FMFG 10-Q Quarterly Report Sept. 30, 2021 | Alphaminr
Farmers & Merchants Bancshares, Inc.
ALPHAMINR

FMFG 10-Q Quarter ended Sept. 30, 2021

Balance Sheet
Cash Flow
Income Statement
FARMERS & MERCHANTS BANCSHARES, INC.
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fmfg20210930_10q.htm
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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 quarterly period ended September 30, 2021

☐

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _______________ to ________________

Commission file number 000-55756

Farmers and Merchants Bancshares, Inc.

(Exact name of registrant as specified in its charter)

Maryland

81-3605835

(State or other jurisdiction of

(I. R. S. Employer Identification No.)

incorporation or organization)

4510 Lower Beckleysville Road, Suite H , Hampstead , Maryland 21074

(Address of principal executive offices)          (Zip Code)

( 410 ) 374-1510

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None.

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 periods 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 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, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition 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).

Yes ☐ No ☑

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,023,487 as of November 12, 2021.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Table of Contents

Page

PART I – FINANCIAL INFORMATION

3

Item 1.  Financial Statements

3

Consolidated balance sheets at September 30, 2021 (unaudited) and December 31, 2020

3

Consolidated statements of income (unaudited) for the three and nine months ended September 30, 2021 and 2020

4

Consolidated statements of comprehensive income (unaudited) for the three and nine months ended September 30, 2021 and 2020

5

Consolidated statements of changes in stockholders’ equity (unaudited) for the three and nine months ended September 30, 2021 and 2020

6

Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2021 and 2020

7

Notes to financial statements (unaudited)

9

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

29

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

48

Item 4.  Controls and Procedures

48

PART II – OTHER INFORMATION

49

Item 1.  Legal Proceedings

49

Item 1A.  Risk Factors

49

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

49

Item 3.  Defaults upon Senior Securities

49

Item 4.  Mine Safety Disclosures

49

Item 5.  Other Information

49

Item 6.  Exhibits

49

SIGNATURES

50

2

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

September 30,

December 31,

2021

2020

(Unaudited)

Assets

Cash and due from banks

$ 39,157,850 $ 39,898,557

Federal funds sold and other interest-bearing deposits

444,014 1,077,113

Cash and cash equivalents

39,601,864 40,975,670

Certificates of deposit in other banks

350,000 850,000

Securities available for sale, at fair value

121,265,582 54,477,286

Securities held to maturity, at cost

21,883,882 23,078,519

Equity security at fair value

547,349 552,566

Restricted stock, at cost

675,400 900,500

Mortgage loans held for sale

1,757,550 1,673,350

Loans, less allowance for loan losses of $3,744,218 and $3,296,538

495,781,194 521,690,514

Premises and equipment, net

6,291,405 7,736,556

Accrued interest receivable

1,579,447 2,057,491

Deferred income taxes, net

1,610,156 1,219,668

Other real estate owned, net of valuation allowance

1,411,605 1,411,605

Bank owned life insurance

15,230,325 11,297,342

Goodwill and other intangibles

7,053,162 7,059,408

Other assets

1,703,283 2,336,607
$ 716,742,204 $ 677,317,082

Liabilities and Stockholders' Equity

Deposits

Noninterest-bearing

$ 125,841,422 $ 103,155,113

Interest-bearing

496,091,137 470,246,434

Total deposits

621,932,559 573,401,547

Securities sold under repurchase agreements

10,475,121 24,753,972

Federal Home Loan Bank of Atlanta advances

5,000,000 5,000,000

Long-term debt, net of issuance costs

16,977,499 16,973,280

Accrued interest payable

323,420 409,622

Other liabilities

5,728,289 5,049,178
660,436,888 625,587,599

Stockholders' equity

Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 3,023,487 in 2021 and 3,011,255 in 2020

30,235 30,113

Additional paid-in capital

28,557,249 28,294,139

Retained earnings

28,040,118 22,698,954

Accumulated other comprehensive (loss) income

( 322,286 ) 706,277
56,305,316 51,729,483
$ 716,742,204 $ 677,317,082

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

3

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

Three months ended

Nine months ended

September 30,

September 30,

2021

2020

2021

2020

Interest income

Loans, including fees

$ 6,059,709 $ 4,489,992 $ 17,828,026 $ 13,205,913

Investment securities - taxable

426,886 159,277 967,841 561,038

Investment securities - tax exempt

149,375 163,522 462,361 462,305

Federal funds sold and other interest earning assets

18,298 9,563 47,743 58,362

Total interest income

6,654,268 4,822,354 19,305,971 14,287,618

Interest expense

Deposits

460,377 690,833 1,589,334 2,429,496

Securities sold under repurchase agreements

9,647 18,020 38,130 95,710

Federal Home Loan Bank advances and other borrowings

192,255 12,752 570,542 25,726

Total interest expense

662,279 721,605 2,198,006 2,550,932

Net interest income

5,991,989 4,100,749 17,107,965 11,736,686

Provision for loan losses

330,000 - 430,000 475,000

Net interest income after provision for loan losses

5,661,989 4,100,749 16,677,965 11,261,686

Noninterest income

Service charges on deposit accounts

187,141 138,288 522,815 414,501

Mortgage banking income

207,471 272,297 704,404 684,664

Bank owned life insurance income

79,942 42,250 232,983 127,473

Gain on sale of premises and equipment

6,897 - 44,510 -

Fair value adjustment on equity security

( 2,056 ) 1 ( 10,214 ) 13,046

Gain on sale of SBA loans

6,917 - 6,917 63,635

Gain on premium call of debt security

621 - 9,190 -

Other fees and commissions

45,045 34,532 126,874 94,277

Total noninterest income

531,978 487,368 1,637,479 1,397,596

Noninterest expense

Salaries

1,895,780 1,462,946 5,366,854 4,114,143

Employee benefits

388,879 376,860 1,299,900 1,183,414

Occupancy

241,557 183,719 737,087 552,265

Furniture and equipment

198,190 175,006 578,562 501,267

Acquisition

- 1,267,401 - 1,612,321

Other

740,722 660,075 2,386,982 1,970,913

Total noninterest expense

3,465,128 4,126,007 10,369,385 9,934,323

Income before income taxes

2,728,839 462,110 7,946,059 2,724,959

Income taxes

606,292 76,863 1,761,718 460,350

Net income

$ 2,122,547 $ 385,247 $ 6,184,341 $ 2,264,609

Earnings per share - basic and diluted

$ 0.70 $ 0.13 $ 2.05 $ 0.76

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

4

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

Three Months Ended

Nine Months Ended

September 30,

September 30,

2021

2020

2021

2020

Net income

$ 2,122,547 $ 385,247 $ 6,184,341 $ 2,264,609

Other comprehensive income (loss), net of income taxes:

Securities available for sale

Net unrealized gain (loss) arising during the period

( 321,489 ) ( 32,263 ) ( 1,428,240 ) 1,023,573

Reclassification adjustment for realized gains and losses included in net income

621 - 9,190 -

Total unrealized gain (loss) on investment securities available for sale

( 320,868 ) ( 32,263 ) ( 1,419,050 ) 1,023,573

Income tax expense (benefit)

( 88,295 ) ( 8,878 ) ( 390,487 ) 281,662

Total other comprehensive income (loss)

( 232,573 ) ( 23,385 ) ( 1,028,563 ) 741,911

Total comprehensive income

$ 1,889,974 $ 361,862 $ 5,155,778 $ 3,006,520

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

5

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three and nine months Ended September 30, 2021 and 2020

(Unaudited)

Additional

Accumulated other

Total

Common stock

paid-in

Retained

comprehensive

stockholders'

Shares

Par value

capital

earnings

income (loss)

equity

Three months ended June 30, 2020

Balance, June 30, 2020

2,991,963 $ 29,920 $ 28,054,158 $ 22,674,059 $ 807,920 $ 51,566,057

Net income

- - - 385,247 - 385,247

Other comprehensive loss

- - - - ( 23,385 ) ( 23,385 )

Dividends reinvested

1 - - 261 - 261

Balance, September 30, 2020

2,991,964 $ 29,920 $ 28,054,158 $ 23,059,567 $ 784,535 $ 51,928,180

Nine months ended September 30, 2020

Balance, December 31, 2019

2,974,019 $ 29,740 $ 27,812,991 $ 21,568,161 $ 42,624 $ 49,453,516

Net income

- - - 2,264,609 - 2,264,609

Other comprehensive income

- - - - 741,911 741,911

Cash dividends, $0.26 per share

- - - ( 773,203 ) - ( 773,203 )

Dividends reinvested

17,945 180 241,167 - - 241,347

Balance, September 30, 2020

2,991,964 $ 29,920 $ 28,054,158 $ 23,059,567 $ 784,535 $ 51,928,180

Three months ended September 30, 2021

Balance, June 30, 2021

3,023,487 $ 30,235 $ 28,557,249 $ 25,917,571 $ ( 89,713 ) $ 54,415,342

Net income

- - - 2,122,547 - 2,122,547

Other comprehensive loss

- - - - ( 232,573 ) ( 232,573 )

Balance, September 30, 2021

3,023,487 $ 30,235 $ 28,557,249 $ 28,040,118 $ ( 322,286 ) $ 56,305,316

Nine months ended September 30, 2021

Balance, December 31, 2020

3,011,255 $ 30,113 $ 28,294,139 $ 22,698,954 $ 706,277 $ 51,729,483

Net income

- - - 6,184,341 - 6,184,341

Other comprehensive loss

- - - - ( 1,028,563 ) ( 1,028,563 )

Cash dividends, $0.28 per share

- - - ( 843,177 ) - ( 843,177 )

Dividends reinvested

12,232 122 263,110 - - 263,232

Balance, September 30, 2021

3,023,487 $ 30,235 $ 28,557,249 $ 28,040,118 $ ( 322,286 ) $ 56,305,316

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

6

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Nine Months Ended September 30,

2021

2020

Cash flows from operating activities

Interest received

$ 19,502,080 $ 14,615,625

Fees and commissions received

1,354,093 1,193,443

Interest paid

( 2,476,513 ) ( 2,666,969 )

Proceeds from sale of mortgage loans held for sale

32,799,205 35,230,924

Origination of mortgage loans held for sale

( 32,883,405 ) ( 37,639,383 )

Cash paid to suppliers and employees

( 8,989,072 ) ( 9,241,695 )

Income taxes paid, net of refunds received

( 1,065,000 ) ( 838,335 )
8,241,388 653,610

Cash flows from investing activities

Proceeds from maturity and call of securities

Available for sale

24,273,762 15,222,262

Held to maturity

2,121,989 1,898,420

Proceeds from sale of securities

Available for sale

- 2,025,000

Held to maturity

- -

Purchase of securities

Available for sale

( 92,992,748 ) ( 19,890,543 )

Held to maturity

( 842,061 ) ( 4,957,679 )

Redemption of certificates of deposit

500,000 -

Loans made to customers, net of principal collected

25,701,580 ( 32,358,278 )

Proceeds from sale of loans

61,595 683,885

Redemption(purchase) of stock in FHLB of Atlanta

225,100 ( 320,100 )

Deposit to transfer agent for subsequent acquisition

- ( 24,807,728 )

Purchase of bank owned life insurance

( 3,700,000 ) -

Proceeds from sale of premises and equipment

1,387,613 -

Purchases of premises, equipment and software

( 227,010 ) ( 299,532 )
( 43,490,180 ) ( 62,804,293 )

Cash flows from financing activities

Net increase (decrease) in

Noninterest-bearing deposits

22,686,309 18,351,388

Interest-bearing deposits

26,047,473 31,110,946

Securities sold under repurchase agreements

( 14,278,851 ) ( 4,640,436 )

Federal Home Loan Bank of Atlanta advances

- 7,000,000

Long-term debt proceeds

- 16,971,874

Dividends paid, net of reinvestments

( 579,945 ) ( 531,856 )
33,874,986 68,261,916

Net (decrease) increase in cash and cash equivalents

( 1,373,806 ) 6,111,233

Cash and cash equivalents at beginning of period

40,975,670 9,121,352

Cash and cash equivalents at end of period

$ 39,601,864 $ 15,232,585

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

7

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Nine Months Ended September 30,

2021

2020

Reconciliation of net income to net cash provided by operating activities

Net income

$ 6,184,341 $ 2,264,609

Adjustments to reconcile net income to net cash provided by operating activities

Depreciation and amortization

356,439 274,241

Provision for loan losses

430,000 475,000

Amortization of right of use asset

14,023 25,677

Equity security dividends reinvested

( 4,997 ) ( 7,690 )

Fair value adjustment on equity securities

10,214 ( 13,046 )

Gain on sale of SBA loans

( 6,917 ) ( 63,635 )

Gain on sale of premises and equipment

( 44,510 ) -

Gain on premium call of debt security

( 9,190 ) -

Amortization of debt issuance costs

4,219 -

Amortization of premiums and accretion of discounts, net

( 38,029 ) 283,207

Bank owned life insurance cash surrender value

( 232,983 ) ( 127,472 )

Increase (decrease) in

Deferred loan fees and costs, net

105 531,441

Accrued interest payable

( 86,202 ) ( 116,037 )

Other liabilities

777,175 196,658

Decrease (increase) in

Mortgage loans held for sale

( 84,200 ) ( 2,408,459 )

Accrued interest receivable

478,044 ( 195,744 )

Other assets

493,856 ( 465,140 )
$ 8,241,388 $ 653,610

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

8

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

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 subsidiary of the Bank, 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, including the insurance premium paid by the Bank to the Insurance Subsidiary through an intermediary, have been eliminated. Effective October 1, 2020, the Company acquired Carroll Bancorp, Inc. and its wholly-owned subsidiary, Carroll Community Bank (collectively, “Carroll”), both of which were based in Eldersburg, Maryland, through a series of merger transactions (the “Merger”). The results of operations and assets acquired and liabilities assumed from Carroll are included only from the effective date of the Merger. The timing of the Merger will impact the comparability of the Company's results of operations for the three and nine months ended September 30, 2021 and 2020.

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 and nine months ended September 30, 2021 do not necessarily reflect the results that may be expected for the fiscal year ending December 31, 2021 or any future 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, 2020, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10 -K for the year ended December 31, 2020.

Summary of Significant Accounting Policies

The accounting and reporting policies reflected in the financial statements conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Management makes estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosures of commitments and contingent liabilities at the balance sheet date, and revenues and expenses during the year. These estimates and assumptions may affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Loans and allowance for loan losses

Loans are stated at the current amount of unpaid principal, adjusted for deferred origination costs, deferred origination fees, premiums and discounts on acquired loans, and the allowance for loan losses. Interest on loans is accrued based on the principal amounts outstanding. Origination fees and costs, along with premiums and accretable discounts, are amortized to income over the terms of loans.

9

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2.

Basis of Presentation (continued)

Past due status is based on the contractual terms of the loan. Management may make an exception to reporting a loan as past due if the past due status is due solely to the loan being past maturity, the Company intends to extend the loan, and the borrower is making principal and interest payments in accordance with the terms of the matured note. The accrual of interest is discontinued when any portion of the principal or interest is 90 days past due and collateral is insufficient to discharge the debt in full. If collection of principal is evaluated as doubtful, then all payments are applied to principal. Loans are considered impaired when, based on current information, management considers it unlikely that the collection of principal and interest payments will be made according to contractual terms. Generally, loans are not reviewed for impairment until the accrual of interest has been discontinued, the loans are included on the watch list, or the loans are troubled debt restructurings (“TDRs”) .

The allowance for loan losses represents an amount which, in management’s judgment, will be adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The Company’s allowance for loan losses consists of three elements: (i) segregating the loan portfolio into pools based upon similar characteristics and risk profiles and applying a loss factor to the pools, based on historical losses within those pools; (ii) applying qualitative factors to the loan pools that consider economic and other factors, both internal and external, affecting the Company and the pools; and (iii) determining specific reserves based on individual evaluation of impaired loans that are not included in the pools discussed above.

The allowances established for probable losses on impaired loans are based on a regular analysis and evaluation of problem loans. Management maintains a watch list of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the borrower’s ability to repay; (ii) the underlying collateral, if any; (iii) the economic environment; and (iv) for commercial borrowers, the industry in which the borrower operates. Specific valuation allowances are determined when the collateral value, if the loan is collateral dependent, or the discounted cash flows of the impaired loan is lower than the carrying value.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool over the prior twenty quarters. The historical loss ratios are updated quarterly based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the annual historical loss ratio and the total dollar amount of the loans in the pool.

Adjustments to the historical valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such adjustments are determined by evaluating, among other things: (i) the impact of economic conditions on the portfolio; (ii) changes in asset quality, including delinquency trends; (iii) the impact of changing interest rates on portfolio risk; (iv) changes in legislative and regulatory policy; (v) the composition and concentrations of credit; and (vi) the effectiveness of the internal loan review function as well as changes to policies and experience of loan personnel. Management evaluates these qualitative factors on a quarterly basis. Each factor could result in an adjustment that is positive, negative, or no impact.

Loan losses are charged to the allowance when management believes that collection is unlikely. Collections of loans previously charged off are added to the allowance at the time of recovery.

Loans acquired in connection with business combinations are recorded at fair value with no carryover of any allowance for loan losses. Fair value of the loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.

10

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2.

Basis of Presentation (continued)

Loans acquired through business combinations that meet the specific criteria of ASC 310 - 30 designated as purchase credit impaired loans are individually evaluated each period to analyze expected cash flows. To the extent that the expected cash flows of a loan have decreased due to credit deterioration, the Company establishes an allowance.

The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. These loans are accounted for under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310 - 30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. The nonaccretable discount includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases in expected cash flows will require us to evaluate the need for an addition to the allowance for loan losses. Subsequent improvement in expected cash flows will result in the transfer of a corresponding amount of the nonaccretable discount, which we will then reclassify as accretable discount to be recognized into interest income over the remaining life of the loan.

Loans acquired through business combinations that do not meet the specific criteria of ASC 310 - 30 are accounted for under ASC 310 - 20, Receivables - Nonrefundable Fees and Other Costs. These loans are initially recorded at fair value, and include credit and interest rate marks associated with acquisition accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans. There is no allowance for loan losses established at the acquisition date for acquired performing loans. Subsequent to acquisition, a quarterly comparison of the remaining fair value discount to the required allowance under appropriate methodology is performed. If the fair value discount remains in excess of the required allowance, then no adjustment is made. If the fair value falls below the required reserve, then a charge to the provision is recorded for the shortfall as part of the allowance for loan losses.

Goodwill and other intangible assets

Goodwill is calculated as the purchase premium, if any, after adjusting for the fair value of net assets acquired in purchase transactions. Goodwill is not amortized but is reviewed for potential impairment on at least an annual basis, with testing between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of a reporting unit. Other intangible assets represent purchased assets that can be distinguished from goodwill because of contractual or other legal rights. The Company’s other intangible asset, the core deposit intangible (“CDI”), has a finite life and is amortized over 10 years on a straight line basis.

11

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

2.

Basis of Presentation (continued)

Recent Accounting Pronouncements

In June 2016, the FASB issued Accounting Standards Update (“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. ASU 2019 - 10 “Financial Instruments – Credit Losses (Topic 326 ), Derivatives and hedging (Topic 815 ), and Leases (Topic 842 ): Effective Dates” extended the implementation date to January 1, 2023 for SEC-registered smaller reporting companies and private companies. The Company is considered a smaller reporting company. The Company has engaged a third -party vendor to assist in the implementation of this ASU.

In March 2020, FASB issued ASU 2020 - 04, “Reference Rate Reform (Topic 848 )”: Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU Provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effect of) reference rate reform, on financial reporting. The risk of termination of the London Interbank Offered Rate (LIBOR), has caused regulators to undertake reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based that are less susceptible to manipulation. ASU 2020 - 04 is effective between March 12, 2020 and December 31, 2022. The Company has identified its products that utilize LIBOR and has begun efforts to transition to an alternative reference rate. The Company continues to evaluate systems to assist in the transaction to a new rate.

In August 2021, the FASB issued ASU 2021 - 06, “'Presentation of Financial Statements (Topic 205 ), Financial Services—Depository and Lending (Topic 942 ), and Financial Services—Investment Companies (Topic 946 ): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33 - 10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33 - 10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No. 33 - 10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33 - 10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants”. The ASU is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2021 - 06 to have a material impact on its consolidated financial statements.

12

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.

Investment Securities

Investments in debt securities are summarized as follows:

Amortized

Unrealized

Unrealized

Fair

September 30, 2021

cost

gains

losses

value

Available for sale

State and municipal

$ 754,714 $ 14,036 $ - $ 768,750

SBA pools

1,594,777 2,240 24,344 1,572,673

Corporate bonds

7,442,780 107,860 7,158 7,543,482

Mortgage-backed securities

111,917,951 575,914 1,113,188 111,380,677
$ 121,710,222 $ 700,050 $ 1,144,690 $ 121,265,582

Held to maturity

State and municipal

$ 21,883,882 $ 1,147,393 $ 55,063 $ 22,976,212

Amortized

Unrealized

Unrealized

Fair

December 31, 2020

cost

gains

losses

value

Available for sale

State and municipal

$ 962,438 $ 24,094 $ - $ 986,532

SBA pools

1,822,226 - 38,419 1,783,807

Corporate bonds

6,692,156 108,172 2,897 6,797,431

Mortgage-backed securities

44,026,055 941,987 58,526 44,909,516
$ 53,502,875 $ 1,074,253 $ 99,842 $ 54,477,286

Held to maturity

State and municipal

$ 23,078,519 $ 1,177,125 $ 10,858 $ 24,244,786

13

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.

Available for Sale

Held to Maturity

Amortized

Fair

Amortized

Fair

September 30, 2021

cost

value

cost

value

Within one year

$ 499,858 $ 508,520 $ - $ -

Over one to five years

3,361,396 3,456,435 797,949 813,733

Over five to ten years

4,336,240 4,347,277 2,039,074 2,237,176

Over ten years

- - 19,046,859 19,925,303
8,197,494 8,312,232 21,883,882 22,976,212

Mortgage-backed securities and

SBA pools, due in monthly installments

113,512,728 112,953,350 - -
$ 121,710,222 $ 121,265,582 $ 21,883,882 $ 22,976,212

December 31, 2020

Within one year

$ 505,372 $ 502,475 $ 487,741 $ 496,463

Over one to five years

4,646,388 4,755,483 793,876 813,523

Over five to ten years

2,300,591 2,323,451 2,476,827 2,687,063

Over ten years

202,243 202,554 19,320,075 20,247,737
7,654,594 7,783,963 23,078,519 24,244,786

Mortgage-backed securities and

SBA pools, due in monthly installments

45,848,281 46,693,323 - -
$ 53,502,875 $ 54,477,286 $ 23,078,519 $ 24,244,786

Securities with a carrying value of $ 19,919,867 and $ 34,958,212 as of September 30, 2021 and December 31, 2020, respectively, were pledged as collateral for government deposits and securities sold under repurchase agreements.

During the nine months ended September 30, 2021, the Company received proceeds of $ 1,263,845 from the call at a premium of available for sale investment securities. The Company realized a $ 9,190 gain on the call of the securities. During the nine months ended September 30, 2020, the Company sold three available for sale securities totalling $ 2,025,000 with no gain or loss.

14

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, 2021 and December 31, 2020.

September 30, 2021

Less than 12 months

12 months or more

Total

Description of investments

Fair Value

Unrealized

Loss

Fair Value

Unrealized

Loss

Fair Value

Unrealized

Loss

State and municipal

$ 1,333,770 $ 24,919 $ 712,730 $ 30,144 $ 2,046,500 $ 55,063

SBA pools

- - 1,292,243 24,344 1,292,243 24,344

Corporate bonds

1,115,155 7,158 - - 1,115,155 7,158

Mortgage-backed securities

74,530,890 1,104,919 757,162 8,269 75,288,052 1,113,188

Total

$ 76,979,815 $ 1,136,996 $ 2,762,135 $ 62,757 $ 79,741,950 $ 1,199,753

December 31, 2020

Less than 12 months

12 months or more

Total

Unrealized

Unrealized

Unrealized

Description of investments

Fair value

losses

Fair value

losses

Fair value

losses

State and municipal

$ 719,430 $ 10,858 $ - $ - $ 719,430 $ 10,858

SBA pools

- - 1,783,807 38,419 1,783,807 38,419

Corporate bonds

502,754 2,897 - - 502,754 2,897

Mortgage-backed securities

9,286,525 57,987 96,652 539 9,383,177 58,526

Total

$ 10,508,709 $ 71,742 $ 1,880,459 $ 38,958 $ 12,389,168 $ 110,700

The factors considered in evaluating securities for impairment include whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis.

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, 2021 and December 31, 2020, management did not have the intent to sell any of the held to maturity or available for sale securities with unrealized losses before a recovery of cost. The unrealized losses detailed in the table above were 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 debt 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 foregoing factors, as of September 30, 2021 and December 31, 2020, management believes that these unrealized losses are temporary and, accordingly, they have not been recognized in the Company’s consolidated statement of income. At September 30, 2021, 57 available for sale and four held to maturity investments had unrealized losses.

At September 30, 2021, none of the available for sale or held to maturity investments were impaired. In determining whether other-than-temporary impairment exists, management considers many factors, including (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

15

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.

Loans

Major categories of loans are as follows:

September 30,

December 31,

2021

2020

Real estate:

Commercial

$ 316,152,601 $ 309,284,811

Construction and land development

28,668,642 33,641,916

Residential

114,593,662 121,327,761

Commercial

40,655,077 61,368,105

Consumer

379,530 288,454
500,449,512 525,911,047

Less:  Allowance for loan losses

3,744,218 3,296,538

Deferred origination fees net of costs

924,100 923,995
$ 495,781,194 $ 521,690,514

Commercial loans in the table above include $ 16.3 million and $ 32.1 million of Paycheck Protection Program (“PPP”) loans as of September 30, 2021 and December 31, 2020, respectively, which are 100% guaranteed by the Small Business Administration (“SBA”). $ 22 million were originated during the nine months ended September 30, 2021 compared to $ 38 million originated in 2020. A substantial portion of the PPP loans in the Company’s portfolio are expected to be forgiven by the SBA. During the nine months ended September 30, 2021, the Company collected approximately $ 1,037,000 in fees from the SBA in connection with the originations of the PPP loans compared to approximately $ 1,286,000 collected in 2020. The fees, net of related origination costs, are being recognized as interest income over the term of the loans using the straight-line method, with accelerated recognition when the loan pays off before maturity through SBA forgiveness or other means. During the nine months ended September 30, 2021, the Company recognized approximately $ 937,000 as interest income.

Nonaccrual loans, segregated by class of loans, were as follows:

September 30,

December 31,

2021

2020

Commercial real estate

$ 4,849,857 $ 4,407,829

Residential real estate

31,500 $ 220,967

Commercial

154,469 -
$ 5,035,826 $ 4,628,796

At September 30, 2021, the Company had two nonaccrual commercial real estate loans totaling $ 4,849,857 , one nonaccrual residential real estate loan totaling $ 31,500 , and one nonaccrual commercial loan totaling $ 154,469 . The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $ 281,720 would have been recorded for the nine months ended September 30, 2021 had these nonaccrual loans been current and performing in accordance with their original terms. The Company allocated $ 253,942 of its allowance for loan losses to these nonaccrual loans. The recorded investment of the nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $ 27,146 at September 30, 2021.

At December 31, 2020, the Company had one nonaccrual commercial real estate loan totaling $ 4,407,829 and two nonaccrual residential real estate loans totaling $ 220,967 . The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $ 13,395 would have been recorded in 2020 had these nonaccrual loans been current and performing in accordance with their original terms. The Company allocated $ 0 of its allowance for loan losses to these nonaccrual loans.

The recorded investment of the nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $ 8,176 at December 31, 2020.

16

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:

90 Days

Past Due 90

30 - 59 Days

60 - 89 Days

or More

Total

Total

Days or More

Past Due

Past Due

Past Due

Past Due

Current

Loans

and Accruing

September 30, 2021

Real estate:

Commercial

$ - $ - $ 507,671 $ 507,671 $ 315,644,930 $ 316,152,601 $ -

Construction and land development

- - - - 28,668,642 28,668,642 -

Residential

- - 31,500 31,500 114,562,162 114,593,662 -

Commercial

- 154,469 - 154,469 40,500,608 40,655,077 -

Consumer

- - - - 379,530 379,530 -

Total

$ - $ 154,469 $ 539,171 $ 693,640 $ 499,755,872 $ 500,449,512 $ -

December 31, 2020

Real estate:

Commercial

$ 182,656 $ - $ - $ 182,656 $ 309,102,155 $ 309,284,811 $ -

Construction and land development

- - - - 33,641,916 33,641,916 -

Residential

24,591 - 220,967 245,558 121,082,203 121,327,761 -

Commercial

- - - - 61,368,105 61,368,105 -

Consumer

- - - - 288,454 288,454 -

Total

$ 207,247 $ - $ 220,967 $ 428,214 $ 525,482,833 $ 525,911,047 $ -

Impaired loans, segregated by class of loans with average recorded investment and interest recognized for the nine months ended September 30, 2021 and 2020 and the year ended December 31, 2020, are set forth in the following table:

Unpaid

Recorded

Recorded

Contractual

Investment

Investment

Total

Average

Principal

With No

With

Recorded

Related

Recorded

Interest

Balance

Allowance

Allowance

Investment

Allowance

Investment

Recognized

September 30, 2021

Commercial real estate

$ 6,875,087 $ 6,367,416 $ 507,671 $ 6,875,087 $ 99,473 $ 6,767,616 $ 77,603

Residential real estate

40,626 40,626 - 40,626 - 20,313 -

Commercial

154,469 - 154,469 154,469 154,469 99,601 1,271
$ 7,070,182 $ 6,408,042 $ 662,140 $ 7,070,182 $ 253,942 $ 6,887,530 $ 78,874

September 30, 2020

Commercial real estate

$ 2,266,855 $ 2,266,855 $ - $ 2,266,855 $ - $ 2,175,922 $ 87,252

Residential real estate

46,075 46,075 - 46,075 - 48,066 2,014
$ 2,312,930 $ 2,312,930 $ - $ 2,312,930 $ - $ 2,223,988 $ 89,266

December 31, 2020

Commercial real estate

$ 6,660,145 $ 6,660,145 $ - $ 6,660,145 $ - $ 4,372,567 $ 345,570

Residential real estate

44,733 44,733 - 44,733 - 47,935 2,139
$ 6,704,878 $ 6,704,878 $ - $ 6,704,878 $ - $ 4,420,502 $ 347,709

17

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.

Loans (continued)

Impaired loans include TDRs which are loans that have been modified to provide economic concessions to borrowers who have experienced 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.

At September 30, 2021, the Company had one commercial real estate loan totaling $ 2,025,230 and one residential real estate loan totaling $ 40,626 that were classified as TDRs. All are included in impaired loans above. At September 30, 2021, both loans were paying as agreed. There have been no charge-offs or allowances associated with these loans.

At December 31, 2020, the Company had two commercial real estate loans totaling $ 2,252,316 and one residential real estate loan totaling $ 44,733 classified as TDRs. One of the commercial real estate loans with a principal balance of $ 182,656 was restructured as a TDR during 2020. All three loans are included in impaired loans above. There have been no charge-offs or allowances associated with these loans.

Section 4013 of the U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act allows financial institutions to suspend application of certain current TDRs accounting guidance under ASC 310 - 40 for loan modifications related to the COVID- 19 pandemic made between March 1, 2020 and the earlier of January 1, 2022 or 60 days after the end of the COVID- 19 national emergency, provided certain criteria are met. This relief can be applied to loan modifications for borrowers that were not more than 30 days past due as of December 31, 2019 and to loan modifications that defer or delay the payment of principal or interest, or change the interest rate on the loan. In April 2020, federal and state banking regulators issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus to provide further interpretation of when a borrower is experiencing financial difficulty, specifically indicating that if the modification is either short-term (e.g., six months) or mandated by a federal or state government in response to the COVID- 19 pandemic, the borrower is not experiencing financial difficulty under ASC 310 - 40. The Company continues to prudently work with borrowers negatively impacted by the COVID- 19 pandemic while managing credit risks and recognizing appropriate allowance for loan losses on its loan portfolio. As of September 30, 2021, one loan totalling $ 4.3 million, or 1 % of the Company’s loan portfolio, was operating under a three -month deferral. This loan was not classified as a TDR as of September 30, 2021 because it met the criteria discussed above.

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:

18

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.

Loans (continued)

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.

Doubtful

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

19

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.

Loans (continued)

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

Above

Pass

Special

September 30, 2021

Excellent

average

Average

Acceptable

watch

mention

Substandard

Doubtful

Total

Real estate:

Commercial

$ - $ 1,481,171 $ 80,794,629 $ 127,643,116 $ 92,864,344 $ 5,607,912 $ 7,761,429 $ - $ 316,152,601

Construction and land development

- - 4,433,922 11,740,442 9,026,739 1,935,693 1,531,846 - 28,668,642

Residential

47,335 758,819 50,882,661 49,801,365 10,606,480 - 2,497,002 - 114,593,662

Commercial

16,414,989 - 6,393,866 13,209,094 4,637,128 - - - 40,655,077

Consumer

7,065 187,751 140,577 3,297 12,486 - - 28,354 379,530
$ 16,469,389 $ 2,427,741 $ 142,645,655 $ 202,397,314 $ 117,147,177 $ 7,543,605 $ 11,790,277 $ 28,354 $ 500,449,512

Above

Pass

Special

December 31, 2020

Excellent

average

Average

Acceptable

watch

mention

Substandard

Doubtful

Total

Real estate:

Commercial

$ - $ 2,010,472 $ 96,178,011 $ 87,860,036 $ 108,045,730 $ 5,951,177 $ 9,239,385 $ - $ 309,284,811

Construction and land development

- - 2,962,300 15,944,499 13,168,844 - 1,566,273 - 33,641,916

Residential

36,285 1,026,824 63,811,389 40,947,548 12,579,311 - 2,926,404 - 121,327,761

Commercial

32,088,058 - 10,037,516 13,532,170 5,710,361 - - - 61,368,105

Consumer

13,729 109,955 131,171 6,671 15,663 - - 11,265 288,454
$ 32,138,072 $ 3,147,251 $ 173,120,387 $ 158,290,924 $ 139,519,909 $ 5,951,177 $ 13,732,062 $ 11,265 $ 525,911,047

The principal balance of loans in the Pass/Watch category as of September 30, 2021 and December 31, 2020 include loans that were granted payment deferrals due to COVID- 19. The loans were downgraded to the Pass/Watch category if they were in a higher rated category at the time the deferral was granted. Loans that completed their deferral and are making scheduled payments again are being re-evaluated on a loan-by-loan basis to determine if they warrant upgrading.

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.

20

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 -month periods ended September 30, 2021 and 2020 and for the year ended December 31, 2020. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

Allowance for loan losses ending

Outstanding loan balances

Provision

balance evaluated for impairment:

evaluated for impairment:

Beginning

for loan

Charge

Ending

Purchase Credit

Purchase Credit

September 30, 2021

balance

losses

offs

Recoveries

balance

Individually

Impaired

Collectively

Individually

Impaired

Collectively

Real estate:

Commercial

$ 2,230,129 $ 348,650 $ - $ 9,500 $ 2,588,279 $ 99,473 $ - $ 2,488,806 $ 6,875,087 $ 87,708 $ 309,189,806

Construction and land development

201,692 32,105 - 12,150 245,947 - - 245,947 - 1,531,846 27,136,796

Residential

644,639 ( 28,549 ) ( 18,970 ) - 597,120 - - 597,120 40,626 570,860 113,982,176

Commercial

111,390 125,133 - 15,000 251,523 154,469 - 97,054 154,469 - 40,500,608

Consumer

2,138 1,863 - - 4,001 - - 4,001 - - 379,530

Unallocated

106,550 ( 49,202 ) - - 57,348 - - 57,348 - - -
$ 3,296,538 $ 430,000 $ ( 18,970 ) $ 36,650 $ 3,744,218 $ 253,942 $ - $ 3,490,276 $ 7,070,182 $ 2,190,414 $ 491,188,916

Allowance for loan losses ending

Outstanding loan balances

Provision

balance evaluated for impairment:

evaluated for impairment:

Beginning

for loan

Charge

Ending

Purchase Credit

Purchase Credit

September 30, 2020

balance

losses

offs

Recoveries

balance

Individually

Impaired

Collectively

Individually

Impaired

Collectively

Real estate:

Commercial

$ 1,763,861 $ 340,084 $ - $ 45,962 $ 2,149,907 $ - $ - $ 2,149,907 $ 2,266,855 $ - $ 236,839,421

Construction and land development

192,828 51,804 - 10,800 255,432 - - 255,432 - - 23,889,344

Residential

478,124 102,515 - - 580,639 - - 580,639 46,075 - 70,582,197

Commercial

107,782 5,429 - 15,835 129,046 - - 129,046 - - 60,442,374

Consumer

4,133 2,260 - - 6,393 - - 6,393 - - 239,062

Unallocated

46,987 ( 27,092 ) - - 19,895 - - 19,895 - - -
$ 2,593,715 $ 475,000 $ - $ 72,597 $ 3,141,312 $ - $ - $ 3,141,312 $ 2,312,930 $ - $ 391,992,398

Allowance for loan losses ending

Outstanding loan balances

Provision

balance evaluated for impairment:

evaluated for impairment:

Beginning

for loan

Charge

Ending

Purchase Credit

Purchase Credit

December 31, 2020

balance

losses

offs

Recoveries

balance

Individually

Impaired

Collectively

Individually

Impaired

Collectively

Real estate:

Commercial

$ 1,763,861 $ 418,806 $ - $ 47,462 $ 2,230,129 $ - $ - $ 2,230,129 $ 6,660,245 $ 151,453 $ 302,473,113

Construction and land development

192,828 ( 5,536 ) - 14,400 201,692 - - 201,692 - 1,566,174 32,075,742

Residential

478,124 166,515 - - 644,639 - - 644,639 215,230 595,433 120,517,098

Commercial

107,782 ( 12,353 ) - 15,961 111,390 - - 111,390 - - 61,368,105

Consumer

4,133 ( 1,995 ) - - 2,138 - - 2,138 - - 288,454

Unallocated

46,987 59,563 - - 106,550 - - 106,550 - - -
$ 2,593,715 $ 625,000 $ - $ 77,823 $ 3,296,538 $ - $ - $ 3,296,538 $ 6,875,475 $ 2,313,060 $ 516,722,512

21

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.

Loans (Continued)

The following table provides activity for the accretable credit discount of purchased loans:

2021

Balance at December 31, 2020

$ 2,250,232

Acquired during the year

-

Accretion

592,014

Adjustments

-

Balance at September 30, 2021

$ 1,658,218

At September 30, 2021, the nonaccretable discount on purchased impaired loans was $ 466,597 , a decrease of $ 460,413 from December 31, 2020 as a result of a transfer to accretable. At September 30, 2021, the accretable discount on purchased impaired loans was $ 216,580 after the accretion of $ 243,833 . At September 30, 2021, the remaining yield premium on purchased loans was $ 1,565,204 . At September 30, 2021, the principal balance of purchased loans was $ 110,690,972 and the carrying value was $ 109,914,791 . At September 30, 2021, there were no residential real estate loans in the process of foreclosure.

5.

Goodwill and Other Intangibles

The Merger effected in October of 2020 resulted in the recording of goodwill and CDI. The following table presents the changes in both assets:

Goodwill

CDI

Total

Balance at December 31, 2020

$ 6,978,208 $ 81,200 $ 7,059,408

Acquired during the year

- - -

Amortization

- ( 6,246 ) ( 6,246 )

Adjustments

- - -

Balance at September 30, 2021

$ 6,978,208 $ 74,954 $ 7,053,162

The CDI is being amortized over 10 years on a straight-line basis. Annual amortization will be $ 8,328 for each of the years ended December 31, 2021 through 2029 and $ 6,246 in 2030. Since the acquisition was a tax-free reorganization, goodwill and CDI are not deductible for income tax purposes.

6.

Lease Commitments

The Company and its subsidiaries are obligated under operating leases for certain office premises.

The following table shows operating lease right of use assets and operating lease liabilities as of September 30, 2021 and December 31, 2020:

Consolidated Balance

Sheet classification

September 30, 2021

December 31, 2020

Operating lease right of use asset

Other assets

$ 1,130,744 $ 1,242,832
Operating lease liabilities

Other liabilities

1,345,902 1,443,966

Operating lease cost included in occupancy expense in the statement of income for the three months ended September 30, 2021 and 2020 was $ 43,178 and $ 49,926 , respectively. Operating lease cost included in occupancy expense in the statement of income for the nine months ended September 30, 2021 and 2020 was $ 144,529 and $ 144,060 respectively.

22

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

6.

Lease Commitments (continued)

A maturity analysis of operating lease liabilities, including those option years for which the Company is reasonably certain to renew, and reconciliation of the undiscounted cash flows to the total operating lease liabilities are as follows:

Year

Amount

2021

$ 44,348

2022

182,426

2023

188,613

2024

194,124

2025

199,809

Thereafter

700,169

Total undiscounted cash flow

1,509,489

Discount

( 163,587 )

Lease liabilities

$ 1,345,902

For operating leases as of September 30, 2021, the weighted average remaining lease term is 7.8 years and the weighted average discount rate is 3.25 %. During the nine -month periods ended September 30, 2021 and 2020, cash paid for amounts included in the measurement of lease liabilities was $ 130,506 and $ 118,383 , respectively.

7.

Capital Standards

Farmers and Merchants Bancshares, Inc. 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 mandatory, and possible additional, discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off‑balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of Common Equity Tier 1 capital, Tier 1 capital, and Total capital (as defined in the regulations) to risk‑weighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (as defined).

In connection with the adoption of the Basel III Capital Rules, the Bank elected to opt-out of the requirement to include accumulated other comprehensive income in Common Equity Tier 1 capital. Common Equity Tier 1 capital for the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions.

Insured depository institutions are required to meet the following in order to qualify as “well capitalized”: (i) a common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8%; (iii) a total risk-based capital ratio of 10%; and (iv) a Tier 1 leverage ratio of 5 %.

23

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.

Capital Standards (continued)

The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased in over a four -year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019 ). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have current applicability to the Bank. As of September 30, 2021, the Bank met all capital adequacy requirements under the Basel III Capital Rules on a fully phased‑in basis.

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

The following table presents actual and required capital ratios as of September 30, 2021 and December 31, 2020 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2021 and December 31, 2020 based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. Capital ratios of the Company are substantially the same as the Bank’s.

Minimum

To Be Well

(Dollars in thousands)

Actual

Capital Adequacy

Capitalized

September 30, 2021

Amount

Ratio

Amount

Ratio

Amount

Ratio

Total capital (to risk-weighted assets)

$ 68,258 13.08 % $ 54,809 10.50 % $ 52,199 10.00 %

Tier 1 capital (to risk-weighted assets)

64,514 12.36 % 44,369 8.50 % 41,759 8.00 %

Common equity tier 1 (to risk- weighted assets)

64,514 12.36 % 36,539 7.00 % 33,929 6.50 %

Tier 1 leverage (to average assets)

64,514 9.17 % 28,146 4.00 % 35,182 5.00 %

Minimum

To Be Well

(Dollars in thousands)

Actual

Capital Adequacy

Capitalized

December 31, 2020

Amount

Ratio

Amount

Ratio

Amount

Ratio

Total capital (to risk-weighted assets)

$ 63,400 12.62 % $ 52,732 10.50 % $ 50,221 10.00 %

Tier 1 capital (to risk-weighted assets)

60,104 11.97 % 42,688 8.50 % 40,177 8.00 %

Common equity tier 1 (to risk- weighted assets)

60,104 11.97 % 35,155 7.00 % 32,644 6.50 %

Tier 1 leverage (to average assets)

60,104 9.05 % 26,569 4.00 % 33,211 5.00 %

To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. As of September 30, 2021, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There have been no conditions or events since that notification that management believes have changed the Bank’s category.

The FDIC, through formal or informal agreement, has the authority to require an institution to maintain higher capital ratios than those provided by statute, to be categorized as well capitalized under the regulatory framework for prompt corrective action.

24

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.

Fair Value

In accordance with FASB ASC 820, “Fair Value Measurements and Disclosure”, the Bank uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (“an exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is the most representative of fair value under current market conditions.

In accordance with the guidance, a hierarchy of valuation techniques is based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under FASB ASC 820 based on these two types of inputs are as follows:

●

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

●

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

●

Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company uses the following methods and significant assumptions to estimate the fair values of the following assets:

●

Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices from a nationally recognized securities pricing agent. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities.

●

Equity security at fair value: The Company’s investment in an equity mutual fund is valued based on the net asset value of the fund, which is classified as Level 1.

25

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.

Fair Value (continued)

●

Other real estate owned (“OREO”): Nonrecurring fair value adjustments to OREO reflect full or partial write-downs that are based on the OREO’s observable market price or current appraised value of the real estate. Since the market for OREO is not active, OREO subjected to nonrecurring fair value adjustments based on the current appraised value of the real estate are classified as Level 3. The appraised value is obtained annually from an independent third party appraiser and is reduced by expected sales costs, which has historically been 10 % of the appraised value.

●

Impaired loans: Nonrecurring fair value adjustments to impaired loans reflect full or partial write-downs and reserves that are based on the impaired loan’s observable market price or current appraised value of the collateral. Since the market for impaired loans is not active, such loans subjected to nonrecurring fair value adjustments based on the current appraised value of the collateral are classified as Level 3. The appraised value is obtained annually from an independent third party appraiser and is reduced by expected sales costs, which has historically been 10 % of the appraised value.

The following table summarizes financial assets measured at fair value on a recurring and nonrecurring basis as of September 30, 2021 and December 31, 2020, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

Carrying Value:

Level 1

Level 2

Level 3

Total

September 30, 2021

Recurring

Available for sale securities

State and municipal

$ - $ 768,750 $ - $ 768,750

SBA pools

- 1,572,673 - 1,572,673

Corporate bonds

- 7,543,482 - 7,543,482

Mortgage-backed securities

- 111,380,677 - 111,380,677
$ - $ 121,265,582 $ - $ 121,265,582

Equity security at fair value

Mutual fund

$ 547,349 $ - $ - $ 547,349

Nonrecurring

Other real estate owned

$ - $ - $ 1,411,605 $ 1,411,605

Impaired loans

- - $ 408,198 $ 408,198

26

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.

Fair Value (continued)

Carrying Value:

Level 1

Level 2

Level 3

Total

December 31, 2020

Recurring

Available for sale securities

State and municipal

$ - $ 986,532 $ - $ 986,532

SBA pools

- 1,783,807 - 1,783,807

Corporate Bonds

- 6,797,431 - 6,797,431

Mortgage-backed securities

- 44,909,516 - 44,909,516
$ - $ 54,477,286 $ - $ 54,477,286

Equity security at fair value

Mutual fund

$ 552,566 $ - $ - $ 552,566

Nonrecurring

Other real estate owned

$ - $ - $ 1,411,605 $ 1,411,605

The estimated fair value of financial instruments that are reported at amortized cost in the Company’s consolidated balance sheets, segregated by the level of the valuation inputs were as follows:

September 30, 2021

December 31, 2020

Carrying

Estimated

Carrying

Estimated

Amount

Fair Value

Amount

Fair Value

Financial assets

Level 1 inputs

Cash and cash equivalents

$ 39,601,864 $ 39,601,864 $ 40,975,670 $ 40,975,670

Level 2 inputs

Certificates of deposit in other banks

350,000 350,000 850,000 850,000

Accrued interest receivable

1,579,447 1,579,447 2,057,491 2,057,491

Securities held to maturity

21,883,882 22,976,212 23,078,519 24,244,786

Mortgage loans held for sale

1,757,550 1,800,891 1,673,350 1,705,781

Restricted stock

675,400 675,400 900,500 900,500

Bank owned life insurance

15,230,325 15,230,325 11,297,342 11,297,342

Level 3 inputs

Loans, net

495,781,194 503,485,138 521,690,514 527,132,047

Financial liabilities

Level 1 inputs

Noninterest-bearing deposits

$ 125,841,422 $ 125,841,422 $ 103,155,113 $ 103,155,113

Securities sold under repurchase agreements

10,475,121 10,475,121 24,753,972 24,753,972

Level 2 inputs

Interest-bearing deposits

496,091,137 496,982,137 470,246,434 474,096,434

Federal Home Loan Bank advances

5,000,000 5,040,000 5,000,000 5,136,000

Long-term debt

16,977,499 17,299,707 16,973,280 17,018,416

Accrued interest payable

323,420 323,420 409,622 409,622

27

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

9.

Earnings per Share

Basic earnings per share is determined by dividing net income available to stockholders by the weighted-average number of shares of common stock outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents, giving retroactive effect to stock dividends declared during the period. Diluted earnings per share is determined in the same manner, except that the weighted-average number of shares of common stock outstanding is adjusted for the dilutive effect of outstanding common stock equivalents. The following table sets forth the calculation of basic and diluted earnings per share for the three and nine -month periods ended September 30, 2021 and 2020. There were no common stock equivalents outstanding for the three and nine -month periods ended September 30, 2021 or 2020.

Three Months Ended

Nine Months Ended

September, 30

September, 30

2021

2020

2021

2020

Net income

$ 2,122,547 $ 385,247 $ 6,184,341 $ 2,264,609

Weighted average shares outstanding

3,023,487 2,991,964 3,015,602 2,980,372

Earnings per share - basic and diluted

$ 0.70 $ 0.13 $ 2.05 $ 0.76

10.

Retirement Plans

The Company has a profit sharing plan qualifying under Section 401 (k) of the Internal Revenue Code. All employees age 21 or more with six months of service are eligible for participation in the plan. The Company matches employee contributions up to 4 % of total compensation and may make additional discretionary contributions. Employee and employer contributions are 100 % vested when made. The Company’s contributions to this plan were $ 52,818 and $ 51,347 for the three -month periods ended September 30, 2021 and 2020, respectively, and $ 194,566 and $ 160,937 for the nine -month periods ended September 30, 2021 and 2020, respectively.

The Company has entered into agreements with 12 employees to provide certain life insurance benefits payable in connection with policies of life insurance on those employees that are owned by the Company. Each of the agreements provides for the amount of death insurance benefits to be paid to beneficiaries of the insured. For this plan, the Company expensed $ 1,661 and $ 1,589 for the three -month periods ended September 30, 2021 and 2020, respectively, and $ 4,982 and $ 4,767 for the nine -month periods ended September 30, 2021 and 2020, respectively.

The Company adopted supplemental executive retirement plans for three of its executives. The plans provide cash compensation to the executive officers under certain circumstances, including a separation of service. The benefits vest over the period from adoption to a specified age for each executive. The Company recorded expenses related to these plans, including interest, of $ 42,000 and $ 51,300 for the three -month periods ended September 30, 2021 and 2020, respectively, and $ 126,000 and $ 153,900 for the nine -month periods ended September 30, 2021 and 2020, respectively.

Retirement plan expenses are included in employee benefits on the consolidated statements of income.

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Item 2.   Management ’ s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of Farmers and Merchants Bancshares, Inc. and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, and with Management’s Discussion and Analysis of Financial Condition and Results of Operations, the audited consolidated financial statements and notes thereto, and the other statistical information contained in the Annual Report of Farmers and Merchants Bancshares, Inc. on Form 10-K for the year ended December 31, 2020 (the “Form 10-K”). References in this report to “us”, “we”, “our”, and “the Company” are to Farmers and Merchants Bancshares, Inc. and, unless the context clearly suggests otherwise, its consolidated subsidiaries.

Forward-Looking Statements

This report may contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report should be aware of the speculative nature of “forward-looking statements.” Statements that are not historical in nature, including those that include the words “intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words, are based on current expectations, estimates and projections about, among other things, the industry and the markets in which we operate, and they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic, market, or business conditions, including those impacted and/or driven by the COVID-19 pandemic; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risks are discussed in detail in the registration statements and periodic reports that Farmers and Merchants Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

Farmers and Merchants Bancshares, Inc.

Farmers and Merchants Bancshares, Inc. is a Maryland corporation and a financial holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended. The Company was incorporated on August 8, 2016 for the purpose of becoming the holding company of Farmers and Merchants Bank (the “Bank”) in a share exchange transaction that was intended to constitute a tax-free exchange under Section 351 of the Internal Revenue Code of 1986, as amended (the “Reorganization”). The Reorganization was consummated on November 1, 2016, at which time the Bank became a wholly-owned subsidiary of the Company and all of the Bank’s stockholders became stockholders of the Company by virtue of the conversion of their shares of common stock of the Bank into an equal number of shares of common stock of the Company.

The Company’s primary business activities are serving as the parent company of the Bank and holding a series investment in First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed protected cell captive insurance company (“FCBI”). The Company owns 100% of one series of membership interests issued by FCBI, which series is deemed a “protected cell” under Tennessee law and has been designated “Series Protected Cell FCB-4” (such series investment is hereinafter referred to as the “Insurance Subsidiary”).

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The Bank is a Maryland commercial bank chartered on October 24, 1919 that is engaged in a general commercial and retail banking business. The Bank has had one inactive subsidiary, Reliable Community Financial Services, Inc., a Maryland corporation that was incorporated in April 1992 to facilitate the sale of fixed rate annuity products and later positioned to sell a full array of investment and insurance products.

The Insurance Subsidiary represents one protected cell of a protected cell captive insurance company ( i.e. , FCBI) that was formed on November 9, 2016 to better manage our risk programs, provide insurance efficiencies, and add operating income by both keeping insurance premiums paid with respect to such risks within our affiliated group of entities and realizing certain tax benefits that are unique to captive insurance companies. The Company’s investment in the Insurance Subsidiary represents one series of membership interests in FCBI. As a “series” limited liability company, FCBI is authorized by state law and its governing instruments to issue one or more series of membership interests, each of which, for all purposes under state law, is deemed to be a legal entity separate and apart from FCBI and its other series.

Effective October 1, 2020, pursuant to a series of merger transactions, Farmers and Merchants Bancshares, Inc. acquired Carroll Bancorp, Inc., and the Bank acquired Carroll Bancshares, Inc.’s wholly-owned bank subsidiary, Carroll Community Bank (collectively, the “Merger”).

The Company maintains an Internet site at www.fmb1919.bank on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

Estimates and Critical Accounting Policies

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. See Note 1 of the Notes to the audited consolidated financial statements as of and for the year ended December 31, 2020, which were included in Item 8 of Part II of the Form 10-K. On an on-going basis, management evaluates estimates, including those related to loan losses and intangible assets, other-than-temporary impairment (“OTTI”) of investment securities, income taxes, and fair value of investments. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements.

The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet.

30

Management applies various valuation methodologies to assets and liabilities which often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for certain assets, such as most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include loans, deposits, borrowings, goodwill, core deposit and other intangible assets, other assets and liabilities obtained or assumed in business combinations. These valuations require the use of various assumptions, including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, and liquidation values. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on our results of operations, financial condition or disclosures of fair value information. In addition to valuation, we must assess whether there are any declines in value below the carrying value of assets that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statements of income. Examples include investment securities, goodwill and core deposit intangible, among others.

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2020.

COVID-19 Pandemic

The COVID-19 pandemic has materially impacted all companies, governmental agencies, and individuals across the Country since the World Health Organization declared it a pandemic on March 11, 2020, and it continues to do so.

The U.S. and state governments reacted to the outbreak of the pandemic by issuing shelter-at-home orders and requiring that non-essential businesses be closed to prevent spread of the virus. The health crisis quickly turned into a financial crisis resulting in guidance and mandates regarding foreclosures and repossessions and accounting and regulatory changes designed to encourage banks to work with customers suffering detrimental financial impact.

Although states, including Maryland, have eased many of the previously-imposed COVID-19 restrictions, including stay-at-home orders and the required closure of non-essential businesses, and many individuals have been vaccinated, there are still a significant number of active infections throughout the Country, including in the State of Maryland, and individuals continue to become infected. As a result, it is possible that states, including Maryland, will re-implement some or all of the COVID-19 related restrictions that have been lifted and again require some or all non-essential businesses to close or drastically alter their business operations, which could have a material adverse impact on our customers and, thus, our financial condition and results of operations.

Paycheck Protection Program

The U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) established the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), which provided small businesses with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses. During 2020, we made over $32 million in PPP loans and acquired $6 million as a result of the Merger. During the first nine months of 2021, we made an additional $22 million of PPP loans. All PPP loans are 100% guaranteed by the SBA, have up to a five-year maturity, and have an interest rate of 1%. These loans may be forgiven by the SBA if the borrower meets certain conditions, including by using at least 75% of the loan proceeds for payroll costs. The majority of the PPP loans made in 2020 have been forgiven as of September 30, 2021. The SBA also established processing fees from 1% to 5%, depending on the loan amount. During the nine months ended September 30, 2021, the Company collected approximately $1,037,000 in fees from the SBA in connection with the originations of the PPP loans compared to approximately $1,286,000 collected in 2020. The fees, net of related origination costs, are being recognized as interest income over the term of the loans using the straight-line method, with accelerated recognition when the loan pays off before maturity through SBA forgiveness or other means. During the nine months ended September 30, 2021, the Company recognized approximately $937,000 as interest income.

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In April 2020, the Bank established eligibility to participate in the Paycheck Protection Program Liquidity Facility (“PPPLF”) which was established by Congress and administered by the Federal Reserve Bank. This facility uses the SBA guaranteed PPP loans as collateral, offering 100% collateral coverage with no recourse to the Bank. The majority of the PPP loan disbursements were to internal, non-interest-bearing accounts for use by borrowers. As a result, we have not yet accessed the PPPLF, but are prepared to utilize the fund when management determines the timing is appropriate.

Financial Condition

Total assets increased by $39,425,122, or 5.8%, to $716,742,204 at September 30, 2021 from $677,317,082 at December 31, 2020. The increase in total assets was due primarily to increases of $65,593,659 in debt securities and $3,932,983 in bank owned life insurance, offset by decreases of $25,909,320 in loans, $1,373,806 in cash and cash equivalents, and $1,445,151 in premises and equipment due to the sale of a former branch location. The decrease in loans was due primarily to a decrease of $15,498,715 in PPP loans.

Total liabilities increased $34,849,289, or 5.6%, to $660,436,888 at September 30, 2021 from $625,587,599 at December 31, 2020. The increase was due primarily to a $48,531,012 increase in deposits, offset by a $14,278,851 decrease in securities sold under repurchase agreements. The increase in deposits was due to an inflow of funds from depositors who have received numerous government stimulus funds.

Stockholders’ equity increased by $4,575,833 to $56,305,316 at September 30, 2021 from $51,729,483 at December 31, 2020. The increase was due primarily to net income for the nine-month period ended September 30, 2021 of $6,184,341, offset by a decrease of $1,028,563 in accumulated other comprehensive (loss) income and dividends paid, net of reinvestment, of $579,945.

Loans

Major categories of loans at September 30, 2021 and December 31, 2020 were as follows:

September 30,

December 31,

2021

2020

Real estate:

Commercial

$ 316,152,601 63 % $ 309,284,811 59 %

Construction/Land development

28,668,642 6 % 33,641,916 6 %

Residential

114,593,662 23 % 121,327,761 23 %

Commercial

40,655,077 8 % 61,368,105 12 %

Consumer

379,530 0 % 288,454 0 %
500,449,512 100 % 525,911,047 100 %

Less:  Allowance for loan losses

3,744,218 3,296,538

Deferred origination fees net of costs

924,100 923,995
$ 495,781,194 $ 521,690,514

Loans decreased by $25,909,320, or 5.0%, to $495,781,194 at September 30, 2021 from $521,690,514 at December 31, 2020. The decrease was due primarily to decreases of $20,713,028 in commercial loans, $4,973,274 in construction/land development loans, and $6,734,099 in residential loans, offset by an increase of $6,867,790 in commercial real estate loans. The decrease in commercial loans was driven primarily by a decrease of $15,760,157 in PPP loans. The allowance for loan losses increased $447,680 to $3,744,218 at September 30, 2021 from $3,296,538 at December 31, 2020. Deferred origination fees, net of costs, increased slightly to $924,100 at September 30, 2021 from $923,995 at December 31, 2020.

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The Company has adopted policies and procedures that seek to mitigate credit risk and to maintain the quality of the loan portfolio. These policies include underwriting standards for new credits as well as the continuous monitoring and reporting of asset quality and the adequacy of the allowance for loan losses. These policies, coupled with continuous training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan, and the experience of the lending officer. The Company’s policy is to make the majority of its loan commitments in the market area it serves. Management believes that this tends to reduce risk because management is familiar with the credit histories of loan applicants and has in-depth knowledge of the risk to which a given credit is subject. Although the loan portfolio is diversified, its performance will be influenced by the economy of the region.

An age analysis of past due loans, segregated by class of loans, as of September 30, 2021 and December 31, 2020 is as follows:

90 Days

Past Due 90

30 - 59 Days

60 - 89 Days

or more

Total

Total

Days or More

Past Due

Past Due

Past Due

Past Due

Current

Loans

and Accruing

September 30, 2021

Real estate:

Commerical

$ - $ - $ 506,671 $ 506,671 $ 315,645,930 $ 316,152,601 $ -

Construction/Land development

- - - - 28,668,642 28,668,642 -

Residential

- - 31,500 31,500 114,562,162 114,593,662 -

Commercial

- 154,469 - 154,469 40,500,608 40,655,077 -

Consumer

- - - - 379,530 379,530 -

Total

$ - $ 154,469 $ 538,171 $ 692,640 $ 499,756,872 $ 500,449,512 $ -

90 Days

Past Due 90

30 - 59 Days

60 - 89 Days

or more

Total

Total

Days or More

Past Due

Past Due

Past Due

Past Due

Current

Loans

and Accruing

December 31, 2020

Real estate:

Commerical

$ 182,656 $ - $ - $ 182,656 $ 309,102,155 $ 309,284,811 $ -

Construction/Land development

- - - - 33,641,916 33,641,916 -

Residential

24,591 - 220,967 245,558 121,082,203 121,327,761 -

Commercial

- - - - 61,368,105 61,368,105 -

Consumer

- - - - 288,454 288,454 -

Total

$ 207,247 $ - $ 220,967 $ 428,214 $ 525,482,833 $ 525,911,047 $ -

It is the Company’s policy to place a loan in nonaccrual status whenever there is substantial doubt about the ability of the borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature of the collateral securing the loan, and the overall economic situation of the borrower when making a nonaccrual decision. Management closely monitors nonaccrual loans. The Company returns a nonaccrual loan to accruing status when (i) the loan is brought current with the full payment of all principal and interest arrearages, (ii) all contractual payments are thereafter made on a timely basis for at least nine months, and (iii) management determines, based on a credit review, that it is reasonable to expect that future payments will be made as and when required by the contract.

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At September 30, 2021, the Company had two nonaccrual commercial real estate loan totaling $4,849,857, one nonaccrual residential real estate loan totaling $31,500, and one nonaccrual commercial loan totaling $154,469. The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $281,720 would have been recorded for the nine months ended September 30, 2021 if these nonaccrual loans had been current and performing in accordance with the original terms. The Company allocated $253,942 of its allowance for loan losses to these nonaccrual loans. The recorded investment of the nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $27,146 at September 30, 2021.

At December 31, 2020, the Company had one nonaccrual commercial real estate loan totaling $4,407,829 and two nonaccrual residential real estate loans totaling $220,967. The loans were secured by real estate, business assets, and personal guarantees. Gross interest income of $13,395 would have been recorded in 2020 if these nonaccrual loans had been current and performing in accordance with the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The recorded investment of the nonaccrual loans was net of charge-offs and a nonaccretable discount totaling $8,176 at December 31, 2020.

Impaired loans as of September 30, 2021 and December 31, 2020 are set forth in the following table:

September 30

December 31,

2021

2020

Impaired loans with no valuation allowance

$ 6,408,042 $ 6,704,878

Impaired loans with a valuation allowance

662,140 -

Total impaired loans

$ 7,070,182 $ 6,704,878

Valuation allowance related to impaired loans

$ 253,942 $ -

Impaired loans include troubled debt restructurings (“TDRs”), which are loans that were modified to provide economic concessions 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.

Section 4013 of the U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act allows financial institutions to suspend application of certain current TDRs accounting guidance under the Financial Accounting Standards Board’s Accounting Standards Codification (“ASC”) 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the earlier of January 1, 2022 or 60 days after the end of the COVID-19 national emergency, provided certain criteria are met. This relief can be applied to loan modifications for borrowers that were not more than 30 days past due as of December 31, 2019 and to loan modifications that defer or delay the payment of principal or interest, or change the interest rate on the loan. In April 2020, federal and state banking regulators issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus to provide further interpretation of when a borrower is experiencing financial difficulty, specifically indicating that if the modification is either short-term ( i.e. , six months) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty under ASC 310-40. The Company continues to prudently work with borrowers negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing appropriate allowance for loan losses on its loan portfolio.

The Company has provided loan modifications to its borrowers who are impacted by the COVID-19 pandemic. Modifications include deferrals of principal and interest for periods up to three months and interest only periods of three months. These deferrals can be extended for an additional three months, subject to approval by the Company. As of September 30, 2021, one loan totalling $4.3 million, or 1% of the Company’s loan portfolio, was operating under a three-month deferral. This loan was not classified as a TDR as of September 30, 2021 because it met the criteria discussed above. See Note 4 to the financial statements included elsewhere in this report for additional information.

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At September 30, 2021, the Company had one commercial real estate loan totaling $2,025,230 and one residential real estate loan totaling $40,626 that were classified as TDRs. All are included in impaired loans above. At September 30, 2021, both loans were paying as agreed. There have been no charge-offs or allowances associated with these loans.

At December 31, 2020, the Company had two commercial real estate loans totaling $2,252,316 and one residential loan totaling $44,733 classified as TDRs. One of the commercial real estate loans with a principal balance of $182,656 was restructured as a TDR during 2020. All three loans are included in impaired loans above. There have been no charge-offs or allowances associated with these loans.

September 30,

December 31,

2021

2020

Restructured loans (TDRs):

Performing as agreed

$ 2,065,856 $ 2,297,049

Not performing as agreed

- -

Total TDRs

$ 2,065,856 $ 2,297,049

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense.  The allowance for loan losses represents an amount which, in management’s judgment, will be adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions.

The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, classified and criticized loans and net charge-offs or recoveries, among other factors.

Although management believes that, based on information currently available, the Company’s allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Company’s level of allowance for loan losses will be sufficient to cover future loan losses incurred by the Company or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions at the time management determined the current level of the allowance for loan losses.

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The following table details activity in the allowance for loan losses by portfolio for the nine-month periods ended September 30, 2021 and 2020 and the year ended December 31, 2020. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

Allowance for loan losses ending

Outstanding loan balances

Provision

balance evaluated for impairment:

evaluated for impairment:

Beginning

for loan

Charge

Ending

Purchase Credit

Purchase Credit

September 30, 2021

balance

losses

offs

Recoveries

balance

Individually

Impaired

Collectively

Individually

Impaired

Collectively

Real estate:

Commercial

$ 2,230,129 $ 348,650 $ - $ 9,500 $ 2,588,279 $ 99,473 $ - $ 2,488,806 $ 6,875,087 $ 87,708 $ 309,189,806

Construction and land development

201,692 32,105 - 12,150 245,947 - - 245,947 - 1,531,846 27,136,796

Residential

644,639 (28,549 ) (18,970 ) - 597,120 - - 597,120 40,626 570,860 113,982,176

Commercial

111,390 125,133 - 15,000 251,523 154,469 - 97,054 154,469 - 40,500,608

Consumer

2,138 1,863 - - 4,001 - - 4,001 - - 379,530

Unallocated

106,550 (49,202 ) - - 57,348 - - 57,348 - - -
$ 3,296,538 $ 430,000 $ (18,970 ) $ 36,650 $ 3,744,218 $ 253,942 $ - $ 3,490,276 $ 7,070,182 $ 2,190,414 $ 491,188,916

Allowance for loan losses ending

Outstanding loan balances

Provision

balance evaluated for impairment:

evaluated for impairment:

Beginning

for loan

Charge

Ending

Purchase Credit

Purchase Credit

September 30, 2020

balance

losses

offs

Recoveries

balance

Individually

Impaired

Collectively

Individually

Impaired

Collectively

Real estate:

Commercial

$ 1,763,861 $ 340,084 $ - $ 45,962 $ 2,149,907 $ - $ - $ 2,149,907 $ 2,266,855 $ - $ 236,839,421

Construction and land development

192,828 51,804 - 10,800 255,432 - - 255,432 - - 23,889,344

Residential

478,124 102,515 - - 580,639 - - 580,639 46,075 - 70,582,197

Commercial

107,782 5,429 - 15,835 129,046 - - 129,046 - - 60,442,374

Consumer

4,133 2,260 - - 6,393 - - 6,393 - - 239,062

Unallocated

46,987 (27,092 ) - - 19,895 - - 19,895 - - -
$ 2,593,715 $ 475,000 $ - $ 72,597 $ 3,141,312 $ - $ - $ 3,141,312 $ 2,312,930 $ - $ 391,992,398

Allowance for loan losses ending

Outstanding loan balances

Provision

balance evaluated for impairment:

evaluated for impairment:

Beginning

for loan

Charge

Ending

Purchase Credit

Purchase Credit

December 31, 2020

balance

losses

offs

Recoveries

balance

Individually

Impaired

Collectively

Individually

Impaired

Collectively

Real estate:

Commercial

$ 1,763,861 $ 418,806 $ - $ 47,462 $ 2,230,129 $ - $ - $ 2,230,129 $ 6,660,245 $ 151,453 $ 302,473,113

Construction and land development

192,828 (5,536 ) - 14,400 201,692 - - 201,692 - 1,566,174 32,075,742

Residential

478,124 166,515 - - 644,639 - - 644,639 215,230 595,433 120,517,098

Commercial

107,782 (12,353 ) - 15,961 111,390 - - 111,390 - - 61,368,105

Consumer

4,133 (1,995 ) - - 2,138 - - 2,138 - - 288,454

Unallocated

46,987 59,563 - - 106,550 - - 106,550 - - -
$ 2,593,715 $ 625,000 $ - $ 77,823 $ 3,296,538 $ - $ - $ 3,296,538 $ 6,875,475 $ 2,313,060 $ 516,722,512

The provision for loan losses was $430,000 and $475,000 for the nine-month periods ended September 30, 2021 and 2020, respectively.

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During the nine-month periods ended September 30, 2021 and 2020, the Company had recoveries from loans written off in prior periods totaling $36,650 and $72,597, respectively, and charge-offs of $18,970 and $0, respectively.

As of September 30, 2021, the Company had $7,894,164 of loans on a watch list, other than impaired loans, for which the borrowers have the potential for experiencing financial difficulties. As of December 31, 2020, the Company had $9,546,879 of such loans. These loans are subject to ongoing management attention and their classifications are reviewed regularly. Watch list loans include loans classified as Special Mention, Substandard, and Doubtful.

Management believes that the $3.7MM reserve at September 30, 2021 and the $430,000 provision for the nine-month period ended September 30, 2021 are appropriate to adequately cover the probable and estimable losses inherent in the loan portfolio. The Company has recorded an elevated level of provision, $600,000, as compared to both the second quarter of 2021 and the third quarter of 2020. The factors driving the elevated quarter-to-date reserve are the same reasons that the year-to-date reserve as of September 30, 2021 is comparable to the amount experienced in the prior year during the height of the COVID-19 pandemic.

First, the results of our quarterly evaluation of the non-PCI loan portfolio evidenced that the required reserve under our allowance policy was in excess of the remaining fair value discount on that portion of the portfolio. The results of this evaluation are directly related to the unique circumstances that were present during the year ended December 31, 2020. Changes in market interest rates declined rapidly in the prior year across the country resulting in a large liquidity premium on our acquired non-PCI portfolio. This premium largely offset the credit discount calculated by senior management during the Day 1 valuation process for the merger. This resulted in a net fair value discount of approximately $140,000. Absent increases in the general reserve components under our allowance policy methodology going forward, Management does not expect this level of provision for the non-PCI acquired portfolio to continue.

Second, two loans to the same borrower that had been granted COVID-19 deferrals are now delinquent and one has been moved to nonaccrual status. This deterioration can be observed in our credit metrics for delinquent and nonaccrual loans and are evident in the increased level of specific reserve in our overall allowance for loan losses. The two loans had an aggregate reserve of $253,000 at September 30, 2021.

Third, a $4.3MM hotel loan has been operating under a COVID-19 deferral for 18 months. The borrower is currently paying as agreed under the deferral agreement and has been making payments of 25% to 50% of the contractually required monthly interest due during 2021. Management has included an allowance factor within the general reserve for COVID-19 deferred loans that have not returned to their contractual payment terms. This factor amounted to 8% as of September 2021 as management senses uncertainty in occupancy rates as the customer moves out of their peak season and into a slower time of year.

These factors increasing the reserve were slightly offset by continued payments made on several other previously COVID-19 deferred loans in which Management has been gradually reducing the allowance factor as payment performance is solidified over time. Management will continue to monitor COVID-19 deferred loans and adjust reserves appropriately based on the facts and circumstances present.

Investment Securities

Investments in debt securities increased by $65,593,659, or 84.6%, to $143,149,464 at September 30, 2021 from $77,555,805 at December 31, 2020. At September 30, 2021 and December 31, 2020, the Company had classified 85% and 70%, respectively, of the investment portfolio as available for sale. The balance of the portfolio was classified as held to maturity.

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Securities classified as available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the Company’s asset/liability management strategy. Available for sale debt securities are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of income taxes. Securities classified as held to maturity, which the Company has both the positive intent and ability to hold to maturity, are reported at amortized cost. The Company records unrealized gains and losses on equity securities in earnings. The Company does not currently follow a strategy of making security purchases with a view to near-term sales, and, therefore, does not own trading securities. The Company manages the investment portfolio within policies that seek to achieve desired levels of liquidity, manage interest rate sensitivity, meet earnings objectives, and provide required collateral for deposit and borrowing activities.

The following table sets forth the carrying value of investments in debt securities at September 30, 2021 and December 31, 2020:

September 30,

December 31,

2021

2020

Available for sale

State and municipal

$ 768,750 $ 986,532

SBA pools

1,572,673 1,783,807

Corporate bonds

7,543,482 6,797,431

Mortgage-backed securities

111,380,677 44,909,516
$ 121,265,582 $ 54,477,286

Held to maturity

State and municipal

$ 21,883,882 $ 23,078,519

The following table sets forth the scheduled maturities of investments in debt securities at September 30, 2021:

Available for Sale

Held to Maturity

Amortized Cost

Fair Value

Amortized Cost

Fair Value

Within 1 year

$ 499,858 $ 508,520 $ - $ -

Over 1 to 5 years

3,361,396 3,456,435 797,949 813,733

Over 5 to 10 years

4,336,240 4,347,277 2,039,074 2,237,176

Over 10 years

- - 19,046,859 19,925,303
8,197,494 8,312,232 21,883,882 22,976,212

SBA Pools

1,594,777 1,572,673 - -

Mortgage-backed securities

111,917,951 111,380,677 - -
$ 121,710,222 $ 121,265,582 $ 21,883,882 $ 22,976,212

SBA pools and mortgage-backed securities are due in monthly installments.

Other Real Estate Owned

Other real estate owned (“OREO”) at September 30, 2021 and December 31, 2020 included two properties with an aggregate carrying value of $1,411,605. The first property is an apartment building in Baltimore, Maryland with a carrying value of $1,411,605 that was acquired in the Merger. The property is under an optional sales contract with no projected closing date. The other property is land in Cecil County, Maryland with a carrying value of $0. It was acquired through foreclosure in 2007. The latter property consists of 10.43 acres and is currently under contract for a gross sales price of $295,000 with closing expected in 2022. Due to the length of time the property has been held, Maryland banking law required a write-down of the value to $0 in 2019.

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Deposits

Total deposits increased by $48,531,012, or 8.5%, to $621,932,559 at September 30, 2021 from $573,401,547 at December 31, 2020. The increase in deposits was due to a $22,686,309 increase in noninterest-bearing accounts, a $25,738,605 increase in savings and money market accounts, and a $13,192,331 increase in interest bearing checking accounts, offset by a $13,086,233 decrease in time deposits.

The following table shows the average balances and average costs of deposits for the nine months ended September 30, 2021 and 2020:

September 30, 2021

September 30, 2020

Average

Average

Balance

Cost

Balance

Cost

Noninterest bearing demand deposits

$ 119,284,008 0.00 % $ 74,243,150 0.00 %

Interest bearing demand deposits

115,751,651 0.19 % 73,702,521 0.30 %

Savings and money market deposits

180,734,271 0.16 % 107,353,960 0.26 %

Time deposits

189,068,595 0.94 % 153,264,507 1.79 %
$ 604,838,525 0.38 % $ 408,564,138 0.79 %

Liquidity Management

Liquidity describes our ability to meet financial obligations that arise out of the ordinary course of business. Liquidity is primarily needed to meet depositor withdrawal requirements, to fund loans, and to fund our other debts and obligations as they come due in the normal course of business. We maintain our asset liquidity position internally through short-term investments, the maturity distribution of the investment portfolio, loan repayments, and income from earning assets. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. The Bank is approved to borrow 75% of eligible pledged single-family residential loans and 50% of eligible pledged commercial loans as well as investment securities, or approximately $87.5 million under a secured line of credit with the Federal Home Loan Bank (“FHLB”). The Bank also has a facility with the Federal Reserve Bank of Richmond (the “Reserve Bank”) under which the Bank can borrow approximately $25.4 million. Finally, the Bank has $23,500,000 ($14,500,000 unsecured and $9,000,000 secured) of overnight federal funds lines of credit available from commercial banks. FHLB advances of $5,000,000 were outstanding as of September 30, 2021 and December 31, 2020. The Company borrowed $17,000,000 to facilitate the acquisition of Carroll as more fully described below. There were no borrowings from the Reserve Bank or our commercial bank lenders at September 30, 2021 and December 31, 2020. Management believes that we have adequate liquidity sources to meet all anticipated liquidity needs over the next 12 months. Management knows of no trend or event which is likely to have a material impact on our ability to maintain liquidity at satisfactory levels.

Borrowings and Other Contractual Obligations

The Company’s contractual obligations consist primarily of borrowings and operating leases for various facilities.

On September 30, 2020, the Company borrowed $17,000,000 from First Horizon Bank (“FHN”) for the purpose of funding a portion of the merger consideration that was payable to the stockholders of Carroll when it was merged with and into the Company on October 1, 2020. Net of issuance costs, the amount of the net long-term debt was $16,977,499 and $16,973,280 as of September 30, 2021 and December 31, 2020, respectively. The loan matures on September 30, 2025. The interest rate on the loan is fixed at 4.10%. The Company is required to make quarterly interest-only payments through October 1, 2021. The Company expects that the amount of these quarterly interest-only payments to be $174,250. During the remaining term of the loan, the Company is required to make quarterly interest and principal payments of approximately $646,472, which will be based on a nine-year straight-line amortization schedule. The remaining balance of approximately $9,916,667 will be due at maturity. To secure its obligations under this loan, the Company pledged all of its shares of common stock of the Bank to FHN.

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Securities sold under agreements to repurchase represent overnight borrowings from customers. Securities owned by the Company which are used as collateral for these borrowings are primarily U.S. government agency securities.

Specific information about the Company’s borrowings and contractual obligations is set forth in the following table:

September 30,

December 31,

2021

2020

Amount oustanding at period-end:

Securities sold under repurchase agreements

$ 10,475,121 $ 24,753,972

Federal Home Loan Bank advances

5,000,000 5,000,000

Long-term debt (net of issuance costs)

16,977,499 16,973,280

Weighted average rate paid at period-end:

Securites sold under repurchase agreements

0.34 % 0.61 %

Federal Home Loan Bank advances

1.00 % 1.00 %

Long-term debt

4.10 % 4.10 %

The Federal Home Loan Bank advances and the long-term debt outstanding at September 30, 2021 will require the following principal payments:

Year ending December 31, 2022

1,888,889

Year ending December 31, 2023

1,888,889

Year ending December 31, 2024

1,888,889

Year ending December 31, 2025

16,333,333

Capital Resources and Adequacy

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 mandatory, and possible additional, discretionary actions by the regulators that, if undertaken, could have a direct material effect on our 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 their assets, liabilities, and certain off‑balance sheet items as calculated under regulatory accounting practices.

Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of Common Equity Tier 1 capital, Tier 1 capital, and Total capital (as defined in the regulations) to risk‑weighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (as defined).

Additional information regarding the capital requirements that apply to us can be found in Note 6 to the consolidated financial statements presented elsewhere in this report and in Item 1 of Part I of the Form 10-K under the heading, “Supervision and Regulation – Capital Requirements”.

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The following table presents actual and required capital ratios as of September 30, 2021 and December 31, 2020 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2021 and December 31, 2020, based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.

Minimum

To Be Well

(Dollars in thousands)

Actual

Capital Adequacy

Capitalized

September 30, 2021

Amount

Ratio

Amount

Ratio

Amount

Ratio

Total capital (to risk-weighted assets)

$ 68,258 13.08 % $ 54,809 10.50 % $ 52,199 10.00 %

Tier 1 capital (to risk-weighted assets)

64,514 12.36 % 44,369 8.50 % 41,759 8.00 %

Common equity tier 1 (to risk- weighted assets)

64,514 12.36 % 36,539 7.00 % 33,929 6.50 %

Tier 1 leverage (to average assets)

64,514 9.17 % 28,146 4.00 % 35,182 5.00 %

December 31, 2020

Total capital (to risk-weighted assets)

$ 63,400 12.62 % $ 52,732 10.50 % $ 50,221 10.00 %

Tier 1 capital (to risk-weighted assets)

60,104 11.97 % 42,688 8.50 % 40,177 8.00 %

Common equity tier 1 (to risk- weighted assets)

60,104 11.97 % 35,155 7.00 % 32,644 6.50 %

Tier 1 leverage (to average assets)

60,104 9.05 % 26,569 4.00 % 33,211 5.00 %

The Company intends to fund future growth primarily with cash, federal funds, maturities of investment securities and deposit growth. Management knows of no other trend or event that will have a material impact on capital.

Off-Balance Sheet Arrangements

In the normal course of business, the Bank makes commitments to extend credit and issues standby letters of credit. Outstanding loan commitments, unused lines of credit, and letters of credit as of September 30, 2021 and December 31, 2020 are as follows:

September 30,

December 31,

2021

2020

Loan commitments

Construction and land development

$ 4,433,714 $ 4,668,250

Commercial

830,000 1,000,000

Commercial real estate

21,009,439 15,772,020

Residential

2,588,000 4,668,750
$ 28,861,153 $ 26,109,020

Unused lines of credit

Home-equity lines

$ 12,775,191 $ 13,716,894

Commercial lines

20,450,433 23,996,679
$ 33,225,624 $ 37,713,573

Letters of credit

$ 1,284,742 $ 1,891,428

Loan commitments and lines of credit are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.

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The maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the commitment. Loan commitments, lines of credit and letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss that is likely to be incurred as a result of funding its credit commitments.

RESULTS OF OPERATIONS

Comparison of Operating Results for the Nine Months Ended September 30, 2021 and 2020

General

Net income for the nine months ended September 30, 2021 was $6,184,341, compared to $2,264,609 for the same period of 2020. The increase of $3,919,732, or 173.1%, was due to a $5,371,279 increase in net interest income, a $239,883 increase in noninterest income, and a $45,000 decrease in the loan loss provision, offset by a $435,062 increase in noninterest expenses and a $1,301,368 increase in income taxes.

The Company incurred significant one-time costs during 2020 in connection with the Merger. The table below provides a comparison of the Company’s results for the nine months ended September 30, 2021 versus the same period of the prior year with and without $1,612,321 of acquisition costs incurred during the nine months ended September 30, 2020.

Nine Months Ended

September 30, 2021

September 30, 2020

Excluding

As Reported

As Reported

Acquisition Costs

Income before taxes

$ 7,946,059 $ 2,724,959 $ 4,337,280

Income taxes

1,761,718 460,350 849,235

Net income

$ 6,184,341 $ 2,264,609 $ 3,488,045

Earnings per share, basic and diluted

$ 2.05 $ 0.76 $ 1.17

Return on average assets

1.18 % 0.63 % 0.97 %

Return on average equity

15.17 % 5.88 % 9.06 %

Net Interest Income

Net interest income was $17,107,965 for the nine months ended September 30, 2021, compared to $11,736,686 for the same period of 2020.

Total interest income for the nine months ended September 30, 2021 was $19,305,971, compared to $14,287,618 for the same period of 2020, an increase of $5,018,353, or 35.1%.

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Total interest income on loans for the nine months ended September 30, 2021 increased by $4,622,113 when compared to the same period of 2021 due to a $140.8 million higher average loan balance for the first nine months of 2021 when compared to the same period of 2020 primarily due to the acquisition of Carroll, offset by a lower loan yield of 4.55% for the first nine months of 2021 versus 4.62% for the same period of 2020. Investment income for the nine months ended September 30, 2021 increased by $406,859, or 39.8%, when compared to the same period of 2020 due to a $43.5 million higher average investment balance, offset by a decrease in fully-taxable equivalent yield to 1.97% for nine months ended September 30, 2021, compared to 2.46% for the same period of 2020. The fully-taxable equivalent yield on total interest-earning assets decreased 26 basis points to 3.94% for the nine months ended September 30, 2021, compared to 4.20% for the same period of 2020. The average balance of total interest-earning assets increased by $200.3 million to $657.7 million for the nine months ended September 30, 2021, compared to $457.4 million for the same period of 2020 primarily due to the Merger.

Total interest expense for the nine months ended September 30, 2021 was $2,198,006, compared to $2,550,932 for the same period of 2020, a decrease of $352,926, or 13.8%. The decrease was due to a lower overall cost of funds on interest bearing deposits and borrowings of 0.56% for the nine months ended September 30, 2021, compared to 0.98% for the same period of 2020, offset by a $171.3 million increase in the average balance of interest-bearing liabilities to $518.8 million in the first nine months of 2021, compared to $347.5 million in the same period of 2020. Cost of funds for time deposits decreased to 0.94% for the nine months ended September 30, 2021 from 1.79% for the same period of 2020. Securities sold under repurchase agreements cost of funds decreased to 0.45% for the first nine months of 2021 from 1.30% for the first nine months of 2020.

Average noninterest-earning assets increased by $19.4 million to $40.0 million in the first nine months of 2021, compared to $20.6 million in the same period of 2020. Average noninterest-bearing deposits increased by $45.0 million to $119.3 million during the first nine months of 2021, compared to $74.2 million in the same period of 2020. The average balance in stockholders’ equity increased by $3.0 million for the nine months ended September 30, 2021, when compared with the same period of 2020.

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The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the nine-month periods ended September 30, 2021 and 2020. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

Nine Months Ended September 30, 2021

Nine Months Ended September 30, 2020

Average

Average

Balance

Interest

Yield

Balance

Interest

Yield

Assets :

Loans

$ 521,978,666 $ 17,828,026 4.55 % $ 381,189,719 $ 13,205,913 4.62 %

Securities, taxable

85,644,831 971,070 1.51 % 41,209,087 564,540 1.83 %

Securities, tax exempt

20,393,689 595,078 3.89 % 21,334,547 590,741 3.69 %

Federal funds sold and other interest-earning assets

29,701,715 50,341 0.23 % 13,641,105 60,940 0.60 %

Total interest-earning assets

657,718,901 19,444,515 3.94 % 457,374,458 14,422,134 4.20 %

Noninterest-earning assets

39,965,396 20,569,704

Total assets

$ 697,684,297 $ 477,944,162

Liabilities and Stockholders ’ Equity :

NOW, savings, and money market

$ 296,485,922 259,248 0.12 % $ 181,056,481 376,248 0.28 %

Certificates of deposit

189,068,595 1,330,086 0.94 % 153,264,507 2,053,248 1.79 %

Securities sold under repurchase agreements

11,269,845 38,130 0.45 % 9,804,072 95,710 1.30 %

Long-term debt

16,975,390 532,777 4.18 % - - -

FHLB advances and other borrowings

5,000,000 37,765 1.01 % 3,397,814 25,726 1.01 %

Total interest-bearing liabilities

518,799,752 2,198,006 0.56 % 347,522,874 2,550,932 0.98 %

Noninterest-bearing deposits

119,284,008 74,243,150

Noninterest-bearing liabilities

5,246,770 4,858,736

Total liabilities

643,330,530 426,624,760

Stockholders' equity

54,353,767 51,319,402

Total liabilities and stockholders' equity

$ 697,684,297 $ 477,944,162

Net interest income

$ 17,246,509 $ 11,871,202

Interest rate spread

3.38 % 3.23 %

Net yield on interest-earning assets

3.50 % 3.46 %

Ratio of average interest-earning assets to Average interest-bearing liabilities

126.78 % 131.61 %

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis based upon tax rates of 21% for Federal and 8.25% for State.

Noninterest Income

Noninterest income for the nine months ended September 30, 2021 was $1,637,479, compared to $1,397,596 for the same period of 2020, an increase of $239,883, or 17.2%. The increase was primarily a result of a $105,510 increase in bank owned life insurance income due to the Merger along with a $3.7 million purchase of additional BOLI in the first quarter of 2021, a $108,314 increase in service charges, as ATM usage and other bank services returned to more normal levels when compared to the beginning of the COVID-19 pandemic in March 2020, and a $44,510 gain on the sale of a former Carroll branch office and equipment, offset by a $56,718 decrease in the gain on sale of SBA loans.

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Noninterest Expense

Noninterest expense for the nine months ended September 30, 2021 totaled $10,369,385, compared to $9,934,323 for the same period of 2020, an increase of $435,062, or 4.4%. The increase was due primarily to increases in salaries and benefits of $1,369,197, in occupancy, furniture and equipment of $262,117, and in other expenses of $416,069, offset by a decrease in costs incurred related to the Merger of $1,612,321. All of the increases resulted from the employees, locations, and customers added in the Merger.

Income Tax Expense

Income tax expense for the nine months ended September 30, 2021 was $1,761,718, compared to $460,350 for the same period of 2020. The effective tax rate was 22.2% for the nine months ended September 30, 2021, compared to 16.9% for the same period of 2020. The increase in income tax expense was due primarily to higher income before income taxes and a lower percentage of tax exempt revenue for the nine months ended September 30, 2021 when compared to the same period in 2020.

Comparison of Operating Results for the Three Months Ended September 30, 2021 and 2020

General

Net income for the three months ended September 30, 2021 was $2,122,547, compared to $385,247 for the same period of 2020. The increase of $1,737,300, or 451.0%, was due to a $1,891,240 increase in net interest income, a $44,610 increase in noninterest income, and a $660,879 decrease in noninterest expenses, offset by a $330,000 increase in the loan loss provision, and a $529,429 increase in income taxes.

The Company incurred significant one-time costs during 2020 in connection with the Merger. The table below provides a comparison of the Company’s results for the second quarter of 2021 versus the same period of the prior year with and without $1,267,401 of acquisition costs incurred during the second quarter of 2020.

Three Months Ended

September 30, 2021

September 30, 2020

Excluding

As Reported

As Reported

Acquisition Costs

Income before taxes

$ 2,728,839 $ 462,110 $ 1,729,511

Income taxes

606,292 76,863 370,835

Net income

$ 2,122,547 $ 385,247 $ 1,358,676

Earnings per share, basic and diluted

$ 0.70 $ 0.13 $ 0.45

Return on average assets

1.19 % 0.31 % 1.10 %

Return on average equity

15.15 % 2.95 % 10.40 %

Net Interest Income

Net interest income was $5,991,989 for the three months ended September 30, 2021, compared to $4,100,749 for the same period of 2020.

Total interest income for the three months ended September 30, 2021 was $6,654,268, compared to $4,822,354 for the same period of 2020, an increase of $1,891,914, or 38.0%.

45

Total interest income on loans for the three months ended September 30, 2021 increased by $1,569,717 when compared to the same period of 2020 due to a $119.7 million higher average loan balance for the three months ended September 30, 2021 when compared to the same period of 2020 primarily due to the Merger and a higher loan yield of 4.73% for the three months ended September 30, 2021 versus 4.57% for the same period of 2020. Investment income for the three months ended September 30, 2021 increased by $253,462, or 78.5%, when compared to the same period of 2020 due to a $60.3 million higher average investment balance, offset by a decrease in fully-taxable equivalent yield to 1.94% for three months ended September 30, 2021, compared to 2.12% for the same period of 2020. The fully-taxable equivalent yield on total interest-earning assets decreased 15 basis points to 3.98% for the three months ended September 30, 2021, compared to 4.13% for the same period of 2020. The average balance of total interest-earning assets increased by $202.0 million to $672.3 million for the three months ended September 30, 2021, compared to $470.3 million for the same period of 2020 primarily due to the Merger.

Total interest expense for the three months ended September 30, 2021 was $662,279, compared to $721,605 for the same period of 2020, a decrease of $59,326, or 8.2%. The decrease was due to a lower overall cost of funds on interest bearing deposits and borrowings of 0.50% for the three months ended September 30, 2021, compared to 0.81% for the same period of 2020, offset by a $168.2 million increase in the average balance of interest-bearing liabilities to $524.7 million in the three months ended September 30, 2021, compared to $356.5 million in the same period of 2020 primarily due to the Merger. Cost of funds for time deposits decreased to 0.75% for the three months ended September 30, 2021 from 1.58% for the same period of 2020. Securities sold under repurchase agreements cost of funds decreased to 0.36% for the three months ended September 30, 2021 from 0.83% for the same period of 2020.

Average noninterest-earning assets increased by $12.4 million to $38.2 million for the three months ended September 30, 2021, compared to $25.8 million in the same period of 2020. Average noninterest-bearing deposits increased by $41.7 million to $124.1 million during the three months ended September 30, 2021, compared to $82.5 million in the same period of 2020. The average balance in stockholders’ equity increased by $3.8 million for the three months ended September 30, 2021 when compared with the same period of 2020.

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The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the three-month periods ended September 30, 2021 and 2020. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

Three Months Ended September 30, 2021

Three Months Ended September 30, 2020

Average

Average

Balance

Interest

Yield

Balance

Interest

Yield

Assets :

Loans

$ 512,953,631 $ 6,059,709 4.73 % $ 393,225,957 $ 4,489,992 4.57 %

Securities, taxable

107,912,735 428,037 1.59 % 43,770,543 150,272 1.37 %

Securities, tax exempt

19,811,359 189,950 3.84 % 23,659,811 207,940 3.52 %

Federal funds sold and other interest-earning assets

31,630,398 19,369 0.24 % 9,651,367 10,069 0.42 %

Total interest-earning assets

672,308,123 6,697,065 3.98 % 470,307,678 4,858,273 4.13 %

Noninterest-earning assets

38,217,888 25,768,859

Total assets

$ 710,526,011 $ 496,076,537

Liabilities and Stockholders ’ Equity :

NOW, savings, and money market

$ 307,799,463 115,652 0.15 % $ 194,896,794 106,356 0.22 %

Certificates of deposit

184,058,190 344,725 0.75 % 147,923,538 584,477 1.58 %

Securities sold under repurchase agreements

10,847,773 9,647 0.36 % 8,651,764 18,020 0.83 %

Long-term debt

16,976,796 179,528 4.23 % - - -

FHLB advances and other borrowings

5,000,120 12,727 1.02 % 5,043,489 12,752 1.01 %

Total interest-bearing liabilities

524,682,342 662,279 0.50 % 356,515,585 721,605 0.81 %

Noninterest-bearing deposits

124,149,640 82,493,506

Noninterest-bearing liabilities

5,667,596 4,804,935

Total liabilities

654,499,578 443,814,026

Stockholders' equity

56,026,433 52,262,511

Total liabilities and stockholders' equity

$ 710,526,011 $ 496,076,537

Net interest income

$ 6,034,786 $ 4,136,668

Interest rate spread

3.48 % 3.32 %

Net yield on interest-earning assets

3.59 % 3.52 %

Ratio of average interest-earning assets to Average interest-bearing liabilities

128.14 % 131.92 %

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis based upon tax rates of 21% for Federal and 8.25% for State.

Noninterest Income

Noninterest income for the three months ended September 30, 2021 was $531,978, compared to $487,368 for the same period of 2020, an increase of $44,610, or 9.2%. The increase was primarily a result of a $37,692 increase in bank owned life insurance income and a $48,853 increase in service charge revenue, as ATM usage and other bank services returned to more normal levels when compared to the beginning of the COVID-19 pandemic in March 2020, offset by a $64,826 decrease in mortgage banking income as a result of residential refinance activity declining from the all-time high levels at the beginning of the COVID-19 pandemic in the second quarter of 2020 when the FRB reduced interest rates to historic lows.

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Noninterest Expense

Noninterest expense for the three months ended September 30, 2021 totaled $3,465,128, compared to $4,126,007 for the same period of 2020, a decrease of $660,879, or 16.0%. The decrease was due primarily to a decrease in costs incurred in connection with the Merger of $1,267,401, offset by increases in salaries and benefits of $444,853, in occupancy, furniture and equipment of $81,022, and in other expenses of $80,647. All of the increases resulted from the employees, locations, and customers added in the Merger.

Income Tax Expense

Income tax expense for the three months ended September 30, 2021 was $606,292, compared to $76,863 for the same period of 2020. The effective tax rate was 22.2% for the three months ended September 30, 2021, compared to 16.6% for the same period of 2020. The increase in income tax expense was due primarily to higher income before income taxes and a lower percentage of tax exempt revenue for the three months ended September 30, 2021 when compared to the same period in 2020.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Our primary market risk is interest rate fluctuation and we have procedures in place to evaluate and mitigate this risk. This market risk and our procedures are described in Item 7 of Part II the on Form 10-K under the heading, “Interest Rate Risk”, which provides information as of December 31, 2020. Management believes that no material changes in market risk or our procedures used to evaluate and mitigate these risks have occurred since December 31, 2020.

Item 4.

Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to our management, including Farmers and Merchants Bancshares, Inc.’s principal executive officer (“PEO”) and the principal financial officer (“PFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of September 30, 2021 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended September 30, 2021, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II – OTHER INFORMATION

Item 1.

Legal Proceedings

None.

Item 1A.

Risk Factors

The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Form 10-K. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults upon Senior Securities

None.

Item 4.

Mine Safety Disclosures

Not Applicable.

Item 5.

Other Information

a.

Form 8-K Information .

On November 15, 2021, the Bank and Mark Krebs, its Executive Vice President and Chief Financial Officer, entered into a First Amendment to Severance Agreement (the “Amendment”).  The parties’ Severance Agreement, dated as of February 19, 2013, provides that Mr. Krebs will be entitled to a severance payment if (i) he terminates his employment in connection with or within 30 days of a “Change in Control” (as defined in the Severance Agreement), (ii) he terminates his employment for “Good Reason” (as defined in the Severance Agreement”) within 12 months of a Change in Control, or (iii) the Bank terminates his employment without “Just Cause” (as defined in the Severance Agreement) within 12 months of a Change in Control.  The amount of the severance payment would be 2.99 times Mr. Krebs’ then-current “base amount” (as defined in Section 280G of the Internal Revenue Code) less the sum of all other “parachute payments” (as defined in Section 280G of the Internal Revenue Code) to which Mr. Krebs is entitled on account of the Change in Control.  The Amendment revised the Severance Agreement by providing that a termination of employment by Mr. Krebs will not be for Good Reason unless he notified the Bank of the event, the Bank failed to cure the event, and his termination occurred within 90 days of the event.  For so long as Mr. Krebs continues to be elected as an officer of the Bank, the term of the Severance Agreement will automatically renew for successive one-year periods.

The foregoing disclosure is being made in this Item 5 rather than in a Form 8-K pursuant to Item 5.02(e) thereof in reliance on Question and Answer 101.01 of the Exchange Act Form 8-K Compliance and Disclosure Interpretations issued by the SEC’s Division of Corporation Finance.

Item 6.

Exhibits

The exhibits filed or furnished with this quarterly report are listed in the following Exhibit Index:

Exhibit

Description

31.1

Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)

31.2

Certifications of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)

32

Certification of the Principal Executive Officer and the Principal Financial Office pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith)

101

Interactive Data Files pursuant to Rule 405 of Regulation S-T (filed herewith)

104

The cover page of Farmers and Merchants Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 formatted in Inline XBRL, included within the Exhibit 101 attachments (filed herewith).

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SIGNATURES

Pursuant to the requirements 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 AND MERCHANTS BANCSHARES, INC.

Date:      November 15, 2021

/s/ James R. Bosley, Jr.

James R. Bosley, Jr.

President and Chief Executive Officer

(Principal Executive Officer)

Date      November 15, 2021

/s/ Mark C. Krebs

Mark C. Krebs

Treasurer and Chief Financial Officer

(Principal Financial Officer & Principal Accounting Officer)

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