Farmers & Merchants Bancshares, Inc. - FORM 10-Q

Attached files

file	filename
EX-32 - EXHIBIT 32 - Farmers & Merchants Bancshares, Inc.	ex_196299.htm
EX-31.2 - EXHIBIT 31.2 - Farmers & Merchants Bancshares, Inc.	ex_196298.htm
EX-31.1 - EXHIBIT 31.1 - Farmers & Merchants Bancshares, Inc.	ex_196297.htm

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 June 30, 2020

☐	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: 2,991,964 as of August 5, 2020.

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 June 30, 2020 (unaudited) and December 31, 2019	3

Consolidated statements of income (unaudited) for the three and six months ended June 30, 2020 and 2019	4

Consolidated statements of comprehensive income (unaudited) for the three and six months ended June 30, 2020 and 2019	5

Consolidated statements of changes in stockholders’ equity (unaudited) for the three and six months ended June 30, 2020 and 2019	6

Consolidated statements of cash flows (unaudited) for the six months ended June 30, 2020 and 2019	7

Notes to financial statements (unaudited)	9

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

Item 3. Quantitative and Qualitative Disclosures About Market Risk	44

Item 4. Controls and Procedures	44

PART II – OTHER INFORMATION	45

Item 1. Legal Proceedings	45

Item 1A. Risk Factors	45

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	45

Item 3. Defaults upon Senior Securities	45

Item 4. Mine Safety Disclosures	45

Item 5. Other Information	45

Item 6. Exhibits	46

SIGNATURES	46

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

	June 30,		December 31,
	2020		2019
	(Unaudited)
Assets

Cash and due from banks	$	26,517,065	$	6,664,307
Federal funds sold and other interest-bearing deposits		476,565		2,457,045
Cash and cash equivalents		26,993,630		9,121,352
Certificates of deposit in other banks		1,600,000		100,000
Securities available for sale		50,595,971		36,531,774
Securities held to maturity		22,092,361		19,510,018
Equity security at fair value		550,806		532,321
Federal Home Loan Bank stock, at cost		611,300		376,200
Mortgage loans held for sale		1,473,976		242,000
Loans, less allowance for loan losses of $3,136,712 and $2,593,715		383,769,692		359,382,843
Premises and equipment		5,041,743		5,036,851
Accrued interest receivable		1,724,532		1,019,540
Deferred income taxes		745,539		1,036,078
Bank owned life insurance		7,230,699		7,145,477
Other assets		2,062,869		2,180,644
	$	504,493,118	$	442,215,098

Liabilities and Stockholders' Equity

Deposits
Noninterest-bearing	$	85,951,086	$	60,659,015
Interest-bearing		345,210,014		315,954,299
Total deposits		431,161,100		376,613,314
Securities sold under repurchase agreements		11,250,921		10,958,118
Federal Home Loan Bank of Atlanta advances		5,000,000		-
Accrued interest payable		309,006		346,214
Other liabilities		5,206,034		4,843,936
		452,927,061		392,761,582
Stockholders' equity
Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 2,991,963 in 2020 and 2,974,019 in 2019		29,920		29,740
Additional paid-in capital		28,054,158		27,812,991
Retained earnings		22,674,059		21,568,161
Accumulated other comprehensive income		807,920		42,624
		51,566,057		49,453,516
	$	504,493,118	$	442,215,098

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

	Three months ended June 30,					Six months ended June 30,
	2020		2019			2020		2019

Interest income
Loans, including fees	$	4,393,267	$	4,172,235		$	8,715,921	$	8,332,321
Investment securities - taxable		191,255		222,272			401,761		397,108
Investment securities - tax exempt		154,699		143,125			298,783		281,213
Federal funds sold and other interest earning assets		16,007		121,824			48,799		196,350
Total interest income		4,755,228		4,659,456			9,465,264		9,206,992

Interest expense
Deposits		832,464		885,246			1,738,663		1,660,777
Securities sold under repurchase agreements		39,496		28,423			77,690		53,722
Federal Home Loan Bank advances and other borrowings		12,865		11,195			12,974		31,748
Total interest expense		884,825		924,864			1,829,327		1,746,247
Net interest income		3,870,403		3,734,592			7,635,937		7,460,745

Provision for loan losses		350,000		-			475,000		13,000

Net interest income after provision for loan losses		3,520,403		3,734,592			7,160,937		7,447,745

Noninterest income
Service charges on deposit accounts		117,658		166,115			276,213		318,175
Mortgage banking income		350,110		72,879			412,367		105,598
Bank owned life insurance income		43,211		242,012			85,223		282,398
Unrealized gain on equity security		4,535		6,911			13,045		14,756
Write down of other real estate owned		-		(210,150	)		-		(210,150	)
Gain on sale of SBA loans		63,635		9,520			63,635		139,535
Other fees and commissions		29,077		35,946			59,745		65,317
Total noninterest income		608,226		323,233			910,228		715,629

Noninterest expense
Salaries		1,296,278		1,309,007			2,651,197		2,635,790
Employee benefits		359,450		314,145			806,554		696,109
Occupancy		185,394		190,543			368,546		404,963
Furniture and equipment		165,812		155,933			326,261		311,080
Acquisition		165,096		-			344,920		-
Other		689,973		639,568			1,310,838		1,316,540
Total noninterest expense		2,862,003		2,609,196			5,808,316		5,364,482

Income before income taxes		1,266,626		1,448,629			2,262,849		2,798,892
Income taxes		230,571		222,808			383,487		476,784
Net income	$	1,036,055	$	1,225,821		$	1,879,362	$	2,322,108

Earnings per share - basic and diluted	$	0.35	$	0.42		$	0.63	$	0.79

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019

Net income	$	1,036,055	$	1,225,821	$	1,879,362	$	2,322,108

Other comprehensive income, net of income taxes:

Securities available for sale
Net unrealized gain arising during the period		883,144		433,834		1,055,835		846,140
Income tax expense		243,019		119,380		290,539		232,836
Total other comprehensive income		640,125		314,454		765,296		613,304

Total comprehensive income	$	1,676,180	$	1,540,275	$	2,644,658	$	2,935,412

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three and six months ended June 30, 2020 and 2019

(Unaudited except for year-end amounts)

					Additional					Accumulated other			Total
	Common stock				paid-in		Retained			comprehensive			stockholders'
	Shares		Par value		capital		earnings			income			equity
Three months ended June 30, 2019
Balance, March 31, 2019		1,682,997	$	16,830	$	27,324,794	$	19,626,222		$	(269,449	)	$	46,698,397

Net income		-		-		-		1,225,821			-			1,225,821
Unrealized loss on securities available for sale net of income tax expense of $119,380		-		-		-		-			314,454			314,454
Cash dividends, $0.25 per share		-		-		-		(740,519	)		-			(740,519	)
Dividends reinvested		8,094		81		236,799		-			-			236,880

Balance, June 30, 2019		1,691,091	$	16,911	$	27,561,593	$	20,111,524		$	45,005		$	47,735,033

Six months ended June 30, 2019
Balance, December 31, 2018		1,682,997	$	16,830	$	27,324,794	$	18,621,382		$	(568,299	)	$	45,394,707

Net income		-		-		-		2,322,108			-			2,322,108
Unrealized loss on securities available for sale net of income tax expense of $232,836		-		-		-		-			613,304			613,304
Reclassification due to adoption of ASU No. 2016-02		-		-		-		(91,447	)		-			(91,447	)
Cash dividends, $0.25 per share		-		-		-		(740,519	)		-			(740,519	)
Dividend Reinvested		8,094		81		236,799					-			236,880

Balance, June 30, 2019		1,691,091	$	16,911	$	27,561,593	$	20,111,524		$	45,005		$	47,735,033

Three months ended June 30, 2020
Balance, March 31, 2020		2,974,019	$	29,740	$	27,812,991	$	22,411,468		$	167,795		$	50,421,994

Net income		-		-		-		1,036,055			-			1,036,055
Unrealized gain on securities available for sale net of income tax expense of $243,019		-		-		-		-			640,125			640,125
Cash dividends, $0.26 per share		-		-		-		(773,464	)		-			(773,464	)
Dividends reinvested		17,944		180		241,167		-			-			241,347

Balance, June 30, 2020		2,991,963	$	29,920	$	28,054,158	$	22,674,059		$	807,920		$	51,566,057

Six months ended June 30, 2020
Balance, December 31, 2019		2,974,019	$	29,740	$	27,812,991	$	21,568,161		$	42,624		$	49,453,516

Net income		-		-		-		1,879,362			-			1,879,362
Unrealized gain on securities available for sale net of income tax expense of $290,539		-		-		-		-			765,296			765,296
Cash dividends, $0.26 per share		-		-		-		(773,464	)		-			(773,464	)
Dividends reinvested		17,944		180		241,167		-			-			241,347

Balance, June 30, 2020		2,991,963	$	29,920	$	28,054,158	$	22,674,059		$	807,920		$	51,566,057

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Six Months Ended June 30,	2020			2019

Cash flows from operating activities
Interest received	$	9,404,760		$	9,156,111
Fees and commissions received		748,326			765,151
Interest paid		(1,866,535	)		(1,477,635	)
Proceeds from sale of mortgage loans held for sale		21,655,071			4,924,657
Origination of mortgage loans held for sale		(22,887,047	)		(5,323,769	)
Cash paid to suppliers and employees		(5,413,489	)		(5,410,566	)
Income taxes paid, net of refunds received		-			(249,711	)
		1,641,086			2,384,238

Cash flows from investing activities
Proceeds from maturity and call of securities
Available for sale		6,711,028			2,923,369
Held to maturity		500,000			500,000
Purchase of securities
Available for sale		(19,890,543	)		(11,643,636	)
Held to maturity		(3,065,625	)		(1,770,815	)
Purchase of certificates of deposit		(1,500,000	)		-
Loans made to customers, net of principal collected		(26,132,027	)		(701,101	)
Proceeds from sale of loans		683,885			1,582,364
Redemption (purchase) of stock in FHLB of Atlanta		(235,100	)		72,100
Purchases of premises, equipment and software		(148,898	)		(45,278	)
		(43,077,280	)		(9,082,997	)

Cash flows from financing activities
Net increase (decrease) in
Noninterest-bearing deposits		25,292,071			(1,707,576	)
Interest-bearing deposits		29,255,715			19,169,973
Securities sold under repurchase agreements		292,803			(2,222,415	)
Federal Home Loan Bank of Atlanta advances		5,000,000			-
Dividends paid, net of reinvestments		(532,117	)		(503,639	)

		59,308,472			14,736,343

Net increase in cash and cash equivalents		17,872,278			8,037,584

Cash and cash equivalents at beginning of period		9,121,352			14,618,237
Cash and cash equivalents at end of period	$	26,993,630		$	22,655,821

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Six Months Ended June 30,	2020			2019

Reconciliation of net income to net cash provided by operating activities
Net income	$	1,879,362		$	2,322,108
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		164,949			176,885
Provision for loan losses		475,000			13,000
Lease expense in excess of rent paid		17,215			20,273
Write down of other real estate owned		-			210,150
Equity security dividends reinvested		(5,440	)		(6,127	)
Unrealized gain on equity security		(13,045	)		(14,756	)
Gain on sale of SBA loans		(63,635	)		(139,535	)
Amortization of premiums and accretion of discounts, net		154,435			46,353
Increase (decrease) in
Deferred loan fees		649,928			(25,409	)
Accrued interest payable		(37,208	)		268,612
Other liabilities		419,608			(36,563	)
Decrease (increase) in
Mortgage loans held for sale		(1,231,976	)		(399,112	)
Accrued interest receivable		(704,992	)		(15,890	)
Bank owned life insurance cash surrender value		(85,222	)		(9,792	)
Other assets		22,107			(25,959	)

	$	1,641,086		$	2,384,238

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

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 have been eliminated.

2.	Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods have been made. Such adjustments were normal and recurring in nature. The results of operations for the three and six months ended June 30, 2020 do not necessarily reflect the results that may be expected for the entire fiscal year ending December 31, 2020 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, 2019, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2020.

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases (Topic 841).” Among other things, in the amendments in ASU 2016-02, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company adopted the provisions of ASU 2016-02, effective January 1, 2019, by recording an asset of $1,400,855, a liability of $1,527,019, a $91,447 adjustment to retained earnings, and a $34,717 adjustment to deferred income taxes.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2.	Basis of Presentation (continued)

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses”. The ASU sets forth a “current expected credit loss” (CECL) model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. 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 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 August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820) - Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 modifies the disclosure requirements on fair value measurements in ASC Topic 820. The amendments in this update remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 was effective for us on January 1, 2020, with early adoption permitted, and did not have a material impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-14, “Compensation - Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20).” ASU 2018-14 amends and modifies the disclosure requirements for employers that sponsor defined benefit pension or other post-retirement plans. The amendments in this update remove disclosures that no longer are considered cost beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. ASU 2018-14 will be effective for us on January 1, 2021, with early adoption permitted, and is not expected to have a material impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” ASU 2018-15 clarifies certain aspects of ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which was issued in April 2015. Specifically, ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 does not affect the accounting for the service element of a hosting arrangement that is a service contract. ASU 2018-15 was effective for us on January 1, 2020, with early adoption permitted, and did not have a material impact on the Company’s financial statements.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

3.	Investment Securities

Investments in debt securities are summarized as follows:

Amortized

Unrealized

Fair

June 30, 2020

cost

gains

losses

value

Available for sale

State and municipal

5,412,696

21,150

5,433,846

SBA pools

1,953,812

48,089

1,905,723

Corporate bonds

2,102,417

81,303

2,183,720

Mortgage-backed securities

40,012,405

1,099,290

39,013

41,072,682

49,481,330

1,201,743

87,102

50,595,971

Held to maturity

State and municipal

22,092,361

979,396

23,071,757

	Amortized		Unrealized		Unrealized		Fair
December 31, 2019	cost		gains		losses		value

Available for sale

State and municipal	$	508,134	$	4,536	$	-	$	512,670
SBA pools		2,203,834		-		52,037		2,151,797
Mortgage-backed securities		33,760,999		255,843		149,535		33,867,307
	$	36,472,967	$	260,379	$	201,572	$	36,531,774

Held to maturity

State and municipal	$	19,510,018	$	588,393	$	480	$	20,097,931

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
June 30, 2020	cost		value		cost		value

Within one year	$	4,905,802	$	4,907,351	$	255,419	$	256,673
Over one to five years		2,359,311		2,446,892		561,187		563,454
Over five to ten years		250,000		263,323		3,224,596		3,315,629
Over ten years		-		-		18,051,159		18,936,001
		7,515,113		7,617,566		22,092,361		23,071,757
Mortgage-backed securities and SBA pools, due in monthly installments		41,966,217		42,978,405		-		-
	$	49,481,330	$	50,595,971	$	22,092,361	$	23,071,757

December 31, 2019

Within one year	$	-	$	-	$	257,150	$	261,204
Over one to five years		258,134		258,838		562,587		565,140
Over five to ten years		250,000		253,832		2,717,125		2,782,474
Over ten years		-		-		15,973,156		16,489,113
		508,134		512,670		19,510,018		20,097,931
Mortgage-backed securities and SBA pools, due in monthly installments		35,964,833		36,019,104		-		-
	$	36,472,967	$	36,531,774	$	19,510,018	$	20,097,931

Securities with a carrying value of $12,385,076 and $11,441,474 as of June 30, 2020 and December 31, 2019, respectively, were pledged as collateral for government deposits and securities sold under repurchase agreements.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.	Investment Securities (continued)

The following table sets forth the Company’s gross unrealized losses on a continuous basis for investments in debt securities, by category and length of time, at June 30, 2020 and December 31, 2019.

June 30, 2020	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	$	-	$	-	$	-	$	-	$	-	$	-
SBA pools		-		-		1,894,913		48,089		1,894,913		48,089
Corporate bonds		-		-		-		-		-		-
Mortgage-backed securities		8,122,683		37,874		311,100		1,139		8,433,783		39,013
Total	$	8,122,683	$	37,874	$	2,206,013	$	49,228	$	10,328,696	$	87,102

December 31, 2019	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	$	251,618	$	480	$	-	$	-	$	251,618	$	480
SBA pools		-		-		2,151,797		52,037		2,151,797		52,037
Mortgage-backed securities		10,643,624		58,063		7,295,788		91,472		17,939,412		149,535
Total	$	10,895,242	$	58,543	$	9,447,585	$	143,509	$	20,342,827	$	202,052

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 June 30, 2020 and December 31, 2019, 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 investment securities are expected to recover as the securities approach their maturity dates or repricing dates or if market yields for such investments decline. Based on the foregoing factors, as of June 30, 2020 and December 31, 2019, management believes that these unrealized losses are temporary and, accordingly, have not been recognized in the Company’s consolidated statement of income.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Loans

Major categories of loans are as follows:

	June 30,		December 31,
	2020		2019

Real estate:
Commercial	$	235,940,173	$	240,938,149
Construction and land development		20,550,954		18,194,955
Residential		75,094,571		76,122,069
Commercial		56,272,588		26,947,503
Consumer		216,190		292,027
		388,074,476		362,494,703
Less: Allowance for loan losses		3,136,712		2,593,715
Deferred origination fees net of costs		1,168,072		518,145
	$	383,769,692	$	359,382,843

At June 30, 2020, the Company had two nonaccrual loans to the same borrower. One is a commercial real estate loans with a balance of $221,330 and was secured by real estate and a personal guarantee. The other is a residential real estate loan with a balance of $49,342 and was secured by real estate. Gross interest income of $6,294 would have been recorded for the three and six months ended June 30, 2020, respectively, if these nonaccrual loans had been current and performing in accordance with the original terms. Neither loan requires an allowance for loss.

At December 31, 2019 the company had no nonaccrual loans.

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
June 30, 2020
Real estate:
Commercial	$	217,398	$	-	$	221,330	$	438,728	$	235,501,445	$	235,940,173	$	-
Construction and land development		-		-		-		-		20,550,954		20,550,954		-
Residential		-		-		49,342		49,342		75,045,229		75,094,571		-
Commercial		-		-		-		-		56,272,588		56,272,588		-
Consumer		-		-		-		-		216,190		216,190		-
Total	$	217,398	$	-	$	270,672	$	488,070	$	387,586,406	$	388,074,476	$	-

December 31, 2019
Real estate:
Commercial	$	224,794	$	-	$	-	$	224,794	$	240,713,355	$	240,938,149	$	-
Construction and land development		-		-		-		-		18,194,955		18,194,955		-
Residential		59,892		-		-		59,892		76,062,177		76,122,069		-
Commercial		-		-		-		-		26,947,503		26,947,503		-
Consumer		-		-		-		-		292,027		292,027		-
Total	$	284,686	$	-	$	-	$	284,686	$	362,210,017	$	362,494,703	$	-

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

Impaired loans, segregated by class of loans with average recorded investment and interest recognized for the three months ended June 30, 2020 and the year ended December 31, 2019, 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
June 30, 2020
Real estate:
Commercial	$	2,502,296	$	2,502,296	$	-	$	2,502,296	$	-	$	2,293,642	$	57,121
Residential		49,342		49,342		-		49,342		-		24,671		-
	$	2,551,638	$	2,551,638	$	-	$	2,551,638	$	-	$	2,318,313	$	57,121

December 31, 2019
Real estate:
Commercial	$	2,084,988	$	2,084,988	$	-	$	2,084,988	$	-	$	2,631,185	$	106,874
Residential		50,057		50,057		-		50,057		-		25,029		2,876
	$	2,135,045	$	2,135,045	$	-	$	2,135,045	$	-	$	2,656,214	$	109,750

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

At June 30, 2020, the Company had two commercial real estate loans totaling $2,280,966 and one residential real estate loan totaling $49,342 that were classified as TDRs. All are included in impaired loans above. At June 30, 2020, both commercial real estate loans are paying as agreed while the residential real estate loan was over 90 days delinquent. There have been no charge-offs or allowances associated with these three loans.

At December 31, 2019, the Company had one commercial real estate loan totaling $2,084,988 and one residential real estate loan totaling $50,057 that were classified as TDRs. All are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these two 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 December 31, 2020 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 June 30, 2020, the Company has modified loans, due to the pandemic and at the borrower’s request, with an aggregate principal balance of $109.2 million, or 30% of its loan portfolio. None of these loans were classified as TDRs as of June 30, 2020 because they met the criteria discussed above. Of these previously-deferred loans, borrowers owing a total of $27.8 million, or 8% of the Company’s loan portfolio, have requested additional three-month deferrals, which requests the Company is currently evaluating.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

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

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

Pass/Watch

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

Special Mention

A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

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

Substandard

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

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (continued)

Doubtful

A doubtful loan has all the weaknesses inherent 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.

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

Above

Pass

Special

June 30, 2020

Excellent

average

Average

Acceptable

watch

mention

Substandard

Doubtful

Total

Real estate:

Commercial

2,450,001

50,720,140

81,411,409

92,362,374

8,996,249

235,940,173

Construction and land development

2,541,548

11,344,078

6,665,328

20,550,954

Residential

36,677

1,267,344

27,359,817

34,608,320

9,348,624

2,473,789

75,094,571

Commercial

31,112,843

5,853,788

14,553,697

4,752,260

56,272,588

Consumer

19,782

93,132

59,332

11,378

17,586

14,980

216,190

31,169,302

3,810,477

86,534,625

141,928,882

113,146,172

11,470,038

14,980

388,074,476

			Above						Pass		Special
December 31, 2019	Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total

Real estate:
Commercial	$	-	$	2,769,944	$	91,274,940	$	110,566,629	$	27,438,005	$	-	$	8,888,631	$	-	$	240,938,149
Construction and land development		-		216,000		4,737,737		8,572,151		4,669,067		-		-		-		18,194,955
Residential		39,817		1,633,783		30,767,418		34,784,120		6,386,377		-		2,510,554		-		76,122,069
Commercial		153,848		20,000		11,682,299		11,995,143		3,096,213		-		-		-		26,947,503
Consumer		2,327		99,385		91,620		60,049		19,214		-		240		19,192		292,027
	$	195,992	$	4,739,112	$	138,554,014	$	165,978,092	$	41,608,876	$	-	$	11,399,425	$	19,192	$	362,494,703

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans (Continued)

The following table details activity in the allowance for loan losses by portfolio for the three-month and six months ended June 30, 2020 and 2019 and for the year ended December 31, 2019. 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

Outstanding loan

Provision

ending balance evaluated

balances evaluated

Beginning

for loan

Charge

Ending

for impairment:

June 30, 2020

balance

losses

offs

Recoveries

balance

Individually

Collectively

Individually

Collectively

Real estate:

Commercial

1,763,861

396,409

44,962

2,205,232

2,502,296

233,437,877

Construction and land development

192,828

22,302

7,200

222,330

20,550,954

Residential

478,124

55,640

533,764

49,342

75,045,229

Commercial

107,782

(7,709

)

15,835

115,908

56,272,588

Consumer

4,133

(740

)

3,393

216,190

Unallocated

46,987

9,098

56,085

2,593,715

475,000

67,997

3,136,712

2,551,638

385,522,838

												Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
June 30, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,754,372	$	(17,650	)	$	-	$	17,799	$	1,754,521	$	-	$	1,754,521	$	2,109,945	$	235,184,971
Construction and land development		196,374		(26,548	)		-		6,826		176,652		-		176,652		-		16,384,252
Residential		401,626		51,910			-		-		453,536		-		453,536		51,870		67,419,352
Commercial		102,610		(10,999	)		-		4,166		95,777		-		95,777		-		21,769,797
Consumer		10,428		(7,134	)		-		-		3,294		-		3,294		-		307,718
Unallocated		43,924		23,421			-		-		67,345		-		67,345		-		-
	$	2,509,334	$	13,000		$	-	$	28,791	$	2,551,125	$	-	$	2,551,125	$	2,161,815	$	341,066,090

												Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
December 31, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,754,372	$	(11,700	)	$	-	$	21,189	$	1,763,861	$	-	$	1,763,861	$	2,084,988	$	238,853,161
Construction and land development		196,374		(17,571	)		-		14,025		192,828		-		192,828		-		18,194,955
Residential		401,626		76,498			-		-		478,124		-		478,124		50,057		76,072,012
Commercial		102,610		(3,995	)		-		9,167		107,782		-		107,782		-		26,947,503
Consumer		10,428		(6,295	)		-		-		4,133		-		4,133		-		292,027
Unallocated		43,924		3,063			-		-		46,987		-		46,987		-		-
	$	2,509,334	$	40,000		$	-	$	44,381	$	2,593,715	$	-	$	2,593,715	$	2,135,045	$	360,359,658

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

5.	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 June 30, 2020 and December 31, 2019:

	Consolidated Balance
	Sheet classification	June 30, 2020		December 31, 2019
Operating lease right of use asset	Other assets	$	1,317,556	$	1,392,281
Operating lease liabilities	Other liabilities		1,501,846		1,559,356

Operating lease cost included in occupancy expense in the statement of income for the three months ended June 30, 2020 and 2019 was $44,343 and $46,414, respectively. Operating lease cost included in occupancy expense in the statement of income for the six months ended June 30, 2020 and 2019 was $94,134 and $94,221, respectively.

Future minimum payments under the agreements, including those option years for which the Company is reasonably certain to renew, are as follows:

Year	Amount

2020	$	100,187
2021		210,955
2022		221,497
2023		228,531
2024		234,910
Thereafter		1,140,679
Total lease payments		2,136,759
Less imputed interest		(634,913	)
Present value of operating lease liabilities	$	1,501,846

For operating leases as of June 30, 2020, the weighted average remaining lease term is 9.0 years and the weighted average discount rate is 3.25%. During the three months ended June 30, 2020 and 2019, cash paid for amounts included in the measurement of lease liabilities was $35,801 and $37,224, respectively. During the six months ended June 30, 2020 and 2019, cash paid for amounts included in the measurement of lease liabilities was $76,920 and $73,948, respectively.

6.	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.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

6.	Capital Standards (continued)

The Basel III Capital Rules became effective for the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). 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.

Under the revised prompt corrective action requirements, as of January 1, 2015, 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%.

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 June 30, 2020, 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.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

6.	Capital Standards (continued)

The following table presents actual and required capital ratios as of June 30, 2020 and December 31, 2019 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2020 and December 31, 2019 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

Capital Adequacy

To Be Well

(Dollars in thousands)

Actual

Phase-In Schedule

Capitalized

June 30, 2020

Amount

Ratio

Amount

Ratio

Amount

Ratio

Total capital (to risk-weighted assets)

52,627

14.22

38,855

10.50

37,005

10.00

Tier 1 capital (to risk-weighted assets)

49,491

13.37

31,454

8.50

29,604

8.00

Common equity tier 1 (to risk- weighted assets)

49,491

13.37

25,903

7.00

24,053

6.50

Tier 1 leverage (to average assets)

49,491

10.11

19,585

4.00

24,481

5.00

						Minimum
						Capital Adequacy					To Be Well
(Dollars in thousands)	Actual					Phase-In Schedule					Capitalized
December 31, 2019	Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	51,274		13.88	%	$	38,775		10.50	%	$	36,928		10.00	%
Tier 1 capital (to risk-weighted assets)		48,681		13.18	%		31,389		8.50	%		29,543		8.00	%
Common equity tier 1 (to risk- weighted assets)		48,681		13.18	%		25,850		7.00	%		24,003		6.50	%
Tier 1 leverage (to average assets)		48,681		10.94	%		17,798		4.00	%		22,247		5.00	%

To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. As of June 30, 2020, 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.

7.	Fair Value

Accounting standards define fair value as the price that would be received upon the sale of an asset or paid upon the transfer of a liability in an orderly transaction between market participants. The price in the principal market used to measure the fair value of the asset or liability is not adjusted for transaction costs. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

The standards require the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. The standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.	Fair Value (continued)

The fair value hierarchy is 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.

●

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.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.	Fair Value (continued)

The following table summarizes financial assets measured at fair value on a recurring and nonrecurring basis as of June 30, 2020 and December 31, 2019, 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
June 30, 2020
Recurring
Available for sale securities
State and municipal	$	-	$	5,433,846	$	-	$	5,433,846
SBA pools		-		1,905,723		-		1,905,723
Corporate bonds		-		2,183,720		-		2,183,720
Mortgage-backed securities		-		41,072,682		-		41,072,682
	$	-	$	50,595,971	$	-	$	50,595,971

Equity security at fair value
Mutual fund	$	550,806	$	-	$	-	$	550,806

Nonrecurring
Impaired loans	$	-	$	-	$	2,551,638	$	2,551,638

December 31, 2019
Recurring
Available for sale securities
State and municipal	$	-	$	512,670	$	-	$	512,670
SBA pools		-		2,151,797		-		2,151,797
Mortgage-backed securities		-		33,867,307		-		33,867,307
	$	-	$	36,531,774	$	-	$	36,531,774

Equity security at fair value
Mutual fund	$	532,321	$	-	$	-	$	532,321

Nonrecurring
Impaired loans	$	-	$	-	$	2,135,045	$	2,135,045

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.	Fair Value (continued)

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:

June 30, 2020

December 31, 2019

Carrying

Estimated

Carrying

Estimated

Amount

Fair Value

Amount

Fair Value

Financial assets

Level 2 inputs

Securities held to maturity

22,092,361

23,071,757

19,510,018

20,097,931

Mortgage loans held for sale

1,473,976

1,497,046

242,000

245,857

Federal Home Loan Bank stock

611,300

376,200

Level 3 inputs

Loans, net

383,769,692

383,695,692

359,382,843

359,346,031

Financial liabilities

Level 1 inputs

Noninterest-bearing deposits

85,951,086

60,659,015

Securities sold under repurchase agreements

11,250,921

10,958,118

Level 2 inputs

Interest-bearing deposits

345,210,014

357,529,014

315,954,299

313,622,299

Federal Home Loan Bank advances

5,000,000

5,162,000

The fair value of mortgage loans held for sale is determined by the expected sales price. The fair value of loans were determined using an exit price methodology. The exit price estimation of fair value is based on the present value of the expected cash flows. The projected cash flows are based on the contractual terms of the loans, adjusted for prepayments and use of a discount rate based on the relative risk of the cash flows, taking into account the loan type, maturity of the loan, liquidity risk, servicing costs, and a required return on debt and capital (Level 3). In addition, an incremental liquidity discount is applied to certain loans, using historical sales of loans during periods of similar economic conditions as a benchmark.

The fair values of interest-bearing checking, savings, and money market deposit accounts are equal to their carrying amounts. The fair values of fixed-maturity time deposits are estimated based on interest rates currently offered for deposits of similar remaining maturities.

The fair value of credit commitments are considered to be the same as the contractual amounts, and are not included in the table above. These commitments generate fees that approximate those currently charged to originate similar commitments.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	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 six months period ended June 30, 2020 and 2019. There were no common stock equivalents outstanding for the three and six months periods ended June 30, 2020 or 2019.

	Three Months Ended, June 30				Six Months Ended, June 30
	2020		2019		2020		2019

Net income	$	1,036,055	$	1,225,821	$	1,879,362	$	2,322,108

Weighted average shares outstanding		2,975,005		2,945,556		2,974,512		2,945,402

Earnings per share - basic and diluted	$	0.35	$	0.42	$	0.63	$	0.79

In September 2019, the Company’s Board of Directors declared a 75% stock dividend that was paid on October 31, 2019. Weighted average shares outstanding for the three and six months ended June 30, 2019 have been retroactively adjusted to reflect the stock dividend.

9.	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 $42,941 and $39,334 for the three months ended June 30, 2020 and 2019, respectively, and $109,590 and $87,988 for the six months ended June 30, 2020 and 2019, 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 $1,589 and $1,468 for the three months ended June 30, 2020 and 2019, respectively, and $3,178 and $2,936 for the six months ended June 30, 2019 and 2018, 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, including interest, of $51,300 and $30,600 for the three months ended June 30, 2020 and 2019, respectively, and 102,600 and $61,200 for the six months ended June 30, 2020 and 2019, respectively.

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

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, 2019 (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”).

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 (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.

On March 6, 2020, the Company, Anthem Acquisition Sub, a wholly-owned subsidiary of the Company (“Merger Sub”) and Carroll Bancorp, (“Carroll”), the parent company of Carroll Community Bank, a Maryland commercial bank (“Carroll Bank”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Merger Sub will be merged with and into Carroll, with Carroll as the surviving corporation, and, immediately thereafter, Carroll will be merged with and into the Company, with the Company as the surviving corporation (collectively, the “Merger”). The Merger Agreement, which has been approved by the boards of the Company, Merger Sub and Carroll, provides that the outstanding shares of Carroll’s common stock will be converted into the right to receive cash in the aggregate amount of $25 million, subject to a dollar-for-dollar reduction if and to the extent Carroll’s tangible book value prior to the closing does not equal or exceed $18,200,000. Immediately following the Merger, Carroll Bank will be merged with and into the Bank, with the Bank as the surviving insured depository institution (the “Bank Merger” and, together with the Merger, the “Merger Transactions”).

Our ability to consummate the Merger Transactions is subject to certain conditions, including, among others, the approval of the Merger by the stockholders of Carroll and the receipt of required regulatory approvals. We expect the Merger to close in the third quarter of 2020, but this date is subject to change. For additional information regarding the pending Merger, please see our Current Reports on Form 8-K filed with the SEC on March 6, 2020 and March 11, 2020.

You should keep in mind that discussions in this report that refer to the Company’s business, operations and risks in the future refer to the Company as a stand-alone entity, and that these considerations will be different with respect to the combined company after the closing of the Merger Transactions.

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, 2019, which were included in Item 8 of Part II of Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2019. 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.

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2019.

COVID-19 Pandemic

On March 11, 2020, the World Health Organization declared a pandemic as a result of the global spread of the coronavirus, commonly referred to as COVID-19. The spread of the disease quickly accelerated in the United States and to date, all 50 states have reported cases. The U.S. and state governments reacted to 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.

As a result of the pandemic affecting the states and local markets in which it operates, the Company successfully implemented its Pandemic Contingency Plan with the goal of protecting the health, safety and financial well-being of its associates and customers. As part of its plan to protect the financial well-being of its customers, the Company chose to participate and educate its customers on the government sponsored plans established to provide financial assistance to businesses.

Although states, including Maryland, have eased several of the COVID-19 restrictions, including stay-at-home orders and the required closure of non-essential businesses, there appears to be a resurgence of COVID-19 cases in many states, including Maryland. As a result, it is possible that states, including Maryland, will re-implement some or all of the COVID-19 related restrictions 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 provides small businesses with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses. Following the enactment of the CARES Act and the establishment of the PPP, we acted expeditiously to prepare our associates so they could guide our customers on the proper procedures necessary to enable them to take advantage of this program. We developed an SBA PPP specific information site within our website that provided detailed information, links and materials for eligible customers to access. Internally, we reallocated resources to review, process and data enter customer applications, working tirelessly over extended hours to provide access to as many local business owners as possible. We were able to fund 172 loan applications for approximately $25.3 million from the first tranche of PPP designated funds. Congress allocated additional funding to the PPP on April 23, 2020. Due to our advance preparation and software implementation, we were able to quickly gain approval for an additional 101 loan applications for approximately $5.8 million through June 30, 2020. In total, we have gained approval for over $31 million to 273 small businesses. Approximately 70% of the loans were under $100,000 in size. These loans are 100% guaranteed by the SBA, have up to a five-year maturity, provide for a six-month deferral period, 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 SBA also established processing fees from 1% to 5%, depending on the loan amount. We have received $1,285,719 in fees.

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, which were all subsequent to quarter end, have been to internal, non-interest-bearing accounts awaiting 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 $62,278,020 or 14.1% during the first half of 2020 to $504,493,118 at June 30, 2020 from $442,215,098 at December 31, 2019. The increase in total assets was due primarily to increases of $24,386,849 in loans, $17,872,278 in cash and cash equivalents and $16,646,540 in debt securities. The increase in loans was due primarily to the origination of the aforementioned PPP loans.

Total liabilities increased $60,165,479 or 15.3% during the first half of 2020 to $452,927,061 at June 30, 2020 from $392,761,582 at December 31, 2019. The increase was due primarily to a $54,547,786 increase in deposits and a $5,000,000 increase in FHLB advances. The increase in deposits was due to an inflow of funds from depositors who abandoned riskier investments for the safety of a bank and to the aforementioned PPP loans. The majority of PPP loans were made to existing customers, so the loan proceeds were deposited in checking accounts. In many cases, the customer has not withdrawn the PPP funds.

Stockholders’ equity increased by $2,112,541 during the first half of 2020 to $51,566,057 at June 30, 2020 from $49,453,516 at December 31, 2019. The increase was due primarily to net income for the period of $1,879,362 and an increase of $765,296 in accumulated other comprehensive income, offset by dividends paid, net of reinvestments of $532,117.

Loans

Major categories of loans at June 30, 2020 and December 31, 2019 are as follows:

	June 30,				December 31,
	2020				2019

Real estate:
Commercial	$	235,940,173	61	%	$	240,938,149	67	%
Construction/Land development		20,550,954	5	%		18,194,955	5	%
Residential		75,094,571	19	%		76,122,069	21	%
Commercial		56,272,588	15	%		26,947,503	7	%
Consumer		216,190	0	%		292,027	0	%
		388,074,476	100	%		362,494,703	100	%
Less: Allowance for loan losses		3,136,712				2,593,715
Deferred origination fees net of costs		1,168,072				518,145
	$	383,769,692			$	359,382,843

Loans increased by $24,386,849 or 6.8% to $383,769,692 at June 30, 2020 from $359,382,843 at December 31, 2019. The increase was due primarily to a $29,325,085 increase in commercial loans because of the origination of $31,112,843 of PPP loans, offset by a $4,997,976 decrease in commercial real estate loans. The allowance for loan losses increased $542,997 to $3,136,712 at June 30, 2020 from $2,593,715 at December 31, 2019.

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 June 30, 2020 and December 31, 2019, 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
June 30, 2020
Real estate:
Commerical	$	217,398	$	-	$	221,330	$	438,728	$	235,501,445	$	235,940,173	$	-
Construction/Land development		-		-		-		-		20,550,954		20,550,954		-
Residential		-		-		49,342		49,342		75,045,229		75,094,571		-
Commercial		-		-		-		-		56,272,588		56,272,588		-
Consumer		-		-		-		-		216,190		216,190		-

Total	$	217,398	$	-	$	270,672	$	488,070	$	387,586,406	$	388,074,476	$	-

					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, 2019
Real estate:
Commerical	$	224,794	$	-	$	-	$	224,794	$	240,713,355	$	240,938,149	$	-
Construction/Land development		-		-		-		-		18,194,955		18,194,955		-
Residential		59,892		-		-		59,892		76,062,177		76,122,069		-
Commercial		-		-		-		-		26,947,503		26,947,503		-
Consumer		-		-		-		-		292,027		292,027		-

Total	$	284,686	$	-	$	-	$	284,686	$	362,210,017	$	362,494,703	$	-

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 six 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.

At June 30, 2020, the Company had two nonaccrual loans to the same borrower. One is a commercial real estate loan with balance of $221,330 and the other is a residential real estate loan with a balance of $49,342. The loans were secured by real estate and business assets, and were personally guaranteed. Gross interest income of $6,294 would have been recorded for the three and six months ended June 30, 2020, respectively, if these nonaccrual loans had been current and performing in accordance with the original terms. Neither loan requires an allowance for loss.

At December 31, 2019 the Company had no nonaccrual loans.

Impaired loans as of June 30, 2020 and December 31, 2019 are set forth in the following table:

	June 30		December 31,
	2020		2019

Impaired loans with no valuation allowance	$	2,551,638	$	2,135,045
Impaired loans with a valuation allowance		-		-
Total impaired loans	$	2,551,638	$	2,135,045

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 June 30, 2020, the Company has modified loans having an aggregate principal balance of $109.2 million, or 30% of its loan portfolio. None of these loans were classified as TDRs as of June 30, 2020 because they met the criteria discussed above. Of these previously-deferred loans, borrowers owing a total of $27.8 million, or 8% of the Company’s loan portfolio, have requested additional three-month deferrals, which requests the Company is currently evaluating.

The Company continues to prudently work with borrowers that have been negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing appropriate allowance for loan losses on its loan portfolio. See Note 4 to the financial statements included elsewhere in this report for additional information.

	June 30,		December 31,
	2020		2019

Restructured loans (TDRs):
Performing as agreed	$	2,280,965	$	2,135,045
Not performing as agreed		49,342		-
Total TDRs	$	2,330,307	$	2,135,045

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.

The following table details activity in the allowance for loan losses by portfolio for the three and six months ended June 30, 2020 and 2019 and the year ended December 31, 2019. 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				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
June 30, 2020	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,763,861	$	396,409		$	-	$	44,962	$	2,205,232	$	-	$	2,205,232	$	2,502,296	$	233,437,877
Construction and land development		192,828		22,302			-		7,200		222,330		-		222,330		-		20,550,954
Residential		478,124		55,640			-		-		533,764		-		533,764		49,342		75,045,229
Commercial		107,782		(7,709	)		-		15,835		115,908		-		115,908		-		56,272,588
Consumer		4,133		(740	)		-		-		3,393		-		3,393		-		216,190
Unallocated		46,987		9,098			-		-		56,085		-		56,085		-		-
	$	2,593,715	$	475,000		$	-	$	67,997	$	3,136,712	$	-	$	3,136,712	$	2,551,638	$	385,522,838

												Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
June 30, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,754,372	$	(17,650	)	$	-	$	17,799	$	1,754,521	$	-	$	1,754,521	$	2,109,945	$	235,184,971
Construction and land development		196,374		(26,548	)		-		6,826		176,652		-		176,652		-		16,384,252
Residential		401,626		51,910			-		-		453,536		-		453,536		51,870		67,419,352
Commercial		102,610		(10,999	)		-		4,166		95,777		-		95,777		-		21,769,797
Consumer		10,428		(7,134	)		-		-		3,294		-		3,294		-		307,718
Unallocated		43,924		23,421			-		-		67,345		-		67,345		-		-
	$	2,509,334	$	13,000		$	-	$	28,791	$	2,551,125	$	-	$	2,551,125	$	2,161,815	$	341,066,090

												Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
December 31, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively

Real estate:
Commercial	$	1,754,372	$	(11,700	)	$	-	$	21,189	$	1,763,861	$	-	$	1,763,861	$	2,084,988	$	238,853,161
Construction and land development		196,374		(17,571	)		-		14,025		192,828		-		192,828		-		18,194,955
Residential		401,626		76,498			-		-		478,124		-		478,124		50,057		76,072,012
Commercial		102,610		(3,995	)		-		9,167		107,782		-		107,782		-		26,947,503
Consumer		10,428		(6,295	)		-		-		4,133		-		4,133		-		292,027
Unallocated		43,924		3,063			-		-		46,987		-		46,987		-		-
	$	2,509,334	$	40,000		$	-	$	44,381	$	2,593,715	$	-	$	2,593,715	$	2,135,045	$	360,359,658

The provision for loan losses was $475,000 for the six months ended June 30, 2020 and $13,000 for the six months ended June 30, 2019.

During the six months ended June 30, 2020 and 2019, the Company had no loan charge-offs. Recoveries from loans written off in prior periods totaled $67,997 and $28,791 for the six months ended June 30, 2020 and 2019, respectively.

As of June 30, 2020, the Company had $8,918,401 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, 2019, the Company had $9,264,380 of such loans. These loans are subject to ongoing management attention and their classifications are reviewed regularly.

Investment Securities

Investments in debt securities increased by $16,646,540 or 29.7% to $72,688,332 at June 30, 2020 from $56,041,792 at December 31, 2019. At June 30, 2020 and December 31, 2019, the Company had classified 70% and 65%, respectively, of the investment portfolio as available for sale. The balance of the portfolio was classified as held to maturity.

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 management 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 June 30, 2020 and December 31, 2019:

	June 30		December 31,
	2020		2019
Available for sale
State and municipal	$	5,433,846	$	512,670
SBA pools		1,905,723		2,151,797
Corporate Bonds		2,183,720		-
Mortgage-backed securities		41,072,682		33,867,307
	$	50,595,971	$	36,531,774

Held to maturity
State and municipal	$	22,092,361	$	19,510,018

The following table sets forth the scheduled maturities of investments in debt securities at June 30, 2020:

	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Within 1 year	$	4,905,802	$	4,907,351	$	255,419	$	256,673
Over 1 to 5 years		2,359,311		2,446,892		561,187		563,454
Over 5 to 10 years		250,000		263,323		3,224,596		3,315,629
Over 10 years		-		-		18,051,159		18,936,001
		7,515,113		7,617,566		22,092,361		23,071,757
SBA Pools		1,953,812		1,905,723		-		-
Mortgage-backed securities		40,012,405		41,072,682		-		-
	$	49,481,330	$	50,595,971	$	22,092,361	$	23,071,757

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

Other Real Estate Owned

The Bank owns one property in Cecil County, Maryland that was acquired through foreclosure in 2007 and is classified as other real estate owned (“OREO”). The Bank was required by statute to write this property down during 2019 to $0 due to the length of time that it has been held by the Bank. The property is under contract to be sold by the end of 2021.

Deposits

Total deposits increased by $54,547,786 or 14.5% to $431,161,100 at June 30, 2020 from $376,613,314 at December 31, 2019. The increase in deposits was due to an $18,908,434 increase in interest bearing checking accounts, a $2,613,525 increase in time deposits, a $2,952,483 increase in money market accounts, a $4,781,273 increase in savings accounts, and a $25,292,071 increase in noninterest-bearing accounts.

The following table shows the average balances and average costs of deposits for the six months ended June 30, 2020 and 2019:

	June 30, 2020					June 30, 2019
	Average					Average
	Balance		Cost			Balance		Cost
Noninterest bearing demand deposits	$	70,072,698		0.00	%	$	59,112,886		0.00	%
Interest bearing demand deposits		68,862,747		0.33	%		54,424,704		0.32	%
Savings and money market deposits		105,378,381		0.29	%		101,329,102		0.32	%
Time deposits		155,964,337		1.88	%		147,036,558		1.92	%
	$	400,278,163		0.87	%	$	361,903,250		0.92	%

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 $60.0 million under a secured line of credit with the FHLB. The Bank also has a facility with the Federal Reserve Bank of Richmond (the “Reserve Bank”) under which the Bank can borrow approximately $22.3 million. Finally, the Bank has an $18,500,000 ($9,500,000 unsecured and $9,000,000 secured) overnight federal funds line of credit available from two commercial banks. FHLB advances of $5,000,000 and $0 were outstanding as of June 30, 2020 and December 31, 2019, respectively. There were no borrowings from the Reserve Bank or our commercial bank lenders at June 30, 2020 and December 31, 2019. 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.

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:

	June 30,			December 31,
	2020			2019
Amount oustanding at period-end:
Securities sold under repurchase agreements	$	11,250,921		$	10,958,118
Federal Home Loan Bank advance matures on March 31, 2025		5,000,000			-
Weighted average rate paid at period-end:
Securites sold under repurchase agreements		1.48	%		1.49	%
Federal Home Loan Bank advances		1.00	%		0.00	%

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.

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”.

The following table presents actual and required capital ratios as of June 30, 2020 and December 31, 2019 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2020 and December 31, 2019, 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
						Capital Adequacy					To Be Well
(Dollars in thousands)	Actual					Phased In Schedule					Capitalized
June 30, 2020	Amount		Ratio			Amount		Ratio			Amount		Ratio

Total capital (to risk-weighted assets)	$	52,627		14.22	%	$	38,855		10.50	%	$	37,005		10.00	%
Tier 1 capital (to risk-weighted assets)		49,491		13.37	%		31,454		8.50	%		29,604		8.00	%
Common equity tier 1 (to risk- weighted assets)		49,491		13.37	%		25,903		7.00	%		24,053		6.50	%
Tier 1 leverage (to average assets)		49,491		10.11	%		19,585		4.00	%		24,481		5.00	%

December 31, 2019

Total capital (to risk-weighted assets)	$	51,274		13.88	%	$	38,775		10.50	%	$	36,928		10.00	%
Tier 1 capital (to risk-weighted assets)		48,681		13.18	%		31,389		8.50	%		29,543		8.00	%
Common equity tier 1 (to risk- weighted assets)		48,681		13.18	%		25,850		7.00	%		24,003		6.50	%
Tier 1 leverage (to average assets)		48,681		10.94	%		17,798		4.00	%		22,247		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 June 30, 2020 and December 31, 2019 are as follows:

	June 30,		December 31,
	2020		2019

Loan commitments
Construction and land development	$	3,090,500	$	1,322,275
Commercial		3,392,868		4,102,000
Commercial real estate		13,326,451		7,560,714
Residential		1,578,500		770,499
	$	21,388,319	$	13,755,488

Unused lines of credit
Home-equity lines	$	3,666,309	$	3,700,404
Commercial lines		19,897,523		22,229,095
	$	23,563,832	$	25,929,499

Letters of credit	$	2,179,399	$	1,935,613

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.

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 Six Months Ended June 30, 2020 and 2019

General

Net income for the six months ended June 30, 2020 was $1,879,362, compared to $2,322,108, for the same period of 2019. The decrease of $442,746 or 19.1% was due to a $443,834 increase in noninterest expenses and a $462,000 increase in the loan loss provision, offset by a $194,599 increase in noninterest income, a $175,192 increase in net interest income, and a $93,297 decrease in income taxes. Included in noninterest expense is $344,920 of one-time expenses incurred in connection with the pending acquisition of Carroll. Without these acquisition costs, net income would have been $2,129,369 for the six months ended June 30, 2020.

	Six Months Ended
	June 30, 2020						June 30, 2019
				Excluding
	As Reported			Acquisition Costs			As Reported

Income before taxes	$	2,262,849		$	2,607,769		$	2,798,892
Income taxes		383,487			478,400			476,784
Net income	$	1,879,362		$	2,129,369		$	2,322,108
Earnings per share	$	0.63		$	0.72		$	0.79
Return on average assets		0.80	%		0.91	%		1.09	%
Return on average equity		7.39	%		8.38	%		9.92	%

Net Interest Income

Net interest income, which is the difference between interest income on loans and investments and interest expense on deposits and borrowings, was $7,635,937 for the six months ended June 30, 2020, compared to $7,460,745 for the same period of 2019.

Total interest income for the six months ended June 30, 2020 was $9,465,264 compared to $9,206,992 for the same period of 2019, an increase of $258,272 or 2.8%.

Total interest income on loans for the six months ended June 30, 2020 increased by $383,600 when compared to the same period of 2019 due to a $32.5 million higher average loan balance for the first six months of 2020 when compared to the same period of 2019, offset by a lower loan yield of 4.65% for the first six months of 2020 versus 4.86% for the same period of 2019. Investment income for the first six months of 2020 increased by $22,223 or 3.2% when compared to the same period of 2019 due to a $11.4 million higher average investment balance, offset by a decrease in the fully-taxable equivalent yield to 2.72% for six months ended June 30, 2020 compared to 3.10% for the same period of 2019. Interest income on federal funds sold and other interest earning assets decreased $147,551 due to a decrease in the fully-taxable equivalent yield to 0.65% for the six months ended June 30, 2020 compared to 2.46% for the same period of 2019. The fully-taxable equivalent yield on total interest-earning assets decreased 31 basis points to 4.25% for the six months ended June 30, 2020 compared to 4.56% for the same period of 2019. The average balance of total interest-earning assets increased by $42.9 million to $450.8 million for the six months ended June 30, 2020 compared to $407.9 million for the same period of 2019.

Total interest expense for the six months ended June 30, 2020 was $1,829,327 compared to $1,746,247 for the same period of 2019, an increase of $83,080, or 4.8%. The increase was due to a $27.8 million increase in the average balance of interest-bearing liabilities to $343.2 million in the first six months of 2020 compared to $315.3 million in the same period of 2019, offset by a lower overall cost of funds on interest bearing deposits and borrowings of 1.07% for the six months ended June 30, 2020 compared to 1.11% for the same period of 2019. Cost of funds for time deposits decreased to 1.88% for the six months ended June 30, 2020 from 1.92% for the same period of 2019. Securities sold under repurchase agreements cost of funds increased to 1.50% for the first six months of 2020 from 1.22% for the first six months of 2019.

Average noninterest-earning assets increased by $1.0 million to $17.9 million in the first six months of 2020 compared to $16.9 million in the same period of 2019. Average noninterest-bearing deposits increased by $11.0 million to $70.1 million during the first six months of 2020 compared to $59.1 million in the same period of 2019. The average balance in stockholders’ equity increased by $4.0 million for the six months ended June 30, 2020, when compared with the same period of 2019.

In 2020, the FRB reduced the federal funds range to 0.00% to 0.25%. As a result, yields on loans and investments have decreased. Our cost of funds is lower than the same period of 2019 and will continue to decline as higher rate certificates of deposit mature and are replaced by lower rate certificates. Management will closely monitor its asset-liability position so that it can respond to any future changes in interest rates and/or changes to the Bank’s interest rate spread.

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 six-month periods ended June 30, 2020 and 2019. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Six Months Ended June 30, 2020							Six Months Ended June 30, 2019
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	375,105,468	$	8,715,921		4.65	%	$	342,577,230	$	8,332,321		4.86	%
Securities, taxable		39,914,284		434,268		2.18	%		31,125,759		400,257		2.57	%
Securities, tax exempt		20,159,139		381,238		3.78	%		17,527,615		353,545		4.03	%
Federal funds sold and other interest-earning assets		15,658,843		50,871		0.65	%		16,667,252		204,645		2.46	%
Total interest-earning assets		450,837,734		9,582,298		4.25	%		407,897,856		9,290,768		4.56	%
Noninterest-earning assets		17,930,373							16,889,429
Total assets	$	468,768,107						$	424,787,285

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	174,241,128		269,892		0.31	%	$	155,753,806		246,014		0.32	%
Certificates of deposit		155,964,337		1,468,771		1.88	%		147,036,558		1,414,763		1.92	%
Securities sold under repurchase agreements		10,386,558		77,690		1.50	%		8,809,262		53,722		1.22	%
FHLB advances and other borrowings		2,565,934		12,974		1.01	%		3,724,862		31,748		1.70	%
Total interest-bearing liabilities		343,157,957		1,829,327		1.07	%		315,324,488		1,746,247		1.11	%

Noninterest-bearing deposits		70,072,698							59,112,886
Noninterest-bearing liabilities		4,708,605							3,533,292
Total liabilities		417,939,260							377,970,666
Stockholders' equity		50,828,847							46,816,619
Total liabilities and stockholders' equity	$	468,768,107						$	424,787,285

Net interest income			$	7,752,971						$	7,544,521

Interest rate spread						3.18	%						3.45	%

Net yield on interest-earning assets						3.44	%						3.70	%

Ratio of average interest-earning assets to Average interest-bearing liabilities						131.38	%						129.36	%

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis.

Noninterest Income

Noninterest income for the six months ended June 30, 2020 was $910,228 compared to $715,629 for the same period of 2019, an increase of $194,599 or 27.2%. The increase was primarily a result of a $306,769 increase in mortgage banking income and a $210,150 lower write down of other real estate owned, offset by a $75,900 lower gain on the sale of SBA loans, $197,175 lower bank owned life insurance income, and $41,962 lower service charges on deposit accounts.

Noninterest Expense

Noninterest expense for the six months ended June 30, 2020 totaled $5,808,316 compared to $5,364,482 for the same period of 2019, an increase of $443,834 or 8.3%. The increase was due primarily to costs incurred related to the pending acquisition of Carroll of $344,920 and an increase in salaries and benefits of $125,852, offset by a decrease in occupancy of $36,417.

Income Tax Expense

Income tax expense for the six months ended June 30, 2020 was $383,487 compared to $476,784 for the same period of 2019. The effective tax rate was 17.0% for the six months ended June 30, 2020 and 2019.

Comparison of Operating Results for the Three Months Ended June 30, 2020 and 2019

Net income for the three months ended June 30, 2020 was $1,036,055 compared to $1,225,821 for the same period of 2019. The decrease of $189,766 or 15.5% was due to a $350,000 increase in the provision for loan losses, a $252,807 increase in noninterest expense, and a $7,763 increase in income taxes, offset by a $135,811 increase in net interest income and a $284,993 increase in noninterest income. Included in noninterest expense are one-time expenses of $165,096 incurred in connection with the pending acquisition of Carroll. Without these acquisition costs, net income would have been $1,155,721 for the three months ended June 30, 2020.

	Three Months Ended
	June 30, 2020						June 30, 2019
				Excluding
	As Reported			Acquisition Costs			As Reported

Income before taxes	$	1,266,626		$	1,431,722		$	1,448,629
Income taxes		230,571			276,001			222,808
Net income	$	1,036,055		$	1,155,721		$	1,225,821
Earnings per share	$	0.35		$	0.39		$	0.42
Return on average assets		0.85	%		0.94	%		1.14	%
Return on average equity		8.05	%		8.98	%		10.34	%

Net Interest Income

Net interest income was $3,870,403 for the three months ended June 30, 2020 compared to $3,734,592 for the same period of 2019.

Total interest income for the three months ended June 30, 2020 was $4,755,228 compared to $4,659,456 for the same period of 2019, an increase of $95,772 or 2.1%.

Total interest income on loans for the three months ended June 30, 2020 increased by $221,032 when compared to the same period of 2019 due to a $44.5 million higher average loan balance for the three months ended June 30, 2020 when compared to the same period of 2019, offset by a lower loan yield of 4.56% for the three months ended June 30, 2020 versus 4.89% for the same period of 2019. Investment income for the three months ended June 30, 2020 decreased by $19,443 or 5.3% when compared to the same period of 2019 due to a decrease in the fully-taxable equivalent yield to 2.15% for three months ended June 30, 2020 compared to 3.07% for the same period of 2019, offset by a $12.1 million higher average investment balance. Interest income on federal funds sold and other interest earning assets decreased $105,817 due to a decrease in the fully-taxable equivalent yield to 0.29% for the three months ended June 30, 2020 compared to 2.46% for the same period of 2019. The fully-taxable equivalent yield on total interest-earning assets was 4.03% for the three months ended June 30, 2020 compared to 4.54% for the same period in 2019. The average balance of total interest-earning assets increased by $57.6 million to $471.7 million for the three months ended June 30, 2020 compared to $414.1 million for the same period of 2019.

Total interest expense for the three months ended June 30, 2020 was $884,825, compared to $924,864 for the same period of 2019, a decrease of $40,039 or 4.3%. The decrease was due to a lower overall cost of funds of 1.00% for the three months ended June 30, 2020 compared to 1.16% for the same period of 2019, offset by a $33.3 million increase in the average balance of interest-bearing liabilities to $353.3 million for the three months ended June 30, 2020 compared to $320.0 million in the same period of 2019. Cost of funds for time deposits decreased to 1.78% for the three months ended June 30, 2020 from 2.01% for the same period of 2019. Securities sold under repurchase agreements cost of funds increased to 1.52% for the three months ended June 30, 2020 from 1.30% for the same period of 2019.

Average noninterest-earning assets increased by $0.3 million to $18.1 million for the three months ended June 30, 2020 compared to $17.8 million in the same period of 2019. Average noninterest-bearing deposits increased by $20.1 million to $80.2 million during the three months ended June 30, 2020, compared to $60.1 million in the same period of 2019. The average balance in stockholders’ equity increased by $4.1 million for the three months ended June 30, 2020 when compared with the same period of 2019.

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 June 30, 2020 and 2019. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Three Months Ended June 30, 2020							Three Months Ended June 30, 2019
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	385,504,008	$	4,393,267		4.56	%	$	340,980,519	$	4,172,235		4.89	%
Securities, taxable		42,130,062		191,255		1.82	%		34,539,984		223,841		2.59	%
Securities, tax exempt		22,294,431		154,699		2.78	%		17,764,788		178,155		4.01	%
Federal funds sold and other interest-earning assets		21,732,471		16,007		0.29	%		20,789,593		127,673		2.46	%
Total interest-earning assets		471,660,972		4,755,228		4.03	%		414,074,884		4,701,904		4.54	%
Noninterest-earning assets		18,145,977							17,838,442
Total assets	$	489,806,949						$	431,913,326

Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	182,463,181		142,326		0.31	%	$	157,687,814		127,566		0.32	%
Certificates of deposit		155,435,092		690,138		1.78	%		150,529,889		757,680		2.01	%
Securities sold under repurchase agreements		10,381,347		39,496		1.52	%		8,773,073		28,423		1.30	%
FHLB advances and other borrowings		5,000,000		12,865		1.03	%		3,000,000		11,195		1.49	%
Total interest-bearing liabilities		353,279,620		884,825		1.00	%		319,990,776		924,864		1.16	%

Noninterest-bearing deposits		80,162,475							60,106,687
Noninterest-bearing liabilities		4,880,166							4,407,313
Total liabilities		438,322,261							384,504,776
Stockholders' equity		51,484,688							47,408,550
Total liabilities and stockholders' equity	$	489,806,949						$	431,913,326

Net interest income			$	3,870,403						$	3,777,040

Interest rate spread						3.03	%						3.39	%

Net yield on interest-earning assets						3.28	%						3.65	%

Ratio of average interest-earning assets to Average interest-bearing liabilities						133.51	%						129.40	%

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis.

Noninterest Income

Noninterest income for the three months ended June 30, 2020 was $608,226 compared to $323,233 for the same period of 2019, an increase of $284,993 or 88.2%. The increase was primarily a result of an increase in mortgage banking revenue of $277,231, a $54,115 increase in the gain on sale of SBA loans, and a $210,150 lower write down of other real estate owned, offset by a $198,801 decrease in bank owned life insurance income and a $48,457 decrease in service charges on deposit accounts.

Noninterest Expense

Noninterest expenses for the three months ended June 30, 2020 totaled $2,862,003 compared to $2,609,196 for the same period of 2019, an increase of $252,807 or 9.7%. The increase was due primarily to costs incurred related to the pending acquisition of Carroll of $165,096, increases in salaries and benefits of $32,576, and an increase in other expenses of $50,405.

Income Tax Expense

Income tax expense for the three months ended June 30, 2020 was $230,571 compared to $222,808 for the same period of 2019. The effective tax rate was 18.2% for the three months ended June 30, 2020, compared to 15.4% for the same period of 2019. The increase in the effective tax rate were due to a lower percentage of tax exempt revenue for the three months ended June 30, 2020 when compared to the same period in 2019.

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, 2019. Management believes that no material changes in market risk or our procedures used to evaluate and mitigate these risks have occurred since December 31, 2019.

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 June 30, 2020 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 June 30, 2020, 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.

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 and in Item 1A of Part II of Farmers and Merchants Bancshares, Inc.’s Quarter Report on Form 10-Q for the quarter ended March 31, 2020. 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

None.

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)

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: August 7, 2020	/s/ James R. Bosley, Jr.
	James R. Bosley, Jr.
	President and Chief Executive Officer
	(Principal Executive Officer)


Date August 7, 2020	/s/ Mark C. Krebs
	Mark C. Krebs, Treasurer and Chief Financial Officer
	(Principal Financial Officer & Principal Accounting Officer)

Farmers & Merchants Bancshares, Inc. - FORM 10-Q - August 7, 2020

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