparing the consolidated financial statements.

Basis of Presentation

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 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.

The Company has several lease agreements, such as branch locations, which are considered operating leases, and therefore, were not previously recognized on the Company’s consolidated statements of condition. The new guidance requires these lease agreements to be recognized as a right-of-use asset and corresponding lease liability.

Our operating leases relate primarily to office space and bank branches. As a result of implementing ASU 2016-02, we recognized an operating lease right-of-use ("ROU") asset of $4.73 million and an operating lease liability of $4.73 million on January 1, 2019, with no impact on our consolidated statement of income or consolidated statement of cash flows compared to the prior lease accounting model. The ROU asset and operating lease liability are recorded in other assets and other liabilities, respectively, in the consolidated balance sheets. See Note 9 – “Leases” for additional information.

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.

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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 to 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 indefinite period of time and/or to use the securities 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 non-interest income.

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.

For equity securities, the entire amount of a market adjustment is 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.

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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 more than insignificant 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.

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 1 ^st 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:

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Pass – A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management's close attention.

Special Mention – A special mention loan or lease has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease 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.

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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 California Department of Business Oversight (“DBO”) 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.

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.

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On March 27, 2020 the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law by Congress. The CARES Act restricts 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. 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 Low Income Housing Tax Credits (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 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 March 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 presentation of diluted basic earnings per common share. See Note 8 – “Dividends and Basic Earnings Per Common Share” for additional information.

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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 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 March 31, 2020, the future estimated amortization expense for the CDI arising from our past acquisitions is as follows:

(in thousands)		2020				2021				2022				2023				2024				Thereafter				Total
Core Deposit Intangible Amortization		$	469			$	611			$	593			$	573			$	549			$	1,688			$	4,483

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.

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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 by Congress. 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 the next 2-3 months. However, there are no guaranties how long the COVID-19 virus may continue to impact our economy, and therefore, the Company.

While we expect the effects of COVID-19 to have an adverse future impact on our business, financial condition and results of operations, we are unable to predict the 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
March 31, 2020	Cost		Gains		Losses		Value
US Treasury Notes	$	14,777	$	622	$	-		15,399
US Govt SBA		10,043		9		98		9,954
Mortgage Backed Securities ⁽¹⁾		482,439		18,945		8		501,376
Other		5,517		-		-		5,517
Total	$	512,776	$	19,576	$	106	$	532,246

	Amortized		Gross Unrealized				Fair/Book
December 31, 2019	Cost		Gains		Losses		Value
US Treasury Notes	$	54,745	$	250	$	-	$	54,995
US Govt SBA		10,902		9		113		10,798
Mortgage Backed Securities ⁽¹⁾		436,531		4,646		99		441,078
Other		515		-		-		515
Total	$	502,693	$	4,905	$	212	$	507,386

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	Amortized		Gross Unrealized				Fair/Book
March 31, 2019	Cost		Gains		Losses		Value
Government Agency & Government-Sponsored Entities	$	3,021	$	6	$	-	$	3,027
US Treasury Notes		164,660		48		34		164,674
US Govt SBA		14,554		5		147		14,412
Mortgage Backed Securities ⁽¹⁾		303,895		1,764		1,639		304,020
Other		5,156		-		-		5,156
Total	$	491,286	$	1,823	$	1,820	$	491,289

⁽¹⁾ All Mortgage Backed Securities consist of securities collateralized by residential real estate and 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):

	Book		Gross Unrealized				Fair
March 31, 2020	Value		Gains		Losses		Value
Obligations of States and Political Subdivisions	$	58,701	$	812	$	10	$	59,503
Total	$	58,701	$	812	$	10	$	59,503

	Book		Gross Unrealized				Fair
December 31, 2019	Value		Gains		Losses		Value
Obligations of States and Political Subdivisions	$	60,229	$	880	$	12	$	61,097
Total	$	60,229	$	880	$	12	$	61,097

	Book		Gross Unrealized				Fair
March 31, 2019	Value		Gains		Losses		Value
Obligations of States and Political Subdivisions	$	54,412	$	571	$	1	$	54,982
Total	$	54,412	$	571	$	1	$	54,982

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 March 31, 2020 by contractual maturity are shown in the following table (in thousands):

	Available-for-Sale				Held-to-Maturity
March 31, 2020	Amortized Cost		Fair/Book Value		Book Value		Fair Value
Within one year	$	5,574	$	5,574	$	3,980	$	3,980
After one year through five years		15,092		15,713		4,894		4,899
After five years through ten years		829		829		24,064		24,783
After ten years		8,842		8,754		25,763		25,841
		30,337		30,870		58,701		59,503

Investment securities not due at a single maturity date:
Mortgage-backed securities		482,439		501,376		-		-

Total	$	512,776	$	532,246	$	58,701	$	59,503

Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

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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
March 31, 2020	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss

Securities Available-for-Sale
US Govt SBA	$	2,458	$	5	$	4,674	$	93	$	7,132	$	98
Mortgage Backed Securities		1,503		2		255		6		1,758		8
Total	$	3,961	$	7	$	4,929	$	99	$	8,890	$	106

Securities Held-to-Maturity
Obligations of States and Political Subdivisions	$	728	$	10	$	-	$	-	$	728	$	10
Total	$	728	$	10	$	-	$	-	$	728	$	10

	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 Govt SBA	$	2,693	$	6	$	5,198	$	107	$	7,891	$	113
Mortgage Backed Securities		131,005		88		713		11		131,718		99
Total	$	133,698	$	94	$	5,911	$	118	$	139,609	$	212

Securities Held-to-Maturity
Obligations of States and Political Subdivisions	$	355	$	12	$	-	$	-	$	355	$	12
Total	$	355	$	12	$	-	$	-	$	355	$	12

	Less Than 12 Months				12 Months or More				Total
March 31, 2019	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss

Securities Available-for-Sale
US Treasury Notes	$	149,962	$	28	$	4,909	$	6	$	154,871	$	34
US Govt SBA		1,310		-		10,823		147		12,133		147
Mortgage Backed Securities		5,434		25		190,452		1,614		195,886		1,639
Total	$	156,706	$	53	$	206,184	$	1,767	$	362,890	$	1,820

Securities Held-to-Maturity
Obligations of States and Political Subdivisions	$	229	$	1	$	360	$	-	$	589	$	1
Total	$	229	$	1	$	360	$	-	$	589	$	1

As of March 31, 2020, the Company held 551 investment securities of which 25 were in an unrealized loss position for less than twelve months. 72 securities were in an unrealized 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.

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U.S. Treasury Notes – At March 31, 2020, no U.S. Treasury Note security investments were in an unrealized loss position for less than 12 months and none were in an unrealized loss position for 12 months or more. The unrealized losses on the Company's investment in U.S. Treasury Notes were $0 at March 31, 2020 and December 31, 2019, and $34,000 at March 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 March 31, 2020, December 31, 2019, and March 31, 2019.

U.S. Government SBA – At March 31, 2020, 16 U.S. Government SBA security investments were in an unrealized loss position for less than 12 months and 53 were in an unrealized loss position for 12 months or more. The unrealized losses on the Company's investment in U.S. Government SBA securities were $98,000 at March 31, 2020 and $113,000 at December 31, 2019, and $147,000 at March 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 March 31, 2020, December 31, 2019, and March 31, 2019.

Mortgage Backed Securities – At March 31, 2020, 5 mortgage backed security investments were in an unrealized loss position for less than 12 months and 19 were in an unrealized loss position for 12 months or more. The unrealized losses on the Company's investment in mortgage backed securities were $8,000, $99,000, and $1.6 million at March 31, 2020, December 31, 2019, and March 31, 2019, respectively. 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 March 31, 2020, December 31, 2019, and March 31, 2019.

Obligations of States and Political Subdivisions - At March 31, 2020, 4 obligation of states and political subdivisions were in an unrealized loss position for less than 12 months. None were in an unrealized loss position for 12 months or more. As of March 31, 2020, one-hundred percent 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 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 obligations of states and political subdivisions were $10,000, $12,000 and $1,000 at March 31, 2020, December 31, 2019 and March 31, 2019, respectively. 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 March 31, 2020, December 31, 2019, and March 31, 2019.

Proceeds from sales and calls of securities for the periods shown were as follows:

(in thousands)	Proceeds		Gains		Losses
Three Months Ended March 31, 2020	$	2,255	$	13	$	-
Three Months Ended March 31, 2019	$	-	$	-	$	-

Pledged Securities

As of March 31, 2020, securities carried at $381.3 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, and $262.1 million at March 31, 2019.

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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 March 31, 2020 and December 31, 2019. This amount was at $12.5 million at March 31, 2019.

5.	Loans & Leases and Allowance for Credit Losses

Loans & Leases consisted of the following:

Loan & Lease Portfolio (in thousands)	March 31, 2020		December 31, 2019		March 31, 2019
Commercial Real Estate	$	868,736	$	846,486	$	823,028
Agricultural Real Estate		594,154		625,767		603,601
Real Estate Construction		126,956		115,644		99,837
Residential 1st Mortgages		256,732		255,253		258,359
Home Equity Lines & Loans		40,747		39,270		40,072
Agricultural		264,771		292,904		257,004
Commercial		404,329		384,795		364,439
Consumer & Other		14,839		15,422		18,418
Leases		105,362		104,470		105,823
Total Gross Loans & Leases		2,676,626		2,680,011		2,570,581
Less: Unearned Income		6,517		6,984		6,613
Subtotal		2,670,109		2,673,027		2,563,968
Less: Allowance for Credit Losses		54,824		55,012		54,907
Net Loans & Leases	$	2,615,285	$	2,618,015	$	2,509,061

The following tables show the allocation of the allowance for credit losses by portfolio segment and by impairment methodology at the dates indicated (in thousands) :

March 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		$	855	$	2,675	$	8,076		$	11,466		$	456		$	3,162	$	192	$	55,012
Charge-Offs		-		-			-			-		-		-			(244	)		(21	)		-		-		(265	)
Recoveries		-		-			-			19		20		28			2			8			-		-		77
Provision		69		(659	)		(22	)		163		88		(1,145	)		990			(61	)		26		551		-
Ending Balance- March 31, 2020	$	11,122	$	14,469		$	1,927		$	1,037	$	2,783	$	6,959		$	12,214		$	382		$	3,188	$	743	$	54,824
Ending Balance Individually Evaluated for Impairment		-		-			-			116		10		398			11			60			-		-		595
Ending Balance Collectively Evaluated for Impairment		11,122		14,469			1,927			921		2,773		6,561			12,203			322			3,188		743		54,229
Loans:
Ending Balance	$	861,311	$	594,154		$	126,956		$	256,732	$	40,747	$	264,771		$	404,329		$	14,839		$	106,270	$	-	$	2,670,109
Ending Balance Individually Evaluated for Impairment		4,486		5,629			-			2,310		200		733			1,517			196			-		-		15,071
Ending Balance Collectively Evaluated for Impairment	$	856,825	$	588,525		$	126,956		$	254,422	$	40,547	$	264,038		$	402,812		$	14,643		$	106,270	$	-	$	2,655,038

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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	$	880		$	2,761		$	8,242		$	11,656		$	494		$	4,022		$	261		$	55,266
Charge-Offs		-			-		-		-			-			-			(592	)		(83	)		-			-			(675	)
Recoveries		-			38		-		13			28			-			90			52			-			-			221
Provision		(556	)		998		700		(38	)		(114	)		(166	)		312			(7	)		(860	)		(69	)		200
Ending Balance- December 31, 2019	$	11,053		$	15,128	$	1,949	$	855		$	2,675		$	8,076		$	11,466		$	456		$	3,162		$	192		$	55,012
Ending Balance Individually Evaluated for Impairment		234			-		-		118			12			99			137			61			-			-			661
Ending Balance Collectively Evaluated for Impairment		10,819			15,128		1,949		737			2,663			7,977			11,329			395			3,162			192			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			229			188			1,528			200			-			-			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

March 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		$	880		$	2,761		$	8,242		$	11,656		$	494		$	4,022		$	261	$	55,266
Charge-Offs		-			-		-			-			-			-			(379	)		(21	)		-			-		(400	)
Recoveries		-			6		-			3			6			-			12			14			-			-		41
Provision		(209	)		395		(42	)		(20	)		(29	)		(794	)		644			(20	)		(14	)		89		-
Ending Balance- March 31, 2019	$	11,400		$	14,493	$	1,207		$	863		$	2,738		$	7,448		$	11,933		$	467		$	4,008		$	350	$	54,907
Ending Balance Individually Evaluated for Impairment		214			-		-			124			13			98			172			6			-			-		627
Ending Balance Collectively Evaluated for Impairment		11,186			14,493		1,207			739			2,725			7,350			11,761			461			4,008			350		54,280
Loans:
Ending Balance	$	815,366		$	603,601	$	99,837		$	258,359		$	40,072		$	257,004		$	364,439		$	18,418		$	106,872		$	-	$	2,563,968
Ending Balance Individually Evaluated for Impairment		4,638			7,238		-			2,469			255			200			1,591			6			-			-		16,397
Ending Balance Collectively Evaluated for Impairment	$	810,728		$	596,363	$	99,837		$	255,890		$	39,817		$	256,804		$	362,848		$	18,412		$	106,872		$	-	$	2,547,571

The ending balance of loans individually evaluated for impairment includes restructured loans in the amount of $2.5 million at March 31, 2020, $2.6 million at December 31, 2019 and $2.7 million at March 31, 2019, which are no longer classified as TDRs.

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The following tables show the loan & lease portfolio allocated by management’s internal risk ratings at the dates indicated (in thousands) :

March 31, 2020	Pass		Special Mention		Substandard		Total Loans & Leases
Loans & Leases:
Commercial Real Estate	$	854,346	$	6,965	$	-	$	861,311
Agricultural Real Estate		580,205		1,136		12,813		594,154
Real Estate Construction		126,956		-		-		126,956
Residential 1st Mortgages		256,027		-		705		256,732
Home Equity Lines & Loans		40,577		-		170		40,747
Agricultural		263,794		-		977		264,771
Commercial		400,735		2,321		1,273		404,329
Consumer & Other		14,392		-		447		14,839
Leases		106,270		-		-		106,270
Total	$	2,643,302	$	10,422	$	16,385	$	2,670,109

December 31, 2019	Pass		Special Mention		Substandard		Total Loans & Leases
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		-		794		255,253
Home Equity Lines & Loans		39,092		-		178		39,270
Agricultural		289,276		2,617		1,011		292,904
Commercial		380,650		3,239		906		384,795
Consumer & Other		14,934		-		488		15,422
Leases		105,402		-		-		105,402
Total	$	2,643,190	$	13,621	$	16,216	$	2,673,027

March 31, 2019	Pass		Special Mention		Substandard		Total Loans & Leases
Loans & Leases:
Commercial Real Estate	$	813,090	$	2,276	$	-	$	815,366
Agricultural Real Estate		587,444		2,847		13,310		603,601
Real Estate Construction		99,837		-		-		99,837
Residential 1st Mortgages		257,878		-		481		258,359
Home Equity Lines & Loans		40,028		-		44		40,072
Agricultural		250,630		6,167		207		257,004
Commercial		360,525		2,983		931		364,439
Consumer & Other		18,263		-		155		18,418
Leases		106,872		-		-		106,872
Total	$	2,534,567	$	14,273	$	15,128	$	2,563,968

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 or leases outstanding at March 31, 2020, December 31, 2019, and March 31, 2019, rated doubtful or loss.

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The following tables show an aging analysis of the loan & lease portfolio by the time past due at the dates indicated

(in thousands) :

March 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	$	-	$	-	$	-	$	-	$	-	$	861,311	$	861,311
Agricultural Real Estate		-		-		-		-		-		594,154		594,154
Real Estate Construction		-		-		-		-		-		126,956		126,956
Residential 1st Mortgages		-		-		-		-		-		256,732		256,732
Home Equity Lines & Loans		226		-		-		-		226		40,521		40,747
Agricultural		-		-		-		549		549		264,222		264,771
Commercial		250		-		-		-		250		404,079		404,329
Consumer & Other		7		-		-		-		7		14,832		14,839
Leases		-		-		-		-		-		106,270		106,270
Total	$	483	$	-	$	-	$	549	$	1,032	$	2,669,077	$	2,670,109

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		240		-		-		-		240		115,404		115,644
Residential 1st Mortgages		-		-		-		-		-		255,253		255,253
Home Equity Lines & Loans		-		-		-		-		-		39,270		39,270
Agricultural		-		-		-		-		-		292,904		292,904
Commercial		77		-		-		-		77		384,718		384,795
Consumer & Other		35		-		-		-		35		15,387		15,422
Leases		-		-		-		-		-		105,402		105,402
Total	$	352	$	-	$	-	$	-	$	352	$	2,672,675	$	2,673,027


March 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	$	-	$	-	$	-	$	-	$	-	$	815,366	$	815,366
Agricultural Real Estate		-		-		-		-		-		603,601		603,601
Real Estate Construction		-		-		-		-		-		99,837		99,837
Residential 1st Mortgages		707		-		-		-		707		257,652		258,359
Home Equity Lines & Loans		-		-		-		-		-		40,072		40,072
Agricultural		-		-		-		-		-		257,004		257,004
Commercial		-		-		-		-		-		364,439		364,439
Consumer & Other		20		-		-		-		20		18,398		18,418
Leases		-		-		-		-		-		106,872		106,872
Total	$	727	$	-	$	-	$	-	$	727	$	2,563,241	$	2,563,968

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The following tables show information related to impaired loans & leases for the periods indicated (in thousands) :

March 31, 2020	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial Real Estate	$	2,888	$	2,888	$	-	$	1,487	$	29
Agricultural Real Estate		5,629		5,629		-		5,642		89
Commercial		1,507		1,507		-		754		15
	$	10,024	$	10,024	$	-	$	7,883	$	133
With an allowance recorded:
Commercial Real Estate	$	-	$	-	$	-	$	1,411	$	-
Agricultural Real Estate		549		549		214		275		-
Residential 1st Mortgages		1,550		1,761		77		1,556		19
Home Equity Lines & Loans		67		78		3		68		1
Agricultural		184		184		184		186		2
Commercial		11		11		11		770		-
Consumer & Other		196		196		61		198		4
	$	2,557	$	2,779	$	550	$	4,464	$	26
Total	$	12,581	$	12,803	$	550	$	12,347	$	159

December 31, 2019	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial Real Estate	$	86	$	86	$	-	$	90	$	8
Agricultural Real Estate		5,654		5,654		-		6,069		379
Commercial		-		-		-		8		1
	$	5,740	$	5,740	$	-	$	6,167	$	388
With an allowance recorded:
Commercial Real Estate	$	2,822	$	2,822	$	234	$	2,853	$	94
Residential 1st Mortgages		1,562		1,770		74		1,601		73
Home Equity Lines & Loans		68		79		7		71		4
Agricultural		188		188		99		195		6
Commercial		1,528		1,528		137		1,554		53
Consumer & Other		200		200		61		54		-
	$	6,368	$	6,587	$	612	$	6,328	$	230
Total	$	12,108	$	12,327	$	612	$	12,495	$	618

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March 31, 2019	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial Real Estate	$	93	$	93	$	-	$	94	$	2
Agricultural Real Estate		7,239		7,238		-		7,239		73
	$	7,332	$	7,331	$	-	$	7,333	$	75
With an allowance recorded:
Commercial Real Estate	$	2,883	$	2,875	$	214	$	2,893	$	23
Residential 1st Mortgages		1,625		1,829		81		1,633		21
Home Equity Lines & Loans		73		83		4		74		1
Agricultural		201		200		98		101		-
Commercial		1,596		1,590		172		1,620		14
Consumer & Other		6		7		6		6		-
	$	6,384	$	6,584	$	575	$	6,327	$	59
Total	$	13,716	$	13,915	$	575	$	13,660	$	134

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. 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.

On March 27, 2020 the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law by Congress. The CARES Act provides 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. 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 and the impact of COVID-19 on the Company.

At March 31, 2020, there were no formal foreclosure proceedings in process for consumer mortgage loans secured by residential real estate properties.

At March 31, 2020, the Company allocated $336,000 of specific reserves to $12.6 million of troubled debt restructured loans & leases, all of which were performing. The Company had no commitments at March 31, 2020 to lend additional amounts to customers with outstanding loans or leases that are classified as TDRs.

During the three-month period ended March 31, 2020, no loans or leases were modified as a troubled debt restructuring.

During the three months ended March 31, 2020, the year ended December 31, 2019, and the three months ended March 31, 2019, there were no payment defaults on loans or leases modified as troubled debt restructurings within twelve months following the modification. The Company considers a loan or lease to be in payment default once it is greater than 90 days contractually past due under the modified terms.

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, 2019 to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings.

During the year ended December 31, 2019, the terms of certain loans were modified 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.

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There were no modifications involving a reduction of the stated interest rate. Modifications involving an extension of the maturity date ranged from 3 months to 6 years.

The following table presents loans by class modified as troubled debt restructured loans for the period 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		1	$	201	$	201
Consumer & Other		1		195		195
Total		2	$	396	$	396

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.

At March 31, 2019, there were no formal foreclosure proceedings in process for consumer mortgage loans secured by residential real estate properties.

At March 31, 2019, the Company allocated $575,000 of specific reserves to $13.7 million of troubled debt restructured loans & leases, all of which were performing. The Company had no commitments at March 31, 2019 to lend additional amounts to customers with outstanding loans or leases that are classified as TDRs.

During the three-month period ended March 31, 2019, the terms of one loan was modified as a troubled debt restructuring. The modification involved a reduction of the stated interest rate of the loan for 5 years and an extension of the maturity date for 10 years.

The following table presents loans or leases by class modified as TDRs during the three-month period ended March 31, 2019 (in thousands):

	March 31, 2019
Troubled Debt Restructurings	Number of Loans		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Agricultural		1	$	201	$	201
Total		1	$	201	$	201

The troubled debt restructurings described above increased the allowance for credit losses by $84,000 for the three months ended March 31, 2019.

6. 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.

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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 into 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 into 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%.

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The following tables present information about the Company’s assets 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 March 31, 2020, Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets		Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
Available-for-Sale Securities:
US Treasury Notes	$	15,399	$	15,399	$	-	$	-
US Govt SBA		9,954		-		9,954		-
Mortgage Backed Securities		501,376		-		501,376		-
Other		5,517		5,207		310		-
Total Assets Measured at Fair Value On a Recurring Basis	$	532,246	$	20,606	$	511,640	$	-

			Fair Value Measurements At December 31, 2019, Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets		Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
Available-for-Sale Securities:
US Treasury Notes	$	54,995	$	54,995	$	-	$	-
US Govt SBA		10,798		-		10,798		-
Mortgage Backed Securities		441,078		-		441,078		-
Other		515		205		310		-
Total Assets Measured at Fair Value On a Recurring Basis	$	507,386	$	55,200	$	452,186	$	-

			Fair Value Measurements At March 31, 2019, Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets		Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)
Available-for-Sale Securities:
Government Agency & Government-Sponsored Entities	$	3,027	$	-	$	3,027	$	-
US Treasury Notes		164,674		164,674		-		-
US Govt SBA		14,412		-		14,412		-
Mortgage Backed Securities		304,020		-		304,020		-
Other		5,156		203		310		4,643
Total Assets Measured at Fair Value On a Recurring Basis	$	491,289	$	164,877	$	321,769	$	4,643

Fair values for Level 2 available-for-sale investment securities are based on quoted market prices for similar securities. During the period ended March 31, 2020, there were no transfers in or out of level 1, 2, or 3.

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Certain securities, categorized as Level 3 assets as of March 31, 2019 consisted of: (1) $3.0 million in limited liability companies (LLC) that invest in CRA qualified SBA loans; (2) $1.4 million in registered warrants issued by California reclamation districts; and (3) $200,000 in The Independent Bankers’ Bank stock. These securities do not have readily available values, and are carried at cost, plus/minus observable price changes, less impairment. The significant unobservable data reflected in the fair value measurement include dealer quotes, projected prepayment speeds/average lives and credit information. There were no gains, losses or transfers in or out of level 3 during the three-month period ended March 31, 2019.

Level 3 Valuations

The following table presents a reconciliation of the level 3 fair value category measured at fair value on a recurring basis:

							Net Realized / Unrealized Gains (Losses)

(in thousands)	Balance at Beginning of Period		Purchases /Additions		Sales / Reductions		Realized		Unrealized		Balance at End of Period
Three months ended March 31, 2019
Available-for-sale debt securities:	$	1,593	$	479	$	675	$	-	$	-	$	1,397
Equity securities:	$	3,246	$	-	$	-	$	-	$	-	$	3,246
Total	$	4,839	$	479	$	675	$	-	$	-	$	4,643

The following tables present information about the Company’s other real estate and impaired loans or leases, 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 or leases are carried at fair value. Impaired loans or leases are only included in the following tables when their fair value is based upon a current 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 March 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	$	1,470	$	-	$	-	$	1,470
Home Equity Lines and Loans		64		-		-		64
Consumer		135						135
Total Impaired Loans		1,669		-		-		1,669
Other Real Estate
Real Estate Construction		873		-		-		873
Total Other Real Estate		873		-		-		873
Total Assets Measured at Fair Value On a Non-Recurring Basis	$	2,542	$	-	$	-	$	2,542

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			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		142		-		-		142
Agricultural		88		-		-		88
Commercial		1,391		-		-		1,391
Consumer		139		-		-		139
Total Impaired Loans		5,751		-		-		5,751
Other Real Estate:
Real Estate Construction		873		-		-		873
Total Other Real Estate		873		-		-		873
Total Assets Measured at Fair Value On a Non-Recurring Basis	$	6,624	$	-	$	-	$	6,624

			Fair Value Measurements At March 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	$	2,660	$	-	$	-	$	2,660
Residential 1st Mortgage		1,540		-		-		1,540
Home Equity Lines and Loans		69		-		-		69
Agricultural		102		-		-		102
Commercial		1,418		-		-		1,418
Total Impaired Loans		5,789		-		-		5,789
Other Real Estate
Real Estate Construction		873		-		-		873
Total Other Real Estate		873		-		-		873
Total Assets Measured at Fair Value On a Non-Recurring Basis	$	6,662	$	-	$	-	$	6,662

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.

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The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at the dates indicated.

March 31, 2020 (in thousands)	Fair Value		Valuation Technique	Unobservable Inputs	Range, Weighted Avg.
Impaired Loans
Residential 1st Mortgage	$	1,470	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		1% - 4%, 2.84	%
Home Equity Lines and Loans	$	64	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		1% - 2%, 1.07	%
Consumer	$	135	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		4%, 4	%

Other Real Estate
Real Estate Construction	$	873	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%, 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	$	142	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		1% - 2%, 1.3	%
Agricultural	$	88	Income Approach	Capitalization Rate		4.3%, 4.3	%
Commercial	$	1,391	Income Approach	Capitalization Rate		3.3%, 3.3	%
Consumer	$	139	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		40.6%, 40.6	%

Other Real Estate:
Real Estate Construction	$	873	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		10%, 10	%

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March 31, 2019 (in thousands)	Fair Value		Valuation Technique	Unobservable Inputs	Range, Weighted Avg.
Impaired Loans
Commercial Real Estate	$	2,660	Income Approach	Capitalization Rate		3.25%, 3.25	%
Residential 1st Mortgage	$	1,540	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		1% -4%, 2.85	%
Home Equity Lines and Loans	$	69	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		1% - 2%, 1.50	%
Agricultural	$	102	Income Approach	Capitalization Rate		5.10%, 5.10	%
Commercial	$	1,418	Income Approach	Capitalization Rate		3.25% - 8.70%, 3.40	%

Other Real Estate
Real Estate Construction	$	873	Sales Comparison Approach	Adjustment for Difference Between Comparable Sales		10%, 10	%

7.	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 valuation of loans held for investment was impacted by the adoption of ASU 2016-01. In accordance with ASU 2016-01, 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. The discount rates used to determine fair value use interest rate spreads that reflect factors such as liquidity, credit, and nonperformance risk of the loans. Loans are considered a Level 3 classification.

The following tables summarize the book value and estimated fair value of financial instruments for the periods indicated:

			Fair Value of Financial Instruments Using
March 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	$	282,960	$	282,960	$	-	$	-	$	282,960

Investment Securities Available-for-Sale		532,246		20,606		511,640		-		532,246

Investment Securities Held-to-Maturity		58,701		-		29,296		30,207		59,503

Loans & Leases, Net		2,615,285		-		-		2,605,120		2,605,120
Accrued Interest Receivable		12,541		-		12,541		-		12,541

Liabilities:
Deposits		3,255,273		2,733,525		524,013		-		3,257,538
Subordinated Debentures		10,310		-		7,415		-		7,415
Accrued Interest Payable		2,430		-		2,430		-		2,430

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			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

			Fair Value of Financial Instruments Using
March 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	$	97,810	$	97,810	$	-	$	-	$	97,810

Investment Securities Available-for-Sale		491,289		164,877		321,769		4,643		491,289

Investment Securities Held-to-Maturity		54,412		-		36,705		18,276		54,981

Loans & Leases, Net		2,509,061		-		-		2,490,197		2,490,197
Accrued Interest Receivable		12,524		-		12,524		-		12,524

Liabilities:
Deposits		3,008,040		2,483,258		521,321		-		3,004,579
Subordinated Debentures		10,310		-		7,600		-		7,600
Accrued Interest Payable		2,193		-		2,193		-		2,193

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8.	Dividends and Basic Earnings Per Common Share

Farmers & Merchants Bancorp common stock is not traded on any exchange. The shares are primarily held by local residents and are not actively traded. However, trades are reported on the OTCQX under the symbol “FMCB.” No cash dividends were declared during the first quarter of 2020 or 2019.

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 presentation of diluted basic earnings per common share. The following table calculates the basic earnings per common share for the three months ended March 31, 2020 and 2019.

( net income in thousands )	2020		2019
Net Income	$	14,122	$	13,549
Weighted Average Number of Common Shares Outstanding		793,504		784,438
Basic and Diluted Earnings Per Common Share	$	17.80	$	17.27

Leases

Lessee – Operating Leases

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 March 31, 2020, operating lease ROU assets and liabilities were $4.81 million and $4.87 million, respectively. Operating lease expenses totaled $208,000 for the three month period ended March 31, 2020. At March 31, 2019, operating lease ROU assets and liabilities were $4.55 million and $4.56 million, respectively. Operating leases had a total cost of $207,000 at March 31, 2019.

The table below summarizes the information related to our operating leases:

(in thousands except for percent and period data)	Three Months Ended March 31, 2020			Year Ended December 31, 2019			Three Months Ended March 31, 2019
Cash Paid for Amounts Included in the Measurement of Lease Liabilities
Operating Cash Flow from Operating Leases	$	197		$	783		$	196
Right-of-Use Assets Obtained in Exchange for New Operating Lease Liabilities	$	-		$	5,645		$	4,729
Weighted-Average Remaining Lease Term - Operating Leases, in Years		7.68			7.88			7.70
Weighted-Average Discount Rate - Operating Leases		3.2	%		3.2	%		2.8	%

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The table below summarizes the maturity of remaining lease liability:

(in thousands)	March 31, 2020
2020	$	598
2021		719
2022		686
2023		697
2024		707
2025 and thereafter		2,105
Total Lease Payments		5,512
Less: Interest		(640	)
Present Value of Lease Liabilities	$	4,872

As of March 31, 2020, we have no additional operating leases for office space that have not yet commenced or that are anticipated to commence during the second quarter of 2020.

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 $106.3 million at March 31, 2020, $107.3 million at December 31, 2019 and $106.9 million at March 31, 2019.

10.	Recent Accounting Pronouncements

Recently Adopted Accounting Guidance

The following paragraphs provide descriptions of recently adopted accounting standards that may have had 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 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 of 2019, enabling us to complete parallel runs using data beginning with the second quarter of 2019 .

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The new guidance had been effective on January 1, 2020. However, on March 27, 2020 in response to Congress passing the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), federal banking regulators issued an interim final rule allowing banks the option of delaying the implementation of CECL until December 31, 2020 or when the coronavirus national emergency ends, whichever comes first. The Company has elected to delay CECL implementation, but continues to run its CECL model quarterly to accumulate data for the ultimate implementation.

Item 2.

Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

The following is management’s discussion and analysis of the major factors that influenced our financial performance for the three months ended March 31, 2020. This analysis should be read in conjunction with our 2019 Annual Report to Shareholders on Form 10-K, and with the unaudited financial statements and notes as set forth in this report.

Forward–Looking Statements

This Form 10-Q contains various forward-looking statements, usually containing the words “estimate,” “project,” “expect,” “objective,” “goal,” or similar expressions and includes assumptions concerning Farmers & Merchants Bancorp’s (together with its subsidiaries, the “Company” or “we”) operations, future results, and prospects. These forward-looking statements are based upon current expectations and are subject to risks and uncertainties. In connection with the “safe-harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary statement identifying important factors which could cause the actual results of events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions.

Such factors include, but are not limited to, the following: (1) economic conditions in the Central Valley of California; (2) significant changes in interest rates and loan prepayment speeds; (3) credit risks of lending and investment activities; (4) changes in federal and state banking laws or regulations; (5) competitive pressure in the banking industry; (6) changes in governmental fiscal or monetary policies; (7) uncertainty regarding the economic outlook resulting from the continuing war on terrorism, as well as actions taken or to be taken by the U.S. or other governments as a result of further acts or threats of terrorism; (8) water management issues in California and the resulting impact on the Company’s agricultural customers; (9) expansion into new geographic markets and new lines of business; (10) the impact of COVID-19 on the Company and its customers (see COVID-19 Disclosure below); and (11) other factors discussed in Item 1A. Risk Factors located in the Company’s 2019 Annual Report on Form 10-K.

Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.

COVID-19 (Coronavirus) Disclosure

In an attempt to slow the accelerating spread of COVID-19, on March 16, 2020 the first cities and counties in Northern California were place under “shelter-in-place” orders. By March 19th, the Governor had placed the entire state under these orders. The economic impact of this situation has already been severe. 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 duration of these orders is not known at this time nor is the pace of recovery once they are lifted.

Designated as an “essential business”, Farmers & Merchants Bank of Central California has kept all branches open and maintained regular business hours during this difficult time. Our staffing levels have remained stable during the COVID-19 crisis. For years we have maintained a pandemic flu contingency plan, and undertook early and prudent measures to protect our employees and customers, while still providing core banking services.

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Impact on the Banking Industry

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law by Congress. The primary impact of this legislation, as well as related federal and state regulatory actions, is as follows:

•

Paycheck Protection Program (“PPP”) … The Small Business Administration (“SBA”) was directed by Congress to provide up to $349 billion (subsequently expanded by an additional $310 billion) in loans to small businesses with less than 500 employees to assist these businesses in meeting their payroll and other financial obligations over the next several months. 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 can forgive them after eight weeks. Farmers & Merchants Bank of Central California has actively participated in the PPP, and since April, 2020 we have funded over $348 million of loans for 1,512 of our small business customers. Although these loans carry a nominal interest rate of 1% the SBA will pay the banks an origination fee of 1-5% depending on the size of the loan. All fees will be capitalized and amortized over the life of the loan. Since the current assumption is that most of these loans will be forgiven after eight weeks, the income statement impact to the Company in the second or third quarter of 2020 could be significant.

•

Temporary Relief from Troubled Debt Restructurings … The CARES Act provides financial institutions, under specific circumstances, the opportunity to temporarily suspend certain requirements under generally accepted accounting principles related to troubled debt restructurings (“TDR”) for a limited period of time to account for the effects of COVID-19. Farmers & Merchants Bank of Central California is actively working with existing borrowers to restructure loans for up to six months, moving to either interest only payments or interest only with principal deferral for up to six months. After six months, any deferred amounts would then be added to the loan payments for the remaining term of the loan.

•

Foreclosure Actions … The CARES Act restricts 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. The Company is working with its borrowers when they make requests to defer payments on their mortgage loans.

•

CECL Implementation Deferral … 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 provides the election to defer CECL implementation until December 31, 2020 or when the national emergency ends, whichever comes first. 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 implementation.

•

Paycheck Protection Program Liquidity Facility (“PPPLF”) … The Federal Reserve Bank has developed a loan program to neutralize the liquidity impact to financial institutions of funding loans made under the PPP. Banks may pledge their PPP loans on a non-recourse basis and borrow against these loans for a period of up to two years at a fixed rate of .35%. Furthermore, since these FRB borrowings are on a non-recourse basis, the loans will not be counted under the calculation of leverage capital ratios. Since Farmers & Merchants Bank of Central California has significant liquidity at the current time, management is currently considering how to best use the PPPLF.

Impact on Farmers & Merchants Bancorp and Farmers & Merchants Bank of Central California

The Company is exposed to the following COVID-19 risks and uncertainties:

•	We may not be able to maintain staff levels in order to operate key activities of our business.

•

Our earnings may be affected by borrowers that cannot make payments on their loans. We have credit exposure to industries that have been impacted by either: (1) the public’s changing habits in response to the risks of COVID-19 (e.g., hotels and restaurants); or (2) the recent “shelter-in-place” orders imposed by local, state and federal officials (e.g., small businesses determined to be “non-essential”).

•	Our liquidity position may be affected as a result of significant and unusual deposit outflows or loan drawdowns.

However, from a financial perspective, as reflected by the following March 31, 2020 measures, the Company entered this period with strong fundamentals which should assist us in responding to the risks of COVID-19:

•	Liquidity consisting of $226 million of Fed Funds Sold and $590 million of Investment Securities;

•	Risk Based Capital Ratio of 12.83%;

•	Allowance for Credit Losses of $54.8 million or 2.05% of total loans and leases; and

•	ROAA of 1.53% and ROAE of 14.90% in first quarter 2020.

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Our credit exposure to the “Hospitality” (primarily hotels) and “Entertainment” (primarily restaurants, health clubs and movie theaters) industries totals $146.4 million in loans and leases outstanding at March 31, 2020. This represents 5.5% of total loans and leases outstanding and 37.1% of total shareholders’ equity, both measures that are thought to be reasonable when compared to peers. Most of these loans: (1) were underwritten with an original LTV of 50-70% on the underlying real estate, providing us what should be adequate collateral coverage; and (2) have financially strong guarantors with liquidity that provides additional protection. Over and above the impact on the Hospitality and Entertainment industries there has been a general economic slowdown as a result of the “shelter-in-place” orders that were issued by the Governor of California in March 2020. This is resulting in increased unemployment in many sectors. The Central Valley of California may be in a better position than other areas to weather this impact because agricultural activity has substantially continued. 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 and other loan restructuring strategies, to help them move through this period of reduced business activity.

Although our 2020 financial performance will, in all likelihood, be negatively impacted by sustained low interest rates and the potential for increased borrower stress, the full extent of this impact cannot be determined at this time. Additionally, these negative impacts may be somewhat mitigated by the fees paid by the SBA under the PPP. We believe that we are well positioned to move through this difficult period with sustained profitability.

Introduction

Farmers & Merchants Bancorp, or the Company, is a bank holding company formed March 10, 1999. Its subsidiary, Farmers & Merchants Bank of Central California, or the Bank, is a California state-chartered bank formed in 1916. Banking services are provided in twenty-nine full-service branches and three stand-alone ATM’s in the Company's service area. The service area includes Sacramento, San Joaquin, Stanislaus, Merced, Contra Costa, Napa and Solano Counties with branches in Sacramento, Elk Grove, Galt, Lodi, Stockton, Linden, Modesto, Turlock, Hilmar, Merced, Manteca, Riverbank, Napa, Walnut Creek, Concord, Rio Vista, Walnut Grove and Lockeford.

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 California Department of Business Oversight (“DBO”) and the Federal Deposit Insurance Corporation (“FDIC”).

Overview

Although the Company has initiated efforts to expand its geographic footprint into the East Bay area of San Francisco and Napa, California (see Item 1: Business – Service Area located in the Company’s 2019 Annual Report on Form 10-K), the Company’s primary service area remains the mid Central Valley of California, a region that can be significantly impacted by the seasonal needs of the agricultural industry. Accordingly, discussion of the Company’s Financial Condition and Results of Operations is influenced by the seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and planting of crops. Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).

The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought conditions in many areas of California, including those in the Company’s primary service area. As a result, reservoir levels are normal 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.

For the three months ended March 31, 2020, Farmers & Merchants Bancorp reported net income of $14,122,000, earnings per share of $17.80 and return on average assets of 1.53%. Return on average shareholders’ equity was 14.90% for the three months ended March 31, 2020.

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For the three months ended March 31, 2019, Farmers & Merchants Bancorp reported net income of $13,549,000, earnings per share of $17.27 and return on average assets of 1.60%. Return on average shareholders’ equity was 16.96% for the three months ended March 31, 2019.

The following is a summary of the financial results for the three-month period ended March 31, 2020 compared to March 31, 2019.

•	Net income increased 4.2% to $14,122,000 from $13,549,000.

•	Earnings per share increased 3.1% to $17.80 from $17.27.

•	Total assets increased 9.6% to $3.7 billion from $3.4 billion.

•	Total loans & leases increased 4.1% to $2.7 billion from $2.6 billion.

•	Total deposits increased 8.2% to $3.3 billion from $3.0 billion.

The primary reasons for the Company’s $573,000 or 4.2% increase in net income in the first quarter of 2020 as compared to the same period of 2019 were:

•	A $1.2 million increase in net interest income related to the growth in earning assets.

•	A $839,000 decrease in legal expense and a $241,000 decrease in FDIC insurance.

•	A decrease in the tax provision from 25.7% to 23.9%.

These positive impacts were partially offset by:

•	A $1.5 million increase in salaries and employee benefits expense and a $754,000 increase in other non-interest expense.

Results of Operations

Net Interest Income / Net Interest Margin

The tables on the following pages reflect the Company's average balance sheets and volume and rate analysis for the three month periods ended March 31, 2020 and 2019.

The average yields on earning assets and average rates paid on interest-bearing liabilities have been computed on an annualized basis for purposes of comparability with full year data. Average balance amounts for assets and liabilities are the computed average of daily balances.

Net interest income is the amount by which the interest and fees on loans & leases and other interest-earning assets exceed the interest paid on interest-bearing sources of funds. For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes. This adjustment is referred to as “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 rate sensitive liabilities are subject to repricing at different times, which exposes the Company to income fluctuations when interest rates change. In order to minimize income fluctuations, the Company attempts to match asset and liability maturities. However, some maturity mismatch is inherent in the asset and liability mix. See “Item 3. Quantitative and Qualitative Disclosures about Market Risk – Interest Rate Risk.”

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Farmers & Merchants Bancorp

Year-to-Date Average Balances and Interest Rates

(Interest and Rates on a Taxable Equivalent Basis)

(in thousands)

				Three Months Ended March 31, 2020									Three Months Ended March 31, 2019
Assets	Balance			Interest			Annualized Yield/Rate			Balance			Interest			Annualized Yield/Rate
Interest Bearing Deposits With Banks	$	289,028		$	947			1.33	%	$	187,461		$	1,125			2.43	%
Investment Securities
U.S. Treasuries		16,298			92			2.30	%		46,617			195			1.67	%
U.S. Govt SBA		10,504			51			1.94	%		15,251			99			2.60	%
Government Agency & Government-Sponsored Entities		-			-			0.00	%		3,028			22			2.91	%
Municipals - Taxable		10,078			86			3.41	%		-			-			0.00	%
Obligations of States and Political Subdivisions - Non-Taxable ⁽¹⁾		49,335			542			4.39	%		54,079			559			4.13	%
Mortgage Backed Securities		436,743			2,918			2.67	%		307,072			2,044			2.66	%
Other		1,801			5			1.11	%		5,183			67			5.17	%
Total Investment Securities		524,759			3,694			2.82	%		431,230			2,986			2.77	%

Loans & Leases: ⁽²⁾
Real Estate		1,821,961			23,649			5.28	%		1,778,866			22,694			5.17	%
Home Equity Line & Loans		39,834			560			5.72	%		39,610			596			6.10	%
Agricultural		265,432			3,431			5.26	%		259,108			3,628			5.68	%
Commercial		391,929			4,873			5.06	%		343,448			4,521			5.34	%
Consumer		14,256			221			6.30	%		17,773			254			5.80	%
Other		770			4			2.11	%		1,079			6			2.26	%
Leases		105,178			1,422			5.50	%		107,867			1,479			5.56	%
Total Loans & Leases		2,639,360			34,160			5.26	%		2,547,751			33,178			5.28	%
Total Earning Assets		3,453,147		$	38,801			4.57	%		3,166,442		$	37,289			4.78	%

Unrealized (Loss) Gain on Securities Available-for-Sale		6,796									(4,019	)
Allowance for Credit Losses		(55,022	)								(55,238	)
Cash and Due From Banks		59,917									56,206
All Other Assets		237,469									217,842
Total Assets	$	3,702,307								$	3,381,233

Liabilities & Shareholders' Equity
Interest Bearing Deposits
Interest Bearing DDA	$	704,065		$	548			0.32	%	$	667,465		$	552			0.34	%
Savings and Money Market		1,015,398			961			0.38	%		910,793			730			0.33	%
Time Deposits		522,548			1,635			1.27	%		513,853			1,539			1.21	%
Total Interest Bearing Deposits		2,242,011			3,144			0.57	%		2,092,111			2,821			0.55	%
Federal Home Loan Bank Advances		4			-			0.00	%		4			-			0.00	%
Subordinated Debentures		10,310			119			4.69	%		10,310			145			5.70	%
Total Interest Bearing Liabilities		2,252,325		$	3,263			0.59	%		2,102,425		$	2,966			0.57	%
Interest Rate Spread ⁽³⁾								3.98	%								4.20	%
Demand Deposits (Non-Interest Bearing)		1,011,298									915,907
All Other Liabilities		59,497									43,375
Total Liabilities		3,323,120									3,061,707

Shareholders' Equity		379,187									319,526
Total Liabilities & Shareholders' Equity	$	3,702,307								$	3,381,233
Net Interest Income and Margin on Total Earning Assets ⁽⁴⁾					35,538			4.19	%					34,323			4.40	%
Tax Equivalent Adjustment					(112	)								(116	)
Net Interest Income				$	35,426			4.17	%				$	34,207			4.38	%

(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)	Interest rate spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.

(4)	Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets.

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Farmers & Merchants Bancorp

Volume and Rate Analysis of Net Interest Revenue

(Interest and Rates on a Taxable Equivalent Basis)

(in thousands)

	Three Months Ended Mar. 31, 2020 compared to Mar. 31, 2019
Interest Earning Assets	Volume			Rate			Net Chg.
Interest Bearing Deposits With Banks	$	466			(644	)	$	(178	)
Investment Securities
U.S. Treasuries		(158	)		55			(103	)
U.S. Govt SBA		(26	)		(22	)		(48	)
Government Agency & Government-Sponsored Entities		(11	)		(11	)		(22	)
Municipals - Taxable		43			43			86
Obligations of States and Political Subdivisions - Non-Taxable		(51	)		34			(17	)
Mortgage Backed Securities		866			8			874
Other		(28	)		(34	)		(62	)
Total Investment Securities		635			73			708

Loans & Leases
Real Estate		500			455			955
Home Equity Line & Loans		3			(39	)		(36	)
Agricultural		87			(284	)		(197	)
Commercial		608			(256	)		352
Consumer		(28	)		(5	)		(33	)
Other		(2	)		-			(2	)
Leases		(39	)		(18	)		(57	)
Total Loans & Leases		1,129			(147	)		982
Total Earning Assets		2,230			(718	)		1,512

Interest Bearing Liabilities
Interest Bearing Deposits
Transaction		29			(33	)		(4	)
Savings and Money Market		89			142			231
Time Deposits		25			71			96
Total Interest Bearing Deposits		143			180			323
Subordinated Debentures		-			(26	)		(26	)
Total Interest Bearing Liabilities		143			1,301			297
Total Change	$	4,139		$	1,168		$	1,215

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.

Net interest income increased $1.2 million or 3.6% to $35.4 million during the first quarter of 2020 compared to $34.2 million for the first quarter of 2019. On a fully tax equivalent basis, net interest income increased 3.5% and totaled $35.5 million at March 31, 2020, compared to $34.3 million at March 31, 2019. As more fully discussed below, the increase in net interest income was primarily due to a $286.7 million increase in average earning assets offset by a 21 basis point decrease in the net interest margin.

Net interest income on a taxable equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin. For the quarter ended March 31, 2020, the Company’s net interest margin was 4.19% compared to 4.40% for the quarter ended March 31, 2019. This decrease in net interest margin was primarily due to a 21 basis point decrease in the yield on earning assets.

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Average loans & leases totaled $2.6 billion for the quarter ended March 31, 2020; an increase of $91.6 million compared to the average balance for the quarter ended March 31, 2019. Loans & leases decreased from 80.5% of average earning assets at March 31, 2019 to 76.4% at March 31, 2020. The annualized yield on the Company’s loan & lease portfolio decreased to 5.26% for the quarter ended March 31, 2020, compared to 5.28 for the quarter ended March 31, 2019. This lower yield offset somewhat the positive impact of increased average loan & lease balances resulting in interest revenue from loans & leases increasing 3.0% to $34.2 million for quarter ended March 31, 2020. The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to continue 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 totaled $524.8 million for the quarter ended March 31, 2020; an increase of $93.5 million compared to the average balance for the quarter ended March 31, 2019. The average investment portfolio yield, on a tax equivalent (TE) basis, was 2.82% for the quarter ended March 31, 2020, compared to 2.77% for the quarter ended March 31, 2019. This overall increase in yield was caused primarily by an increase in the mix of mortgage-backed securities as a percentage of total securities. As a result of the combined impact of these mix, balance and yield changes, tax equivalent interest income on securities increased $708,000 to $3.7 million for the quarter ended March 31, 2020, compared to $3.0 million for the quarter ended March 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 was 0.10% in March 2020 compared to 2.40% in March 2019. Average interest bearing deposits with banks for the quarter ended March 31, 2020, was $289.0 million, an increase of $101.6 million compared to the average balance for the quarter ended March 31, 2019. Interest income on interest bearing deposits with banks for the quarter ended March 31, 2020, decreased $178,000 to $947,000 compared to the quarter ended March 31, 2019.

Average interest-bearing liabilities increased $149.9 million or 7.13% during the first quarter of 2020. Of that increase: (1) interest-bearing transaction deposits increased $36.6 million; (2) savings and money market deposits increased $104.6 million; (3) time deposits increased $8.7 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”).

Total interest expense on interest bearing deposits was $3.1 million for the first quarter of 2020 as compared to $2.8 million for the first quarter of 2019. The average rate paid on interest-bearing deposits was 0.57% for the first quarter of 2020 compared to 0.55% for the first quarter of 2019. The Company continues to experience aggressive competitor rates on interest bearing deposits which it may need to meet in order to retain key customers. This could place negative pressure on future deposit rates and net interest margin.

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.

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Allowance for Credit Losses

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 1 ^st mortgages; (5) home equity lines and loans; (6) agricultural; (7) commercial; (8) consumer & other; and (9) equipment leases. See “Financial Condition – Loans & Leases” for examples of loans & leases made by the Company. The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans & leases and loans & leases that are not impaired, is combined to determine the Company's overall allowance, which is included on the consolidated balance sheet.

The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability. For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans 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.”

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In addition, the Company's and Bank's regulators, including the FRB, DBO 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.

Based upon the results of the Company’s credit loss review and analysis, no provision was required for credit losses during the first quarter of 2020 and 2019. Net charge-offs during the first quarter of 2020 were $188,000 compared to net charge-offs of $360,000 in the first quarter of 2019. See “Overview – Looking Forward: 2020 and Beyond”, “Critical Accounting Policies and Estimates – Allowance for Credit Losses” and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” located in the Company’s 2019 Annual Report on Form 10-K.

After reviewing all factors above, management concluded that the allowance for credit losses, as of March 31, 2020, and March 31, 2019 were adequate .

	Three Months Ended March 31,
Allowance for Credit Losses (in thousands)	2020			2019
Balance at Beginning of Period		55,012			55,266
Loans or Leases Charged Off		(265	)		(400	)
Recoveries of Loans or Leases Previously Charged Off		77			41
Provision Charged to Expense		0			0
Balance at End of Period		54,824			54,907

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The table below breaks out current quarter activity by portfolio segment (in thousands):

March 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		$	855	$	2,675	$	8,076		$	11,466		$	456		$	3,162	$	192	$	55,012
Charge-Offs		-		-			-			-		-		-			(244	)		(21	)		-		-		(265	)
Recoveries		-		-			-			19		20		28			2			8			-		-		77
Provision		69		(659	)		(22	)		163		88		(1,145	)		990			(61	)		26		551		-
Ending Balance- March 31, 2020	$	11,122	$	14,469		$	1,927		$	1,037	$	2,783	$	6,959		$	12,214		$	382		$	3,188	$	743	$	54,824

The Allowance for Credit Losses at March 31, 2020 decreased an insignificant $188,000 from December 31, 2019. The Company believes that an allowance of 2.05% of gross loans provides sufficiently for our exposure at the current time. During the first quarter: (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) were reduced; (2) reserves for Commercial Real Estate, Leases, Commercial, Residential 1 ^st Mortgages and Home Equity (where our COVID-19 exposure is thought to be greater since many of these companies and consumers will be impacted by “non-essential” designations and “shelter-in-place” orders) were increased; and (3) the “Unallocated” reserve was increased. See “Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure.

See “Management’s Discussion and Analysis - Financial Condition – Classified Loans & Leases and Non-Performing Assets” for further discussion regarding these loan categories.

See “Note 5. Allowance for Credit Losses” for additional details regarding the provision and allowance for credit losses.

Non-Interest Income

Non-interest income includes: (1) service charges and fees from deposit accounts; (2) net gains and losses from investment securities; (3 ) increases in the cash surrender value of bank owned life insurance; (4) debit card and ATM fees; (5) net gains and losses on non-qualified deferred compensation plans; and (6) fees from other miscellaneous business services.

Overall, non-interest income decreased $1.5 million or 34.4% for the three months ended March 31, 2020, compared to the same period of 2019. This decrease was primarily due to a $1.7 million increase in the net loss on deferred compensation investments (Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income), somewhat offset by: (1) a $100,000 increase in debit card and ATM fees; and (2) a $44,000 increase in service charges on deposit accounts.

Non-Interest Expense

Non-interest expense for the Company includes expenses for: (1) salaries and employee benefits; (2) net gains and losses on non-qualified deferred compensation plan investments; (3) occupancy; (4) equipment; (5) supplies; (6) legal fees; (7) professional services; (8) data processing; (9) marketing; (10) deposit insurance; (11) ORE carrying costs and gains/losses on sale; and (12) other miscellaneous expenses.

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Overall, non-interest expense decreased $655,000 or 3.2% for the three months ended March 31, 2020, compared to the same period in 2019. This decrease was primarily comprised of: (1) a $1.7 million increase in the net loss on deferred compensation investments (Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income); (2) a $839,000 decrease in legal fees; and (3) a $241,000 decrease in FDIC insurance. These positive impacts were somewhat offset by: (1) increased salaries and employee benefits of $1.5 million; (2) a $209,000 increase in the amortization of low income housing tax credit investments; and (3) a $311,000 increase in staff recruitment and training.

Income Taxes

The Bank’s provision for income taxes decreased 5.0% to $4.4 million for the first quarter of 2020 compared to the first quarter of 2019. The effective tax rate for the first quarter of 2020 was 23.9% compared to 25.7% for the first quarter of 2019. The Company’s effective tax rate fluctuates from quarter to quarter due primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the 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.

Financial Condition

This section discusses material changes in the Company’s balance sheet at March 31, 2020, as compared to December 31, 2019 and to March 31, 2019. As previously discussed (see “Overview”) the Company’s financial condition can be influenced by the seasonal banking needs of its agricultural customers.

Investment Securities and Federal Funds Sold

The investment portfolio provides the Company with an income alternative to loans & leases. The debt securities in the Company’s investment portfolio have historically been comprised primarily of: (1) mortgage-backed securities issued by federal government-sponsored entities; (2) debt securities issued by US Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times, the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity without subjecting the Company to the interest rate risk associated with mortgage-backed securities.

The Company’s investment portfolio at March 31, 2020 was $590.9 million compared to $545.7 million at the end of 2019, an increase of $45.2 million or 8.3%. At December 31, 2019, the investment portfolio totaled $567.6 million. 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 15.9% of the Company’s total assets as compared to 15.3% at December 31, 2019, and 16.1% at March 31, 2019.

As of March 31, 2020, the Company held $58.7 million of municipal investments, all classified as HTM. Of this balance, $27.7 million were bank-qualified municipal bonds, and $31.0 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 March 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 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 $225.7 million at March 31, 2020, $223.2 million at December 31, 2019 and $43.4 million at March 31, 2019.

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The Company classifies its investments as held-to-maturity (“HTM”), trading, or available-for-sale (“AFS”). Securities are classified as HTM and are carried at amortized cost when the Company has the intent and ability to hold the securities to maturity. Trading securities are securities acquired for short-term appreciation and are carried at fair value, with unrealized gains and losses recorded in non-interest income. As of March 31, 2020, December 31, 2019 and March 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.

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 1 ^st Mortgages - These are loans primarily made on owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC; however, we will make loans on rural residential properties up to 40 acres. Most residential loans have terms from ten to twenty years and carry fixed rates priced off of treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income.”

Home Equity Lines and Loans - These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $250,000; Combined Loan To Value (CLTV) does not exceed 80%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1 ^st lien position.

Agricultural - These are loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 24 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.

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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 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.

See “Item 3. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” for a discussion about the credit risks the Company assumes and its overall credit risk management practices.

Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan & lease structure. See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan & lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan & lease type. The Company’s policies require that loans & leases are approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting procedures for all loan & lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease.

Most loans & leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan is made.

In order to be responsive to borrower needs, the Company prices loans & leases: (1) on both a fixed rate and adjustable rate basis; (2) over different terms; and (3) based upon different rate indices; as long as these structures are consistent with the Company’s interest rate risk management policies and procedures. See “Item 3. Quantitative and Qualitative Disclosures About Market Risk-Interest Rate Risk” for further details.

Overall, the Company's loan & lease portfolio at March 31, 2020 totaled $2.7 billion, an increase of $106.1 million or 4.1% over March 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. No assurances can be made that this growth in the loan & lease portfolio will continue.

Loans & leases at March 31, 2020 decreased $2.9 million from $2.7 billion at December 31, 2019. This relatively small overall decrease was primarily a result of $59.7 million in normal seasonal pay downs of loans made to the Company’s agricultural customers, somewhat offset by growth in other portfolio segments.

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The following table sets forth the distribution of the loan & lease portfolio by type and percent as of the periods indicated.

Loan & Lease Portfolio
	March 31, 2020				December 31, 2019				March 31, 2019
(in thousands)	$		%		$		%		$		%
Commercial Real Estate	$	868,736	32.5	%	$	846,486	31.6	%	$	823,028	32.0	%
Agricultural Real Estate		594,154	22.2	%		625,767	23.3	%		603,601	23.5	%
Real Estate Construction		126,956	4.7	%		115,644	4.3	%		99,837	3.9	%
Residential 1st Mortgages		256,732	9.6	%		255,253	9.5	%		258,359	10.1	%
Home Equity Lines and Loans		40,747	1.5	%		39,270	1.5	%		40,072	1.6	%
Agricultural		264,771	9.9	%		292,904	10.9	%		257,004	10.0	%
Commercial		404,329	15.1	%		384,795	14.4	%		364,439	14.2	%
Consumer & Other		14,839	0.6	%		15,422	0.6	%		18,418	0.7	%
Leases		105,362	3.9	%		104,470	3.9	%		105,823	4.0	%
Total Gross Loans & Leases		2,676,626	100.0	%		2,680,011	100.0	%		2,570,581	100.0	%
Less: Unearned Income		6,517				6,984				6,613
Subtotal		2,670,109				2,673,027				2,563,968
Less: Allowance for Credit Losses		54,824				55,012				54,907
Net Loans & Leases	$	2,615,285			$	2,618,015			$	2,509,061

Classified Loans & Leases and Non-Performing Assets

All loans & leases are assigned a credit risk grade using grading standards developed by bank regulatory agencies. See “Results of Operations - Provision and Allowance for Credit Losses” for more detail on risk grades. The Company utilizes the services of a third-party independent loan review firm to perform evaluations of individual loans & leases and review the credit risk grades the Company places on loans & leases. Loans & leases that are judged to exhibit a higher risk profile are referred to as “classified” and these loans & leases receive increased management attention. As of March 31, 2020, classified loans totaled $16.4 million compared to $16.2 million at December 31, 2019 and $15.1 million at March 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 March 31, 2020 non-accrual loans & leases totaled $549,000. There were no non-accrual loans or leases at December 31, 2019 or March 31, 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. 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.

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As of March 31, 2020, restructured loans & leases on accrual totaled $12.0 million as compared to $12.1 million at December 31, 2019. Restructured loans on accrual at March 31, 2019 were $13.7 million.

Other Real Estate - Loans where the collateral has been repossessed are classified as other real estate ("ORE") or, if the collateral is personal property, the loan is classified as other assets on the Company's financial statements.

The following table sets forth the amount of the Company's non-performing loans & leases (defined as non-accrual loans & leases plus accruing loans & leases past due 90 days or more) and ORE as of the dates indicated.

Non-Performing Assets
(in thousands)	March 31, 2020			December 31, 2019			March 31, 2019
Non-Performing Loans & Leases	$	549		$	-		$	-
Other Real Estate		873			873			873
Total Non-Performing Assets		1,422			873			873

Non-Performing Loans & Leases
as a % of Total Loans & Leases		0.00	%		0.00	%		0.00	%
Restructured Loans & Leases (Performing)		12,028			12,105			13,697

Although management believes that non-performing loans & leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. Specific reserves of $214, $0, and $0 have been established for non-performing loans & leases at March 31, 2020, December 31, 2019 and March 31, 2019, respectively.

Foregone interest income on non-accrual loans & leases, which would have been recognized during the period, if all such loans & leases had been current in accordance with their original terms, totaled $2,000 for the period ended March 31, 2020, and $0 for the year ended December 31, 2019, and period ended March 31, 2019.

The Company reported $873,000 of ORE at March 31, 2020, December 31, 2019, and at March 31, 2019.

Except for those classified and non-performing loans & leases discussed above, the Company’s management is not aware of any loans & leases as of March 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 agricultural industry is facing challenges associated with: (1) weakness in export markets due to a stronger dollar, uncertain trade policies and shipping restrictions related to COVID-19; (2) tight labor markets and higher wages due to legislative changes at the state and federal levels; and (3) proposed changes in immigration policy and the resulting impact on the labor pool.

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•

See “Part I, Item 1A. Risk Factors” in the Company’s 2019 Annual Report on Form 10-K, and “Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure.

Deposits

One of the key sources of funds to support earning assets is the generation of deposits from the Company’s customer base. The ability to grow the customer base, and subsequently deposits, is a significant element in the performance of the Company.

The Company's deposit balances at March 31, 2020 have increased $247.2 million or 8.2% compared to March 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. The company continues to experience significant competitive pressures on deposit rates. The Company remains selective in how they respond to competitor rates, which may impact future deposit growth.

Although total deposits have increased 8.2% since March 31, 2019, importantly, low cost transaction accounts continue to grow at a strong pace as well:

•	Demand and interest-bearing transaction accounts increased $134.6 million or 8.57% since March 31, 2019.

•	Savings and money market accounts have increased $115.7 million or 12.7% since March 31, 2019.

•	Time deposit accounts have decreased $3.0 million or 0.3% since March 31, 2019.

The Company's deposit balances at March 31, 2020 have decreased $22.7 million or 0.69% compared to December 31, 2019. Savings and money market deposits increased 3.4% or $33.7 million while demand and interest-bearing transaction accounts decreased by $60.3 million or 3.4% and time deposit accounts increased by $3.8 million or 0.7%. Deposit trends in the first half of the year can be impacted by the seasonal needs of our agricultural customers.

Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings

Lines of credit with the Federal Reserve Bank and the Federal Home Loan Bank are other key sources of funds to support earning assets. These sources of funds are also used to manage the Company’s interest rate risk exposure, and as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB Advances at March 31, 2020, December 31, 2019, or March 31, 2019. There were no Federal Funds purchased or advances from the FRB at March 31, 2020, December 31, 2019 or March 31, 2019.

As of March 31, 2020 the Company has additional borrowing capacity of $617.5 million with the Federal Home Loan Bank and $462.8 million with the Federal Reserve Bank. Any borrowings under these lines would be collateralized with loans that have been accepted for pledging at the FHLB and FRB.

Long-Term Subordinated Debentures

On December 17, 2003, the Company raised $10 million through an offering of trust-preferred securities (“TPS”). See Note 12 located in “Item 8. Financial Statements and Supplementary Data” of the Company’s 2019 Annual Report on Form 10-K. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our TPS will continue to qualify as regulatory capital (See “Capital”). These securities accrue interest at a variable rate based upon 3-month LIBOR plus 2.85%. Interest rates reset quarterly and were 3.69% as of March 31, 2020, 4.75% at December 31, 2019 and 5.46% at March 31, 2019. The average rate paid for these securities for the first quarter of 2020 was 4.58% and 5.66% for the first quarter of 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.

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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 $394.2 million at March 31, 2020, $369.3 million at December 31, 2019, and $330.3 million at March 31, 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 implementation of Basel III requirements will increase the required capital levels that the Company and the Bank must maintain. The final rules include new minimum risk-based capital and leverage ratios, which would be phased in over time. The new minimum capital level requirements applicable to the Company and the Bank under the final rules will be: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets (“RWA”); (ii) a Tier 1 capital ratio of 6% of RWA; (iii) a total capital ratio of 8% of RWA; and (iv) a Tier 1 leverage ratio of 4% of total assets. The final rules also establish a "capital conservation buffer" of 2.5% above each of the new regulatory minimum capital ratios, which would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0% of RWA; (ii) a Tier 1 capital ratio of 8.5% of RWA; and (iii) a total capital ratio of 10.5% of RWA. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. The final rules also permit the Company’s subordinated debentures issued in 2003 to continue to be counted as Tier 1 capital.

The final rules became effective as applied to the Company and the Bank on January 1, 2015, with a phase in period through January 1, 2019. The Company believes that it is currently in compliance with all of these capital requirements and that they did 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. There are no conditions or events since that notification that management believes have changed the Bank’s category.

(in thousands)	Actual					Current Regulatory Capital Requirements					Well Capitalized Under Prompt Corrective Action
The Company:	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of March 31, 2020
Total Capital Ratio	$	416,239		12.83	%	$	259,488		8.0	%		N/A		N/A
Common Equity Tier 1 Capital Ratio	$	365,514		11.27	%	$	145,962		4.5	%		N/A		N/A
Tier 1 Capital Ratio	$	375,514		11.58	%	$	194,616		6.0	%		N/A		N/A
Tier 1 Leverage Ratio	$	375,514		10.19	%	$	147,409		4.0	%		N/A		N/A

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(in thousands)	Actual					Current Regulatory Capital Requirements					Well Capitalized Under Prompt Corrective Action
The Bank:	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of March 31, 2020
Total Capital Ratio	$	415,595		12.81	%	$	259,458		8.0	%	$	324,322		10.0	%
Common Equity Tier 1 Capital Ratio	$	374,875		11.56	%	$	145,945		4.5	%	$	210,810		6.5	%
Tier 1 Capital Ratio	$	374,875		11.56	%	$	194,593		6.0	%	$	259,458		8.0	%
Tier 1 Leverage Ratio	$	374,875		10.18	%	$	147,340		4.0	%	$	184,175		5.0	%

As previously discussed (see “Long-Term Subordinated Debentures”), in order to supplement its regulatory capital base, during December 2003 the Company issued $10 million of trust preferred securities. On March 1, 2005, the Federal Reserve Board issued its final rule effective April 11, 2005, concerning the regulatory capital treatment of trust preferred securities (“TPS”) by bank holding companies (“BHCs”). Under the final rule BHCs may include TPS in Tier 1 capital in an amount equal to 25% of the sum of core capital net of goodwill. Any portion of trust-preferred securities not qualifying as Tier 1 capital would qualify as Tier 2 capital subject to certain limitations. The Company has received notification from the Federal Reserve Bank of San Francisco that all of the Company’s trust preferred securities currently qualify as Tier 1 capital.

The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability.

In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since then, and most recently, on 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” of the Company’s 2019 Annual Report on Form 10-K for additional information.

There were no stock repurchases during the first quarter of 2020 or 2019. The remaining dollar value of shares that may yet be purchased under the Company’s Common Stock Repurchase Plan is approximately $20 million.

On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights Agent. The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan. Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of the Company’s 2019 Annual Report on Form 10-K for further explanation.

During the first quarter of 2020, the Company issued 523 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. These shares were issued at a price of $770.00 per share based upon a valuation completed by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital.

See “Part I, Item 2. COVID-19 (Coronavirus) Disclosure” for a discussion of how loans made under the federal government’s Paycheck Protection Program will impact capital calculations and ratios.

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Critical Accounting Policies and Estimates

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the Company’s financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These judgments govern areas such as the allowance for credit losses, the fair value of financial instruments and accounting for income taxes.

For a full discussion of the Company’s critical accounting policies and estimates see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2019 Annual Report on Form 10-K.

Off Balance Sheet Commitments

In the normal course of business the Company enters into financial instruments with off balance sheet risks in order to meet the financing needs of its customers. These financial instruments consist of 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)	March 31, 2020		December 31, 2019		March 31, 2019
Commitments to Extend Credit	$	939,064	$	919,982	$	829,080
Letters of Credit		20,047		20,346		19,192
Performance Guarantees Under Interest Rate Swap Contracts Entered Into Between Our Borrowing Customers and Third Parties		3,640		1,513		472

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 March 31, 2020, December 31, 2019 and March 31, 2019. We do not anticipate any material losses as a result of these transactions.

ITEM 3.

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.

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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 DBO 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.

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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 March 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.

See “PART 1. – Item 2. - Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure” for a discussion of how COVID-19 may impact credit risk.

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 March 31, 2020, the Company’s estimated net interest income sensitivity to changes in interest rates, as a percent of net interest income was a decrease in net interest income of 0.7% if rates increase by 200 basis points and an increase in net interest income of 0.5% if rates decline 100 basis points. Comparatively, at December 31, 2019, the Company’s estimated net interest income sensitivity to changes in interest rates, as a percent of net interest income was an increase in net interest income of 2.0% if rates increase by 200 basis points and a decrease in net interest income of 2.0% if rates decline 100 basis points.

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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” of the Company’s 2019 Annual Report on Form 10-K) 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 $78 million and repurchase lines of $112 million with major banks. As of March 31, 2020, the Company has additional borrowing capacity of $617 million with the FHLB and $463 million with the FRB. Borrowings under these lines are collateralized with loans or securities that have been accepted for pledging at the FHLB and FRB.

At March 31, 2020, the Company had available sources of liquidity, which included cash and cash equivalents and unpledged investment securities AFS of approximately $400 million, which represents 10.74% of total assets.

See “PART 1. – Item 2. - Management’s Discussion and Analysis - COVID-19 (Coronavirus) Disclosure” for a discussion of how COVID-19 may impact liquidity risk.

ITEM 4.

CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures designed to ensure that 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 designing these controls and procedures, management recognizes that they can only provide reasonable assurance of achieving the desired control objectives. Management also evaluated the cost-benefit relationship of possible controls and procedures.

As of the end of the period covered by this report, the Company carried out an evaluation of the effectiveness of Company’s disclosure controls and procedures under the supervision and with the participation of the Chief Executive Officer, the Chief Financial Officer and other senior management of the Company. The evaluation was based, in part, upon reports and affidavits provided by a number of executives. Based on the foregoing, the Company’s Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the internal controls over financial reporting subsequent to the date the Company completed its evaluation.

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PART II. OTHER INFORMATION

ITEM 1. 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.

ITEM 1A. Risk Factors

See “Item 1A. Risk Factors” in the Company’s 2019 Annual Report to Shareholders on Form 10-K. In management’s opinion, with the exception of the disclosure regarding COVID-19 (see “PART 1. – Item 2. - Management’s Discussion and Analysis - COVID-19 Disclosure”), there have been no material changes in risk factors since the filing of the 2019 Form 10-K.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

There were no shares repurchased by Farmers & Merchants Bancorp during the first quarter of 2020. The remaining dollar value of shares that may yet be purchased under the Company’s Stock Repurchase Plan is approximately $20.0 million.

During the first quarter of 2019, the Company issued 3,586 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. These shares were issued at a price of $715.00 per share based upon a valuation completed by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder.

The 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.” Additionally, management is aware that there are private transactions in the Company’s common stock.

ITEM 3. Defaults Upon Senior Securities

Not applicable

ITEM 4. Mine Safety Disclosures

Not applicable

ITEM 5. Other Information

None

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ITEM 6. Exhibits

Exhibit No.	Description

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.
32	Certifications 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	XBRL Instance Document
101.SCH	XBRL Schema Document
101.CAL	XBRL Calculation Linkbase Document
101.LAB	XBRL Label Linkbase Document
101.PREXBRL	Presentation Linkbase Document
101.DEF	XBRL Definition Linkbase Document

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SIGNATURES

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

	FARMERS & MERCHANTS BANCORP

Date: May 8, 2020	/s/ Kent A. Steinwert

	Kent A. Steinwert
	Chairman, President
	& Chief Executive Officer (Principal Executive Officer)

Date: May 8, 2020	/s/ Stephen W. Haley

	Stephen W. Haley
	Executive Vice President and
	Chief Financial Officer
	(Principal Financial & Accounting Officer)

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Part I. Financial Information Item 1. Financial Statements Item 2. Management S Discussion and Analysis Of Financial Condition and Results Of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures Part II. Other Information Item 1. Legal Proceedings Item 1A. Risk Factors Item 2. Unregistered Sales Of Equity Securities and Use Of Proceeds Item 3. Defaults Upon Senior Securities Item 4. Mine Safety Disclosures Item 5. Other Information Item 6. Exhibits

Exhibits

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. 32 Certifications 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.

FMCB 10-Q Quarter ended March 31, 2020

Exhibits