Farmers & Merchants Bancorp (FMCB or the Company) (OTC:FMCB) is a bank holding company headquartered in Lodi, California, with $5.4 billion in total assets at September 30, 2023. FMCB is primarily a small-medium-sized business lender with 29 branch offices and 3 stand-alone ATMS, serving a compact area in Central California, as shown in the map at right. Its service areas include the counties of Sacramento, San Joaquin, Solano, Stanislaus, and Merced, as well as the east region of the San Francisco Bay area, including the counties of Napa, Alameda, and Contra Costa. The Company conducts its activities through its wholly-owned banking subsidiary, Farmers & Merchants Bank of Central California (F & M Bank or the Bank), which was begun in 1916, and has a long history and strong ties with the communities it serves.
FMCB’s specialty is agricultural lending, with which it has been engaged for over 100 years. The Company is the 14th largest agricultural lender in the United States and the largest agricultural lender west of the Rocky Mountains. The geographic region in which FMCB operates is characterized by Delta-rich bottomland and fed by streams and rivers from the run-off of the Sierra Mountains. The agricultural loan book is dominated by lending to orchards, such as apples, cherries, and walnuts (33% of the ag portfolio), dairy (16%), wine grapes (14%), mixed use (17%), leasing and equipment (10%), and other (10%).
The Company typically does not pursue acquisitions, favoring de novo growth though it has made several smaller strategic acquisitions to improve geographic diversification and expand into the East Bay area of San Francisco, which the Company believes is an attractive growth market, particularly as trade develops in East Asia. In 2016, FMCB acquired Delta National Bancorp for $7 million, expanding into both Manteca and Riverbank. During 2018, the Company completed the $27 million acquisition of Bank of Rio Vista, gaining entry into both Rio Vista and Walnut Grove, and enhancing its market share in Lodi. In January 2018, the Company opened a loan production office in Napa, California, which was converted to a full-service branch in the third quarter of 2018.
FMCB emphasizes steady profitable growth, using several key metrics as a goal: to improve earnings per share (EPS) and return on average equity (ROE) on a trailing twelve months’ basis, as well as to grow dividends and increase shareholder ownership percentages through its stock buyback program. Its track record has been impressive. Over the last four years since 2018, EPS has grown at a 14% compound annual growth rate (CAGR) and ROE has averaged 15.4%, while the return on assets (ROA) has averaged 1.45%. Results in 2023 have been even more noteworthy, with FMCB reporting record nine-month net income of $66.9 million (up 22% year over year), a 1.70% ROA, and a 17.4% ROE.
While the dividend grew at only a 4% CAGR since and is well below the 14% EPS growth rate, we note that FMCB has paid a dividend in each of the last 88 years and has grown the dividend for 58 consecutive years. Based upon this record, FMCB was ranked 15th out of 50 public companies to be considered a “Dividend King.” A “Dividend King” is a company that's grown its dividend payment for at least 50 consecutive years.
FMCB’s loan portfolio has a concentration in commercial real estate, accounting for 37% of total loans, as shown on the chart at right. The rest of the lending book consists of agricultural real estate (21% of total gross loans), commercial and industrial (14%), residential and home equity real estate (11%) construction real estate (5%), agricultural (8%), and commercial leases (4%). About 75% of loans are secured, usually by real estate, inventory, accounts receivable, equipment, machinery, or other corporate assets (e.g., crops or livestock), though the primary source of repayment is cash flow. Positively, the Company has minimal exposure to commercial office buildings, as this sector is currently experiencing economic weakness. Approximately 60% of the loan portfolio is fixed rate. The remaining 40% have floating rates, which are tied to the prime rate, resetting when the prime rates change, and also have interest rate floors that protect against downside risk should rates drop dramatically.
Asset quality is exceptionally robust. For the latest five years, net charge-offs as a percent of average loans averaged a nominal 0.01%, while allowance for credit losses averaged 1.98% of yearend loans and were even stronger at 2.08% of loans at September 30, 2023. Nonperforming assets (which include nonperforming loans, troubled debt restructurings that are current in payments, and foreclosed assets) as a percent of loans and foreclosed assets averaged a low 0.30% over five years and were covered by the allowance for loan losses at 11.5X. For the quarter ended September 30, 2023, these figures improved to 0.15% and 13.8X, respectively.
The reasons behind FMCB’s stellar asset quality are severalfold. First and foremost is the Company’s operating philosophy. The Company stresses relationship banking focusing on providing a suite of financial products to long-time customers (sometimes extending back generations) rather than a transactional approach. Moreover, its customers tend to be well-established, middle-market companies with solid financial profiles. Importantly, FMCB does not buy loan participations or shared national credits based upon the underwriting standards of other banks. FMCB also does not chase yield, preferring to ignore business rather than chase that extra 10 basis points of yield on a loan that could cause problems in the future.
In addition, loan underwriting is done in the local offices by experienced loan officers who know their customers well. Approval for loans is centralized at headquarters in Lodi by the loan committee, which meets weekly. The loan committee consists of senior credit officials at FMCB and also sets client and industry lending limits. Moreover, the Board of Directors also gets involved and must approve loans over a certain pre-established limit.
The Company has two primary sources of liquidity that can be used during periods of economic stress: on-balance-sheet liquidity and off-balance-sheet liquidity, such as secured and unsecured lines of credit. At September 30, 2023, liquid assets (consisting of cash and equivalents plus US Treasuries/US Agency mortgage securities in the available-for-sale investment securities portfolio) accounted for 14% of total assets. Importantly, a large portion of FMCB’s liquid assets is cash and equivalents, typically accounting for a hefty 11-12% of total assets. As measured against purchased funds (composed of confidence-sensitive financing, such as deposits greater than $250,000, foreign deposits, trading account liabilities, commercial paper, federal funds purchased, and repurchase agreements), liquid assets represented a comfortable 244% of purchased funds at the end of 2023’s third quarter. On the funding side, the majority of funding comes from the Company’s deposit base. Core deposits, which equal total deposits less foreign deposits, brokered deposits, and certificates of deposit over $250,000, have been increasing over the last few years, growing at a 13.0% CAGR in the four years since 2018 and cover a solid 125% of loans at September 30, 2023. Notably, FMCB does not use brokered deposits or short-term borrowings.
As to off-balance-sheet liquidity, FMCB has $2.2 billion in lines of credit (carrying 5.50-5.70% interest rates), primarily with the FHLB and Federal Reserve, with advances on the credit lines collateralized by $2.9 billion in loans and securities. At September 30, 2023, there were no advances under these lines.
As to long-term debt, the Company has one long-term debt issue outstanding: $10.3 million of junior subordinated notes due on December 17, 2033 that were issued with proceeds from the sale of a similar amount of trust preferred securities, which count as Tier 1 capital.
FMCB attempts to match fund maturities of assets and liabilities in order to minimize interest-rate risk. Though FMCB attempts to remain interest rate neutral, we note that FMCB’s balance sheet is currently asset sensitive by about $1.1 billion over the near term. This means that a greater proportion of assets reprice or mature within the next year as compared to liabilities. Given the recent rise in interest rates and expectations for this to continue over the short term, this is having the continuing effect of boosting net interest margins. However, any rapid drop in interest rates (which is currently not expected), would have the opposite effect, squeezing net interest margins and hurting profitability.
FMCB and its subsidiary bank, F&M Bank, are considered well capitalized, the highest rating possible under the FDIC's four-risk category rating system, as shown in the following table. Under the FDIC's risk-based capital guidelines, different categories of assets (including certain off-balance sheet items) are assigned different risk weights, based on the credit risk of the asset. These risk-weighted assets are added together to derive the risk weight of the entire asset base and then measured against Tier 1 and Total capital to determine capital adequacy.
We note that in 2021 FMCB strategically changed the classification of the majority of its investment securities portfolio to held-to-maturity (HTM—carried at amortized cost) from available-for-sale (AFS—carried at fair market value). This allows FMCB to exclude unrealized losses on its HTM investment securities portfolio from shareholders’ equity as long as it does not sell. However, should FMCB sell any HTM securities (which are mostly AAA-rated U.S. government-backed mortgage bonds), it must reclassify all of its HTM securities as available for sale and potentially realize big losses on securities not sold. Unrealized losses on the HTM investment securities portfolio developed due to the rapid rise in interest rates over the last year or so, depressing prices of the HTM securities. As of September 30, 2023, FMCB had unrealized losses on its HTM investment securities portfolio of $189 million, representing about 36% of total shareholders’ equity.
The majority of the Company’s net revenue stream derives from net interest income, which typically accounts for roughly 90% of total net revenues. In 2022, net interest income contributed 92% of net revenue (as shown in the chart at right), with card processing at 4%, other at 3%, and service charges on deposit accounts at 1%. Net interest income has grown at a CAGR of 11.4% over the four years since 2018, largely due to growth in average interest-earning assets, which have increased at a 14.5% CAGR. The net interest margin has been somewhat volatile, though has remained in a solid 3.46%-4.32% range from 2018 through 2022, and has improved to a 4.20%-4.53% range in 2023 to date. This increase was driven by a mismatch in FMCB’s asset/liability structure and occurred despite steadily rising interest expense in 2023, the result of higher deposit costs.
The provision for credit losses is typically fairly low, and averaged about 9 basis points of average assets over the 2018-2022 period. This has increased in 2023 to a still-minimal 20 basis points of average assets, due to FMCB’s general concerns about the economy. We note that on January 1, 2022, FMCB adopted the Financial Accounting Standards Board’s Current Expected Credit Loss (CECL) impairment standard, which requires “life-of-loan” estimates of losses to be recorded for unimpaired loans. Adoption of CECL did not have a material impact on loss provisions or earnings when adopted, but will likely affect credit loss provisions going forward.
As to expenses, the largest contributor to the Company’s expense base is compensation, accounting for approximately two-thirds of total noninterest expense. Despite this, compensation costs have been well controlled, rising at a CAGR of 6.4%, well below the 9.2% CAGR of the Company’s net revenues. This has contributed to an improving efficiency ratio, which has dropped from 53% in 2018 to 44% in 2022 and 43% in 2023’s third quarter.
As a result, net income has grown at a CAGR of 13.3%, 90 basis points less than the 14.2% CAGR of diluted earnings per share (EPS). This is due to the Company’s share repurchases, which have reduced shares outstanding by almost 5% since the end of 2019. FMCB just extended its existing share buyback program, authorizing an additional $25 million of share repurchases through December 31, 2024.
FMCB has increased its annual dividend payment every year since 1965. The semiannual dividend was just boosted 6% from $8.30 per share to $8.80 per share ($17.60 per share annually) and provides a 1.88% yield. The Company has maintained the dividend throughout periods of financial turmoil, as a demonstration of good faith in its financial strength and future prospects. We expect this to continue.
In conclusion, FMCB is a conservatively managed bank that has a demonstrated track record of strong growth and profitability and is intent upon maximizing shareholder value. The balance sheet is strong, with excellent levels of liquidity, solid core deposit funding with no brokered deposits, no short-term borrowings, and a robust capital position. Our main quibbles with FMCB are: (1) growth in the dividend, with the payout ratio decreasing to 17% in 2022 from 24% in 2018 and (2) the mismatch in FMCB’s asset/liability structure, which could hurt profitability should interest rates drop suddenly.
The stock trades at $936.00 in a 52-week range of $932.00-$1088.00. Liquidity is on the thin side, reflecting the fact that there are about 1,500 shareholders, many of whom are employees or customers of FMCB. The P/E ratio based on trailing twelve months’ earnings is 8.2X, which seems reasonable though it is above the 7.9X median of our small-cap bank universe. Price to tangible book value is 1.36X, well above the 0.84X median of our small-cap bank universe. By that measure, FMCB appears fully valued.
INCOME STATEMENT & BALANCE SHEET FINANCIAL DATA
SUBSCRIBE TO ZACKS SMALL CAP RESEARCH to receive our articles and reports emailed directly to you each morning. Please visit our website for additional information on Zacks SCR.
DISCLOSURE: Zacks SCR has received compensation from the issuer directly, from an investment manager, or from an investor relations consulting firm, engaged by the issuer, for providing research coverage for a period of no less than one year. Research articles, as seen here, are part of the service Zacks SCR provides and Zacks SCR receives quarterly payments totaling a maximum fee of up to $40,000 annually for these services provided to or regarding the issuer. Full Disclaimer HERE.
