FMFG 10-Q Quarter ended Sept. 30, 2018

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		September 30,				December 31,
		2018				2017
		(Unaudited)
Assets
Cash and due from banks		$	9,773,804			$	6,235,186
Federal funds sold and other interest-bearing deposits			2,844,890				1,002,199
Cash and cash equivalents			12,618,694				7,237,385
Certificates of deposit in other bank			342,000				100,000
Securities available for sale			23,409,440				27,929,510
Securities held to maturity			18,119,599				18,204,182
Equity security at fair value			496,916				503,881
Federal Home Loan Bank stock, at cost			575,800				1,063,600
Mortgage loans held for sale			150,000				327,700
Loans, less allowance for loan losses of $2,672,584 and $2,458,911			341,327,272				332,533,706
Premises and equipment			5,137,072				5,206,271
Accrued interest receivable			968,951				1,020,256
Deferred income taxes			1,145,214				998,032
Other real estate owned			210,150				265,500
Bank owned life insurance			7,012,864				6,891,590
Other assets			670,392				622,856
		$	412,184,364			$	402,904,469
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing		$	59,561,564			$	64,403,133
Interest-bearing			289,952,691				255,393,291
Total deposits			349,514,255				319,796,424
Securities sold under repurchase agreements			12,163,423				21,768,507
Federal Home Loan Bank of Atlanta advances			3,000,000				17,000,000
Accrued interest payable			296,868				180,620
Other liabilities			2,672,864				2,359,986
			367,647,410				361,105,537
Stockholders' equity
Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 1,675,200 shares in 2018 and 1,667,813 shares in 2017			16,752				16,678
Additional paid-in capital			27,086,751				26,869,796
Retained earnings			18,204,888				15,306,625
Accumulated other comprehensive income			(771,437	)			(394,167	)
			44,536,954				41,798,932
		$	412,184,364			$	402,904,469

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		Three months ended September 30								Nine months ended September 30
		2018				2017				2018				2017
Interest income
Loans, including fees		$	4,189,626			$	3,863,788			$	12,171,765			$	11,245,018
Investment securities - taxable			145,791				189,096				450,649				558,648
Investment securities - tax exempt			142,493				152,519				428,055				454,626
Federal funds sold and other interest earning assets			47,280				26,614				117,973				72,097
Total interest income			4,525,190				4,232,017				13,168,442				12,330,389
Interest expense
Deposits			604,697				357,200				1,543,023				1,000,884
Securities sold under repurchase agreements			42,841				37,208				112,242				121,495
Federal Home Loan Bank advances and other borrowings			16,480				48,397				125,427				118,757
Total interest expense			664,018				442,805				1,780,692				1,241,136
Net interest income			3,861,172				3,789,212				11,387,750				11,089,253
Provision for loan losses			(100,000	)			225,000				25,000				350,000
Net interest income after provision for loan losses			3,961,172				3,564,212				11,362,750				10,739,253
Noninterest income
Service charges on deposit accounts			160,665				172,107				496,393				525,107
Mortgage banking income			105,144				76,916				219,805				185,649
Bank owned life insurance income			40,880				43,096				121,274				129,340
Net unrealized (loss) gain on equity securities			(3,869	)			-				(15,348	)			-
Gain (loss) on sale and write down of other real estate owned			(55,350	)			-				(55,350	)			-
Gain on sale of SBA loans			3,317				-				63,825				217,563
Other fees and commissions			21,634				20,873				73,433				80,115
Total noninterest income			272,421				312,992				904,032				1,137,774
Noninterest expense
Salaries			1,344,759				1,278,741				3,892,971				3,670,613
Employee benefits			328,258				317,231				1,018,280				996,398
Occupancy			168,759				152,157				535,448				503,578
Furniture and equipment			148,945				156,700				475,953				491,356
Other			606,346				594,879				1,932,585				1,916,018
Total noninterest expense			2,597,067				2,499,708				7,855,237				7,577,963
Income before income taxes			1,636,526				1,377,496				4,411,545				4,299,064
Income taxes			327,838				363,040				835,674				1,166,162
Net income		$	1,308,688			$	1,014,456			$	3,575,871			$	3,132,902
Earnings per share - basic and diluted		$	0.78			$	0.61			$	2.14			$	1.89

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		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
Net income		$	1,308,688			$	1,014,456			$	3,575,871			$	3,132,902
Other comprehensive income (loss), net of income taxes:
Securities available for sale
Net unrealized gain (loss) arising during the period			(115,428	)			(13,552	)			(534,867	)			169,317
Reclassification adjustment for realized gains and losses included in net income			-				-				-				-
Total unrealized gain (loss) on investment securities available for sale			(115,428	)			(13,552	)			(534,867	)			169,317
Income tax expense (benefit) relating to investment securities available for sale			(31,762	)			(5,346	)			(147,181	)			66,787
Total other comprehensive income (loss)			(83,666	)			(8,206	)			(387,686	)			102,530
Total comprehensive income		$	1,225,022			$	1,006,250			$	3,188,185			$	3,235,432

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										Additional								Accumulated other				Total
		Common stock								paid-in				Retained				comprehensive				stockholders'
		Shares				Par value				capital				earnings				income				equity
Balance, December 31, 2016			1,656,390			$	16,564			$	26,562,919			$	12,713,099			$	(280,305	)		$	39,012,277
Net income			-				-				-				3,132,902				-				3,132,902
Unrealized gain on securities available for sale net of income tax expense of $66,787			-				-				-				-				102,530				102,530
Cash dividends, $0.37 per share			-				-				-				(612,864	)			-				(612,864	)
Dividends reinvested			4,310				43				112,760				-				-				112,803
Balance, September 30, 2017			1,660,700			$	16,607			$	26,675,679			$	15,233,137			$	(177,775	)		$	41,747,648
Balance, December 31, 2017			1,667,813			$	16,678			$	26,869,796			$	15,306,625			$	(394,167	)		$	41,798,932
Net income			-				-				-				3,575,871				-				3,575,871
Unrealized loss on securities available for sale net of income tax benefit of $147,181			-				-				-				-				(387,686	)			(387,686	)
Reclassification due to adoption of ASU No. 2016-01															(10,416	)			10,416				-
Cash dividends, $0.40 per share			-				-				-				(667,192	)			-				(667,192	)
Dividends reinvested			7,337				73				215,406				-				-				215,479
Shares issued			50				1				1,549				-				-				1,550
Balance, September 30, 2018			1,675,200			$	16,752			$	27,086,751			$	18,204,888			$	(771,437	)		$	44,536,954

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Nine Months Ended September 30,		2018				2017
Cash flows from operating activities
Interest received		$	13,200,699			$	12,459,877
Fees and commissions received			789,631				790,871
Interest paid			(1,664,444	)			(1,193,825	)
Proceeds from sale of mortgage loans held for sale			10,513,771				8,540,009
Origination of mortgage loans held for sale			(10,336,071	)			(8,489,409	)
Cash paid to suppliers and employees			(7,490,137	)			(4,933,897	)
Income taxes paid, net of refunds received			(588,898	)			(1,166,162	)
			4,424,551				6,007,464
Cash flows from investing activities
Proceeds from maturity and call of securities
Available for sale			3,867,038				5,441,743
Held to maturity			165,000				1,054,308
Purchase of securities
Available for sale			-				(1,132,225	)
Held to maturity			(63,242	)			(1,805,923	)
Purchase of certificate of deposit			(242,000	)			-
Loans made to customers, net of principal collected			(9,473,587	)			(27,550,876	)
Proceeds from sale of loans			729,511				2,752,563
(Purchase) redemption of stock in FHLB of Atlanta			487,800				(242,800	)
Purchases of premises, equipment and software			(176,346	)			(51,313	)
			(4,705,826	)			(21,534,523	)
Cash flows from financing activities
Net increase (decrease) in
Noninterest-bearing deposits			(4,841,569	)			(3,148,915	)
Interest-bearing deposits			34,559,400				14,503,517
Securities sold under repurchase agreements			(9,605,084	)			(3,663,750	)
Federal Home Loan Bank of Atlanta advances			(14,000,000	)			7,000,000
Dividends paid, net of reinvestments			(451,713	)			(500,061	)
Common stock issued			1,550				-
			5,662,584				14,190,791
Net increase (decrease) in cash and cash equivalents			5,381,309				(1,336,268	)
Cash and cash equivalents at beginning of period			7,237,385				13,312,915
Cash and cash equivalents at end of period		$	12,618,694			$	11,976,647

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Nine Months Ended September 30,		2018				2017
Reconciliation of net income to net cash provided by operating activities
Net income		$	3,575,871			$	3,132,902
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			289,097				320,966
Provision for loan losses			25,000				350,000
Write down of other real estate owned			55,350				-
Mutual fund dividend reinvested			(8,383	)			(7,845	)
Mutual fund unrealized loss included in net income			15,348				-
Gain on sale of loans			(63,825	)			(217,563	)
Decrease (increase) in mortgage loans held for sale			177,700				50,600
Amortization of premiums and accretion of discounts, net			100,989				79,969
Increase (decrease) in
Deferred loan fees			(10,665	)			103,405
Accrued interest payable			116,248				47,311
Other liabilities			312,878				651,010
Decrease (increase) in
Accrued interest receivable			51,305				33,928
Bank owned life insurance cash surrender value			(121,274	)			(129,340	)
Other assets			(91,088	)			1,592,121
		$	4,424,551			$	6,007,464

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1. Principles of consolidation

The consolidated financial statements include the accounts of Farmers and Merchants Bancshares, Inc. and its wholly owned subsidiaries, Farmers and Merchants Bank (the “Bank”), and Series Protected Cell FCB-4 (the “Insurance Subsidiary”), and one indirect subsidiary, Reliable Community Financial Services, Inc. (collectively the “Company”, “we”, “us”, or “our”). The Insurance Subsidiary constitutes an investment in a series of membership interests, 100% owned by the Company, issued by First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed property and casualty insurance company. Intercompany balances and transactions have been eliminated.

2.      Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods have been made. Such adjustments were normal and recurring in nature. The results of operations for the three months and nine months ended September 30, 2018 do not necessarily reflect the results that may be expected for the entire fiscal year ending December 31, 2018 or any other interim period. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 31, 2017, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K.

Recent Accounting Pronouncements

In January 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments in ASU 2016-01, among other things: (i) requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (ii) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables); and (iii) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost. The amendments within this ASU are effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. The new guidance permits early adoption of the provision that exempts private companies and not-for-profit organizations from having to disclose at fair value information about financial instruments measured at amortized cost. The Company adopted the provisions of ASU 2016-01, effective January 1, 2018, by recording a $10,416 adjustment to retained earnings and reclassifying the Company’s ownership of a mutual fund, considered an equity security, to a separate line on the consolidated balance sheet as of December 31, 2017.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 841).” Among other things, ASU 2016-02 will require lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company anticipates that the impact of ASU 2016-02’s implementation will be an equal increase in assets and liabilities of approximately $1,500,000.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses”. The ASU sets forth a “current expected credit loss” (CECL) model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently assessing the impact of the adoption of this ASU on its consolidated financial statements and has begun developing an implementation plan.

In March 2017, the FASB issued ASU 2017-08, “Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20) – Premium Amortization on Purchased Callable Debt Securities.” ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 and is not expected to have a material impact on our financial statements.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

3.	Investment Securities

Investments in debt securities are summarized as follows:

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.      Investment Securities (continued)

Contractual maturities, shown below, will differ from actual maturities because borrowers and issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Securities with a carrying value of $16,624,704 and $31,982,381 as of September 30, 2018 and December 31, 2017, respectively, were pledged as collateral for Federal Home Loan Bank advances, government deposits and securities sold under repurchase agreements.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.      Investment Securities (continued)

The following table sets forth the Company’s gross unrealized losses on a continuous basis for investments in debt securities, by category and length of time, at September 30, 2018 and December 31, 2017.

Management has the ability and intent to hold securities classified as held to maturity until they mature, at which time the Company should receive full value for the securities. As of September 30, 2018 and December 31, 2017, management did not have the intent to sell any of the securities before a recovery of cost. The unrealized losses are due to increases in market interest rates over the yields available at the time the underlying securities were purchased as well as other market conditions for each particular security based upon the structure and remaining principal balance. The fair values of the investment securities are expected to recover as the securities approach their maturity dates or repricing dates or if market yields for such investments decline. Based on the these factors, as of September 30, 2018 and December 31, 2017, management believes the unrealized losses detailed in the table above are temporary and, accordingly, none of these unrealized losses have been recognized in the Company’s consolidated statement of income.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.

Loans

Major categories of loans are as follows:

Non-accrual loans, segregated by class of loans, were as follows:

At September 30, 2018, the Company had two nonaccrual commercial real estate loans to one borrower totaling $1,678,811 . The loans were secured by real estate and business assets, and were personally guaranteed. Gross interest income of $35,467 would have been recorded in 2018 if this nonaccrual loan had been current and performing in accordance with the original terms. The Company allocated $210,686 of its allowance for loan losses for this nonaccrual loan. A formal appraisal of the collateral of this loan by a certified appraiser will be completed in the fourth quarter. The Company will adjust the reserve amount or charge off a portion of the loan, if necessary based on the appraisal, in the fourth quarter of 2018.

At December 31, 2017, the Company had one nonaccrual commercial real estate loan totaling $2,245,743. The loan was secured by real estate and business assets, and was personally guaranteed. Gross interest income of $82,070 would have been recorded in 2017 if this nonaccrual loan had been current and performing in accordance with the original terms. The Company allocated $127,213 of its allowance for loan losses for this nonaccrual loan. The balance of the nonaccrual loan was net of charge-offs of $275,000 at December 31, 2017. The loan was paid off by the borrower during the three months ended June 30, 2018. The Company recorded a recovery of $151,000 during the three months ended June 30, 2018 and $46,660 during the three months ended September 30, 2018.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

An age analysis of past due loans, segregated by type of loan, is as follows:

Impaired loans, segregated by class of loans, are set forth in the following table:

Impaired loans also include certain loans that have been modified in troubled debt restructurings (“TDRs”) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

At September 30, 2018, the Company had one loan classified as a TDR. The loan is included in impaired loans above and is a commercial real estate loan with a balance of $2,146,651 . The loan is paying as agreed.

At December 31, 2017, the Company had three commercial real estate loans totaling $2,937,439 classified as TDRs. Two loans totaling $774,274 were restructured as TDRs during 2017 and were paid off during the quarter ended June 30, 2018. All are included in impaired loans above. The remaining loan is paying as agreed. There have been no charge-offs or allowances associated with these three loans.

As part of our portfolio risk management, the Company assigns a risk grade to each loan. The factors used to determine the grade are the payment history of the loan and the borrower, the value of the collateral and net worth of the guarantor, and cash flow projections of the borrower. Excellent, Above Average, Average and Acceptable grades are assigned to loans with limited or no delinquent payments and more than sufficient collateral and/or cash flow.

A description of the general characteristics of loans characterized as watch list or classified is as follows:

Pass/Watch

Loans graded as Pass/Watch are secured by generally acceptable assets which reflect above-average risk. The loans warrant closer scrutiny by management than is routine, due to circumstances affecting the borrower, the borrower’s industry, or the overall economic environment. Borrowers may reflect weaknesses such as inconsistent or weak earnings, break even or moderately deficit cash flow, thin liquidity, minimal capacity to increase leverage, or volatile market fundamentals or other industry risks. Such loans are typically secured by acceptable collateral, at or near appropriate margins, with realizable liquidation values.

Special Mention

A special mention loan 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 asset or in the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Borrowers may exhibit poor liquidity and leverage positions resulting from generally negative cash flow or negative trends in earnings. Access to alternative financing may be limited to finance companies for business borrowers and may be unavailable for commercial real estate borrowers.

Substandard

A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Borrowers may exhibit recent or unexpected unprofitable operations, an inadequate debt service coverage ratio, or marginal liquidity and capitalization. These loans require more intense supervision by Company management.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

Doubtful

A doubtful loan has all the weaknesses inherent as a substandard loan with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans by credit grade, segregated by loan type, are as follows:

The Company’s allowance for loan losses is based on management’s evaluation of the risks inherent in the Company’s loan portfolio and the general economy. The allowance for loan losses is maintained at the amount management considers adequate to cover estimated losses in loans receivable that are deemed probable based on information currently known to management. The allowance is based upon a number of factors, including current economic conditions, actual loss experience by pools of similar loans, diversification and size of the portfolio, adequacy of the collateral, the amount of non-performing loans and industry trends. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to make additional provisions for estimated loan losses based upon judgments different from those of management.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (Continued)

The following table details activity in the allowance for loan losses by portfolio for the nine months ended September 30, 2018 and 2017, and the year ended December 31, 2017. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)