Equibles

10-Q

Farmers & Merchants Bancshares, Inc. (FMFG)

10-Q 2023-11-14 For: 2023-09-30
View Original
Added on April 06, 2026

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended September 30, 2023

☐ 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<br> incorporation or organization) (I. R. S. Employer Identification No.)

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

(Address of principal executive offices)          (Zip Code)

(410) 374-1510

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐

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

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

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

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

Yes ☐ No ☑

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,092,368 as of November 13, 2023.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Table of Contents

Page
PART I – FINANCIAL INFORMATION 3
Item 1.  Financial Statements 3
Consolidated balance sheets at September 30, 2023 (unaudited) and December 31, 2022 3
Consolidated statements of income (unaudited) for the three and nine months ended  September 30, 2023 and 2022 4
Consolidated statements of comprehensive income (loss) (unaudited) for the three and nine months ended September 30, 2023 and 2022 5
Consolidated statements of changes in stockholders’ equity (unaudited) for the three and nine months ended September 30, 2023 and 2022 6
Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2023 and 2022 7
Notes to financial statements (unaudited) 9
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations 37
Item 3.  Quantitative and Qualitative Disclosures About Market Risk 49
Item 4.  Controls and Procedures 49
PART II – OTHER INFORMATION 50
Item 1.  Legal Proceedings 50
Item 1A.  Risk Factors 50
Item 2.  Unregistered Sales of Equity Securities, Use of Proceeds, and Issuer Purchases of Equity Securities 50
Item 3.  Defaults upon Senior Securities 50
Item 4.  Mine Safety Disclosures 50
Item 5.  Other Information 50
Item 6.  Exhibits 50
SIGNATURES 51

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

December 31,*
2022
Assets
Cash and due from banks 23,474,989 $ 6,414,822
Federal funds sold and other interest-bearing deposits 1,536,689 848,715
Cash and cash equivalents 25,011,678 7,263,537
Certificates of deposit in other banks 100,000 100,000
Securities available for sale, at fair value 136,563,220 126,314,449
Securities held to maturity, at amortized cost less allowance for credit losses of 92,045 and 0 20,134,028 20,508,997
Equity security, at fair value 482,907 489,145
Restricted stock, at cost 863,500 1,332,500
Mortgage loans held for sale - 428,355
Loans, less allowance for credit losses of 4,516,402 and 4,150,198 526,133,041 516,920,540
Premises and equipment, net 6,093,372 6,186,594
Accrued interest receivable 2,018,786 1,815,784
Deferred income taxes, net 9,901,701 8,392,658
Other real estate owned, net 1,242,365 1,242,365
Bank owned life insurance 14,846,937 14,585,342
Goodwill and other intangibles, net 7,036,506 7,042,752
Other assets 6,209,726 5,587,654
756,637,767 $ 718,210,672
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing 113,326,966 $ 126,695,349
Interest-bearing 530,935,768 496,915,775
Total deposits 644,262,734 623,611,124
Securities sold under repurchase agreements 5,357,674 5,175,303
Federal Home Loan Bank of Atlanta advances 5,000,000 20,000,000
Federal Reserve Bank advances 33,000,000 -
Long-term debt, net of issuance costs 13,683,195 15,095,642
Accrued interest payable 1,491,099 349,910
Other liabilities 5,581,129 6,203,730
708,375,831 670,435,709
Stockholders' equity
Common stock, par value .01 per share, authorized 5,000,000 shares; issued and outstanding 3,092,368 shares in 2023 and 3,071,214 in 2022 30,924 30,712
Additional paid-in capital 29,979,718 29,549,914
Retained earnings 38,940,539 35,300,166
Accumulated other comprehensive loss (20,689,245 ) (17,105,829 )
48,261,936 47,774,963
756,637,767 $ 718,210,672

All values are in US Dollars.

* Derived from audited consolidated financial statements

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

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

Three months ended Nine months ended
September 30, September 30,
2023 2022 2023 2022
Interest income **** **** **** **** **** **** **** **** **** **** **** ****
Loans, including fees $ 6,609,039 $ 5,606,913 $ 19,023,308 $ 16,660,625
Investment securities - taxable 996,586 783,606 2,528,793 2,170,154
Investment securities - tax exempt 137,254 140,185 416,626 430,495
Federal funds sold and other interest earning assets 258,818 55,361 469,721 89,663
Total interest income 8,001,697 6,586,065 22,438,448 19,350,937
Interest expense **** **** **** **** **** **** **** **** **** **** **** ****
Deposits 2,239,808 313,556 5,010,624 971,320
Securities sold under repurchase agreements 12,110 2,874 23,949 8,558
Federal Home Loan Bank advances 39,289 12,727 452,272 37,765
Federal Reserve Bank advances 378,500 - 391,763 -
Long-term debt 145,001 165,156 444,953 505,268
Total interest expense 2,814,708 494,313 6,323,561 1,522,911
Net interest income 5,186,989 6,091,752 16,114,887 17,828,026
(Recovery of) provision for credit losses (75,000 ) 95,000 (570,000 ) 95,000
Net interest income after (recovery of) provision for credit losses 5,261,989 5,996,752 16,684,887 17,733,026
Noninterest income **** **** **** **** **** **** **** **** **** **** **** ****
Service charges on deposit accounts 195,566 201,251 586,999 574,444
Mortgage banking income 33,585 8,155 92,514 195,829
Bank owned life insurance income 89,748 70,479 261,595 179,735
Fair value adjustment on equity security (13,769 ) (17,611 ) (15,343 ) (62,524 )
Gain on sale of SBA loans - - - 158,123
Other fees and commissions 78,096 75,211 243,125 229,326
Total noninterest income 383,226 337,485 1,168,890 1,274,933
Noninterest expense **** **** **** **** **** **** **** **** **** **** **** ****
Salaries 1,916,804 1,987,991 5,643,742 5,656,643
Employee benefits 348,048 418,422 1,483,278 1,367,829
Occupancy 229,135 229,273 645,398 670,938
Furniture and equipment 246,896 203,075 739,547 642,283
Other 1,005,065 945,930 2,677,065 2,815,182
Total noninterest expense 3,745,948 3,784,691 11,189,030 11,152,875
Income before income taxes 1,899,267 2,549,546 6,664,747 7,855,084
Income taxes 467,128 575,236 1,661,640 1,779,239
Net income $ 1,432,139 $ 1,974,310 $ 5,003,107 $ 6,075,845
Earnings per share - basic and diluted $ 0.46 $ 0.65 $ 1.63 $ 2.00

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

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

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

Three Months Ended Nine Months Ended
September 30, September 30,
2023 2022 2023 2022
Net income $ 1,432,139 $ 1,974,310 $ 5,003,107 $ 6,075,845
Other comprehensive loss, net of income taxes:
Securities available for sale
Net unrealized loss arising during the period (4,197,837 ) (5,960,588 ) (4,943,835 ) (22,423,388 )
Total unrealized loss on investment securities available for sale (4,197,837 ) (5,960,588 ) (4,943,835 ) (22,423,388 )
Income tax benefit 1,155,140 1,640,205 1,360,419 6,170,356
Total other comprehensive loss (3,042,697 ) (4,320,383 ) (3,583,416 ) (16,253,032 )
Total comprehensive (loss) income $ (1,610,558 ) $ (2,346,073 ) $ 1,419,691 $ (10,177,187 )

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

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three and Nine months Ended September 30, 2023 and 2022

(Unaudited)

Additional Accumulated other Total
paid-in Retained comprehensive stockholders'
Par value capital earnings income (loss) equity
Three months ended September 30, 2022 **** **** **** **** **** **** **** **** **** **** **** **** **** ****
Balance, June 30, 2022 3,053,487 $ 30,535 $ 29,197,475 $ 32,288,555 $ (13,327,585 ) $ 48,188,980
Net income - - - 1,974,310 - 1,974,310
Other comprehensive loss - - - - (4,320,383 ) (4,320,383 )
Dividends reinvested - - (135 ) 136 - 1
Balance, September 30, 2022 3,053,487 $ 30,535 $ 29,197,340 $ 34,263,001 $ (17,647,968 ) $ 45,842,908
Nine months ended September 30, 2022 **** **** **** **** **** **** **** **** **** **** **** **** **** ****
Balance, December 31, 2021 3,037,137 $ 30,372 $ 28,857,422 $ 29,128,600 $ (1,394,936 ) $ 56,621,458
Net income - - - 6,075,845 - 6,075,845
Other comprehensive loss - - - - (16,253,032 ) (16,253,032 )
Cash dividends, 0.31 per share - - - (941,444 ) - (941,444 )
Dividends reinvested 16,350 163 339,918 - - 340,081
Balance, September 30, 2022 3,053,487 $ 30,535 $ 29,197,340 $ 34,263,001 $ (17,647,968 ) $ 45,842,908
Three months ended September 30, 2023 **** **** **** **** **** **** **** **** **** **** **** **** **** ****
Balance, June 30, 2023 3,090,368 $ 30,904 $ 29,941,488 $ 37,508,400 $ (17,646,548 ) $ 49,834,244
Net income - - - 1,432,139 - 1,432,139
Other comprehensive loss - - - - (3,042,697 ) (3,042,697 )
Stock-based compensation 2,000 20 38,230 - - 38,250
Balance, September 30, 2023 3,092,368 $ 30,924 $ 29,979,718 $ 38,940,539 $ (20,689,245 ) $ 48,261,936
Nine months ended September 30, 2023 **** **** **** **** **** **** **** **** **** **** **** **** **** ****
Balance, December 31, 2022 3,071,214 $ 30,712 $ 29,549,914 $ 35,300,166 $ (17,105,829 ) $ 47,774,963
Net income - - - 5,003,107 - 5,003,107
Other comprehensive loss - - - - (3,583,416 ) (3,583,416 )
Stock-based compensation 2,000 20 38,230 - - 38,250
Cash dividends, 0.31 per share - - - (1,013,499 ) - (1,013,499 )
Reclassification due to the adoption of ASU 2016-13 - - - (341,392 ) - (341,392 )
Dividends reinvested 19,154 192 391,574 (7,843 ) - 383,923
Balance, September 30, 2023 3,092,368 $ 30,924 $ 29,979,718 $ 38,940,539 $ (20,689,245 ) $ 48,261,936

All values are in US Dollars.

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

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Nine Months Ended September 30, 2023 2022
Reconciliation of net income to net cash provided by operating activities **** **** **** **** **** ****
Net income $ 5,003,107 $ 6,075,845
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 382,691 354,814
(Recovery of) provision for credit losses (570,000 ) 95,000
(Accretion) amortization of right of use asset (3,920 ) 4,412
Equity security dividends reinvested (9,105 ) (5,156 )
Unrealized loss on equity security 15,343 62,524
Gain on sale of SBA loans - (158,123 )
Gain on sale of premises and equipment (9,000 ) -
Gain on fair value hedge (28,133 ) -
Stock based compensation 38,250 -
Amortization of debt issuance costs 4,219 4,218
Amortization of premiums and (accretion of discounts), net (82,391 ) (237,876 )
Bank owned life insurance cash surrender value (261,595 ) (179,735 )
Increase (decrease) in
Deferred loan fees and costs, net (7,148 ) (136,377 )
Accrued interest payable 1,141,189 (35,644 )
Other liabilities (702,985 ) 228,072
Decrease (increase) in
Mortgage loans held for sale 428,355 (243,500 )
Accrued interest receivable (203,002 ) 8,681
Other assets (52,244 ) (433,594 )
Net cash provided by operating activities 5,083,631 5,403,561

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

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Nine Months Ended September 30, 2023 2022
Cash flows from investing activities **** **** **** **** **** ****
Proceeds from maturity and call of securities
Available for sale 9,033,423 15,121,772
Held to maturity 373,420 1,398,420
Purchase of securities
Available for sale (24,888,256 ) (17,278,216 )
Purchases of certificates of deposit - 250,000
Loans made to customers, net of principal collected (8,927,917 ) (24,044,676 )
Proceeds from sale of loans - 1,250,154
Redemption (purchase) of stock in FHLB of Atlanta 469,000 (19,600 )
Purchase of bank owned life insurance - (2,800,000 )
Proceeds from sale of premises and equipment 9,000 -
Purchases of premises, equipment and software (256,735 ) (384,873 )
Net cash used in investing activities (24,188,065 ) (26,507,019 )
Cash flows from financing activities **** **** **** **** **** ****
Net increase (decrease) in
Noninterest-bearing deposits (13,368,383 ) 7,094,065
Interest-bearing deposits 34,084,829 5,588,443
Securities sold under repurchase agreements 182,371 8,616
Federal Home Loan Bank of Atlanta advances - -
Federal Reserve Bank advances 33,000,000 -
Federal Home Loan Bank of Atlanta advances (15,000,000 ) -
Long-term debt principal payments (1,416,666 ) (1,416,665 )
Dividends paid, net of reinvestments (629,576 ) (601,363 )
Net cash provided by financing activities 36,852,575 10,673,096
Net (decrease) increase in cash and cash equivalents 17,748,141 (10,430,362 )
Cash and cash equivalents at beginning of period 7,263,537 26,462,106
Cash and cash equivalents at end of period $ 25,011,678 $ 16,031,744
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 5,236,743 $ 1,675,435
Cash paid during the period for income taxes 1,850,848 2,531,122
Supplemental disclosure of non-cash transactions:
Net unrealized loss on securities available for sale (5,614,156 ) (22,423,388 )

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

  • 8 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

1. Principles of consolidation

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

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 (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods have been made. Such adjustments were normal and recurring in nature. The results of operations for the three- and nine-month periods ended September 30, 2023 do not necessarily reflect the results that may be expected for the fiscal year ending December 31, 2023 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, 2022, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2022 that was filed with the Securities and Exchange Commission (the “SEC”).

Recent Accounting Pronouncements

Management has the responsibility for the selection and use of appropriate accounting policies. The significant accounting policies used by the Company are described in the notes to the consolidated financial statements.

The following accounting guidance has been approved by the Financial Accounting Standards Board (“FASB”) and would apply to the Company if the Company entered into an applicable activity.

In March 2020, FASB issued Accounting Standards Update (“ASU”) 2020-04, “Reference Rate Reform (Topic 848)”: Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU Provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effect of) reference rate reform, on financial reporting. The risk of termination of the London Interbank Offered Rate (“LIBOR”), has caused regulators to undertake reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based that are less susceptible to manipulation. ASU 2020-04 is effective between March 12, 2020 and December 31, 2022. As of September 30, 2023, the Company has converted all of its LIBOR loans to an alternative reference rate.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

In December 2022, FASB issued ASU 2022-06, “Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848”. ASU 2022-06 extends the period of time preparers can utilize the reference rate reform relief guidance in Accounting Standards Codification (“ASC”) Topic 848. The objective of the guidance in ASC Topic 848 is to provide relief during the temporary transition period, so the FASB included a sunset provision within Topic 848 based on expectations of when the LIBOR would cease being published. In 2021, the UK Financial Conduct Authority delayed the intended cessation date of certain tenors of USD LIBOR to September 30, 2023. To ensure the relief in ASC Topic 848 covers the period of time during which a significant number of modifications may take place, the ASU defers the sunset date of ASC Topic 848 from December 31, 2022 to December 31, 2024, after which entities will no longer be permitted to apply the relief in ASC Topic 848. The ASU is effective for all entities upon issuance. As of September 30, 2023, the Company has converted all of its LIBOR loans to an alternative reference rate.

Recently Adopted Accounting Developments

During June 2016, FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”.  The ASU, as amended, requires an entity to measure expected credit losses for financial assets carried at amortized cost based on historical experience, current conditions, and reasonable and supportable forecasts. Among other things, the ASU also amended the impairment model for available for sale securities and addressed purchased financial assets with deterioration.   The Company adopted ASU 2016-13 as of January 1, 2023. The adjustment recorded at adoption to the overall allowance for credit losses, which consisted of adjustments to the allowance for credit losses on loans and held-to-maturity securities, as well as an adjustment to the Company’s reserve for unfunded loan commitments, was $704,410. The adjustment net of tax recorded to stockholders’ equity totaled $341,392.

The Company is utilizing a third-party model to tabulate its estimate of current expected credit losses (“CECL”), using an average charge off or loss rate methodology. In accordance with ASC Topic 326, the Company has segmented its loan portfolio based on similar risk characteristics which included call report categories as well watch list and collateral-dependent. The Company primarily utilizes historical loss rates for the CECL calculation based on Company-specific historical losses and supplemented with peer loss history where applicable.  For its reasonable and supportable forecasting of CECL, the Company analyzes a simple regression using forecasted economic metrics and historical peer loss data. To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company may consider the following qualitative adjustment factors: economic conditions; concentrations of credit; interest rates; ability of staff; loan review; trends in loan quality; policy changes; and changes in nature and/or volume of loans. The Company’s CECL implementation process was overseen by the Chief Financial Officer and included an assessment of data availability and gap analysis, data collection, consideration and analysis of multiple loss estimation methodologies, an assessment of relevant qualitative factors and correlation analysis of multiple potential loss drivers and their impact on the Company’s historical loss experience.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

In March 2022, FASB issued ASU 2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The amendments in this ASU were applied prospectively, except for the transition method related to the recognition and measurement of troubled debt restructurings an entity had the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. ASU 2022-02 was effective for the Company on January 1, 2023, and it did not have a material impact on the Company’s consolidated financial statements.

In March 2022, FASB issued ASU 2022-01, “Derivatives and Hedging (Topic 815), Fair Value Hedging - Portfolio Layer Method.” ASU 2022-01 clarifies the guidance in ASC Topic 815 on fair value hedge accounting of interest rate risk for portfolios of financial assets and is intended to better align hedge accounting with an organization’s risk management strategies. In 2017, FASB issued ASU 2017-12 to better align the economic results of risk management activities with hedge accounting. One of the major provisions of that standard was the addition of the last-of-layer hedging method. For a closed portfolio of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities, the last-of-layer method allows an entity to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows. ASU 2022-01 renames that method the portfolio layer method. ASU 2022-01 was effective for the Company on January 1, 2023.

Summary of Significant Accounting Policies

There have been no changes to significant accounting policies since the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 was issued other than described below.

Allowance for Credit Losses. As further discussed below, we adopted ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” on January 1, 2023. ASC Topic 326 replaced the previous “incurred loss” model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The new CECL model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance sheet credit exposures based on historical experience, current conditions, and reasonable and supportable forecasts. In connection with the adoption of ASC Topic 326, we revised certain accounting policies and implemented certain accounting policy elections. Results for reporting periods beginning after January 1, 2023 will be presented under ASC Topic 326, while periods prior to January 1, 2023 will be reported in accordance with GAAP applicable for the time period. The revised accounting policies are described below.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

Allowance for Credit Losses - Held-to-Maturity Securities: The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account, calculated in accordance with ASC Topic 326, which is deducted from the amortized cost basis of held-to-maturity securities to present management's best estimate of the net amount expected to be collected. Held-to-maturity securities are charged-off against the allowance when deemed uncollectible by management. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. Management has made the accounting policy election to exclude accrued interest receivable on held-to-maturity securities from the estimate of credit losses. Further information regarding our policies and methodology used to estimate the allowance for credit losses on held-to-maturity securities is presented in Note 3 - Securities.

Allowance For Credit Losses - Available-for-Sale Securities: For available-for-sale securities in an unrealized loss position, we first assess whether (i) we intend to sell the security or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either case is affirmative, any previously recognized allowances are charged-off and the security's amortized cost is written down to fair value through income. If neither case is affirmative, the security is evaluated to determine whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and any adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive (loss) income. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management has made the accounting policy election to exclude accrued interest receivable on available-for-sale securities from the estimate of credit losses. Available-for-sale securities are charged-off against the allowance or, in the absence of any allowance, written down through income when deemed uncollectible by management or when either of the aforementioned criteria regarding intent or requirement to sell is met. Prior to the adoption of ASU 2016-13, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that were deemed to be other than temporary were reflected in earnings as realized losses. In estimating other-than-temporary impairment losses prior to January 1, 2023, management considered, among other things, (i) the length of time and the extent to which the fair value had been less than cost, (ii) the financial condition and near-term prospects of the issuer and (iii) the intent and our ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Allowance for Credit Losses - Loans: The allowance for credit losses on loans is a contra-asset valuation account, calculated in accordance with ASC Topic 326, which is deducted from the amortized cost basis of loans to present management's best estimate of the net amount expected to be collected. Loans are charged-off against the allowance when deemed uncollectible by management. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. Management has made the accounting policy election to exclude accrued interest receivable on loans from the estimate of credit losses.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

The amount of the allowance represents management's best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing collectability over the loans' contractual terms, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals and modifications unless (i) management has a reasonable expectation that a loan to an individual borrower that is experiencing financial difficulty will be modified or (ii) such extension or renewal options are not unconditionally cancellable by us and, in such cases, the borrower is likely to meet applicable conditions and likely to request extension or renewal. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. The allowance for credit losses is measured on a collective basis for portfolios of loans when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Expected credit losses for collateral dependent loans, including loans where the borrower is experiencing financial difficulty but foreclosure is not probable, are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.

Credit loss expense related to loans reflects the totality of actions taken on all loans for a particular period including any necessary increases or decreases in the allowance related to changes in credit loss expectations associated with specific loans or pools of loans. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate appropriateness of the allowance is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

In calculating the allowance for credit losses, most loans are segmented into pools based upon similar characteristics and risk profiles. Common characteristics and risk profiles include the type/purpose of loan, underlying collateral, and historical/expected credit loss patterns. For modeling purposes, our loan pools include (i) commercial real estate - owner occupied, (ii) commercial real estate - non-owner occupied, (iii) construction/land development, (iv) residential – multifamily, (v) residential – single family (vi) residential – single family home equity, (vii) commercial and industrial (viii) consumer and other. We periodically reassess each pool to ensure that the loans within the pool continue to share similar characteristics and risk profiles and to determine whether further segmentation is necessary.

The average charge-off method calculates an estimate of losses based upon past experience, which is applied prospectively across the life of each loan. This method allows for analysis and calculation on a note-by-note basis due to the CECL model calculating future cash flows at the individual note level based upon note characteristics. A forward balance is calculated from each note’s prior period balance, less monthly principal paydown and prepayment amount.

The Company utilizes its own loss data as the source for its historical loss calculations within the CECL model, where appropriate. This information is sourced from call report data and spans back to an effective start date of March 31, 2000. Loss data will continuously be uploaded into the model across subsequent periods, with results always one quarter in arrears. Utilization of loss rates

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

across this length of time helps to incorporate results recognized across the full economic cycle and smooth periods of economic recession and recovery. The Company may deviate from utilization of its own loss rates on an as-needed basis when said loss rates have historically been non-existent. The Company may also deviate from its existing loss rates when said rates are no longer indicative of the current portfolio composition/quality, such as historical rates impacted by losses resulting from purchased loan portfolios which have since matured or been divested. In these events, the Company will utilize aggregate loss rates recognized from banks of comparable asset size throughout the state of Maryland, incurred across the same period, March 31, 2000 to present.

The measurement of expected credit losses is impacted by loan/borrower attributes and certain macroeconomic variables. Significant loan/borrower attributes utilized in our modeling processes include, among other things, (i) origination date, (ii) maturity date, (iii) payment type, (iv) collateral type and amount, (v) current risk grade, (vi) current unpaid balance and commitment utilization rate, (vii) payment status/delinquency history and (viii) expected recoveries of previously charged-off amounts.

Management qualitatively adjusts model results for risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor (“Q-Factor”) and other qualitative adjustments may increase or decrease management's estimate of expected credit losses by a calculated percentage or amount based upon the estimated level of risk. The various risks that may be considered in making Q-Factor and other qualitative adjustments include, among other things, the impact of (i) any concentrations of credit, (ii) local and national economic and business conditions, (iii) changes in the nature and volume of the underlying loans, (iv) changes in the experience, ability, and depth of our lending management and staff, (v) changes in volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified loans, (vi) our credit review function, (vii) changes in lending policies and procedures and, (viii) other factors such as rising interest rates.

In some cases, management may determine that an individual loan exhibits unique risk characteristics which differentiate the loan from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral.

Allowance for Credit Losses - Off-Balance-Sheet Credit Exposures: The allowance for credit losses on off-balance-sheet credit exposures is a liability account, calculated in accordance with ASC Topic 326, representing expected credit losses over the contractual period for which we are exposed to credit risk resulting from a contractual obligation to extend credit. No allowance is recognized if we have the unconditional right to cancel the obligation. The allowance is reported as a component of other liabilities in our consolidated balance sheets. Adjustments to the allowance are reported in our income statement as a component of credit loss expense.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

The table below provides the impact of the implementation of ASC Topic 326:

December 31, 2022 January 1, 2023
Pre-ASC 326<br> Adoption Impact of ASC<br> 326 Adoption As Reported<br> Under ASC<br> 326
Assets:
Loans, gross $ 521,679,143 $ 233,411 $ 521,912,554
Allowance for credit losses:
Loans:
Real estate:
Commercial 2,818,582 (350,838 ) 2,467,744
Construction and land development 164,596 280,179 444,775
Residential 793,919 538,435 1,332,354
Commercial 337,303 135,200 472,503
Consumer 4,706 (4,537 ) 169
Unallocated 31,092 (31,092 ) -
Allowance for credit losses on loans 4,150,198 567,347 4,717,545
Loans, net 517,528,945 (333,936 ) 517,195,009
Allowance for credit losses on debt securities held to maturity - 51,990 51,990
Net deferred tax asset - 129,607 129,607
Liabilities:
Allowance for credit losses on off balance sheet credit exposures - 85,073 85,073
Total equity $ 49,834,244 $ (341,392 ) $ 49,492,852

Derivative Financial Instruments: At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (i) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (ii) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), and (iii) an instrument with no hedging designation (“stand-alone derivative”). For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in current earnings as fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income (loss) and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. Changes in the fair value of derivatives not designated or that do not qualify for hedge accounting are reported currently in earnings, as non-interest income.

Accrued settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Accrued settlements on derivatives not designated or that do not qualify for hedge accounting are reported in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.

The Company is exposed to losses if a counterparty fails to make its payments under a contract in which the Company is in the net receiving position. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements. All the contracts to which the Company is a party settle monthly or quarterly. In addition, the Company obtains collateral above certain thresholds of the fair value of its derivatives for each counterparty based upon their credit standing and the Company has netting agreements with the dealers with which it does business.

The Company’s derivative financial instruments are described more fully in Note 7.

Stock-based Compensation: The Company recognizes in the income statement the grant date fair value of stock awards, restricted stock and restricted stock units. The fair value related to forfeitures of stock awards, restricted stock and restricted stock units are recorded to the income statement as they occur, reducing stock-based compensation expense in that period. The Company classifies stock-based compensation as either an equity award or a liability award. Equity classified awards are valued as of the grant date using either an observable market price or a valuation methodology. Liability classified awards are valued at fair value at each reporting date. For the periods presented, all of the Company's stock awards, restricted stock, and restricted stock units are classified as equity awards.

During the third quarter of 2023, the Company granted stock awards under the Farmers and Merchants Bancshares, Inc. 2023 Equity Compensation Plan (the “Plan).  Each share of common stock subject to such awards is valued at the fair market value of such share (as defined in the Plan”) as of the grant date.

The Company’s stock-based compensation is described more fully in Note 12.

Management believes that the accounting policies adopted by management are consistent with authoritative GAAP and are consistent with those followed by our peers.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3. Investment Securities

Investments in debt securities are summarized as follows:

Amortized Unrealized Unrealized Fair Allowance for Net Carrying
September 30, 2023 cost gains losses value Credit Losses Amount
Available for sale ****** ****** ****** ****** ****** ****** ****** ****** ****** ****** ****** ******
State and municipal $ 500,000 $ - $ 28,965 $ 471,035 $ - $ 471,035
SBA pools 839,905 1,520 11,577 829,848 - 829,848
Corporate bonds 10,367,728 - 1,443,028 8,924,700 - 8,924,700
Mortgage-backed securities 153,977,642 - 27,640,005 126,337,637 - 126,337,637
$ 165,685,275 $ 1,520 $ 29,123,575 $ 136,563,220 $ - $ 136,563,220
Held to maturity ****** ****** ****** ****** ****** ****** ****** ****** ****** ****** ****** ******
State and municipal $ 20,226,073 $ - $ 2,248,646 $ 17,977,427 $ 92,045 $ 20,134,028
Amortized Unrealized Unrealized Fair
--- --- --- --- --- --- --- --- ---
December 31, 2022 cost gains losses value
Available for sale ****** ****** ****** ****** ****** ****** ****** ******
State and municipal $ 570,122 $ - $ 17,841 $ 552,281
SBA pools 1,033,606 1,425 15,234 1,019,797
Corporate bonds 10,414,146 - 1,024,250 9,389,896
Mortgage-backed securities 137,896,519 - 22,544,044 115,352,475
$ 149,914,393 $ 1,425 $ 23,601,369 $ 126,314,449
Held to maturity ****** ****** ****** ****** ****** ****** ****** ******
State and municipal $ 20,508,997 $ 4,176 $ 1,633,378 $ 18,879,795

The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account that is deducted from the amortized cost basis of held-to-maturity securities to present the net amount expected to be collected. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to securities issued by states and political subdivisions, management considers (i) issuer bond ratings, (ii) historical loss rates for given bond ratings, (iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, and (iv) internal forecasts. Unrated bonds were underwritten similar to commercial loans and the financial condition of the issuer is monitored periodically. Expected credit losses on commercial loans are applied to unrated bonds.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3. Investment Securities (continued)

The following table summarizes Moody's and/or Standard & Poor's bond ratings (Company’s primary credit quality indicator) for our portfolio of held-to-maturity securities issued by states and political subdivisions as of September 30, 2023 at amortized cost:

September 30, 2023
AAA 2,782,091
AA 10,413,097
A 3,804,166
BAA 249,202
Not rated 2,977,517
Total 20,226,073

Historical loss rates associated with securities having similar grades as those in our portfolio have generally not been significant. Furthermore, as of September 30, 2023, there were no past due principal or interest payments associated with these securities and none are on nonaccrual.

The following table details activity in the allowance for credit losses on held-to-maturity securities for the three and nine months ended September 30, 2023:

Three Months Ended Nine Months Ended
September 30, 2023 September 30, 2023
Beginning balance $ 50,445 $ -
Impact of adopting ASC 326 - 51,990
Credit loss expense 41,600 40,055
Ending balance $ 92,045 $ 92,045

Available for sale securities accrued interest receivable totaled $354,729 and $310,324 and held to maturity securities accrued interest receivable totaled $103,064 and $122,874 as of September 30, 2023 and December 31, 2022, respectively.  Both are grouped in accrued interest receivable on the balance sheet.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3. Investment Securities (continued)

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

Available for Sale Held to Maturity
Amortized Fair Amortized Fair
September 30, 2023 cost value cost value
Within one year $ 1,509,228 $ 1,453,715 $ - $ -
Over one to five years 8,541,532 7,237,103 893,845 863,621
Over five to ten years 816,968 704,917 5,839,636 5,327,247
Over ten years - - 13,492,592 11,786,559
10,867,728 9,395,735 20,226,073 17,977,427
Mortgage-backed securities and
SBA pools, due in monthly installments 154,817,547 127,167,485 - -
$ 165,685,275 $ 136,563,220 $ 20,226,073 $ 17,977,427

Securities with a carrying value of $49,830,882 and $24,258,980 as of September 30, 2023 and December 31, 2022, respectively, were pledged as collateral for government deposits, securities sold under repurchase agreements, and the Federal Reserve’s Bank Term Funding Program.

During the nine-month periods ended September 30, 2023 and 2022, there were no sales of securities.

The following table sets forth the Company’s gross unrealized losses on a continuous basis for investments in available for sale (“AFS”) debt securities, by category and length of time, at September 30, 2023. At December 31, 2022 held to maturity debt securities are included in addition to AFS.

September 30, 2023 Less than 12 months 12 months or more Total
Description of investments Fair Value Unrealized<br> Loss Fair Value Unrealized Loss Fair Value Unrealized Loss
State and municipal $ 239,978 $ 10,023 $ 231,057 $ 18,942 $ 471,035 $ 28,965
SBA pools - - 700,027 11,577 700,027 11,577
Corporate bonds 336,100 63,900 8,588,600 1,379,128 8,924,700 1,443,028
Mortgage-backed securities 23,495,317 1,155,954 102,842,320 26,484,051 126,337,637 27,640,005
Total $ 24,071,395 $ 1,229,877 $ 112,362,004 $ 27,893,698 $ 136,433,399 $ 29,123,575
December 31, 2022 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 $ 13,668,676 $ 1,057,412 $ 1,537,715 $ 593,807 $ 15,206,391 $ 1,651,219
SBA pools - - 857,259 15,234 857,259 15,234
Corporate bonds 4,184,875 356,746 4,805,021 667,504 8,989,896 1,024,250
Mortgage-backed securities 25,284,430 2,293,151 90,068,045 20,250,893 115,352,475 22,544,044
Total $ 43,137,981 $ 3,707,309 $ 97,268,040 $ 21,527,438 $ 140,406,021 $ 25,234,747

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans and allowance for credit losses

Major categories of loans are as follows:

September 30, December 31,
2023 2022
Real estate:
Commercial $ 367,260,065 $ 351,794,702
Construction and land development 21,137,478 23,978,373
Residential 112,068,945 114,683,149
Commercial 30,612,786 31,066,497
Consumer 171,426 156,422
531,250,700 521,679,143
Less: Allowance for credit losses 4,516,402 4,150,198
Deferred origination fees net of costs 601,257 608,405
$ 526,133,041 $ 516,920,540

The following tables present the amortized cost basis of loans on nonaccrual status and loans past 90 days or more still accruing as of September 30, 2023 and December 31, 2022:

Nonaccrual Loans Past
With No Due 90 Days
Allowance or More and
for Credit Loss Nonaccrual Still Accruing
September 30, 2023
Real estate:
Commercial $ - $ 502,961 $ -
Construction and land development - - -
Residential - - -
Commercial - 152,449 -
Consumer - - -
$ - $ 655,410 $ -
December 31, 2022
Real estate:
Commercial $ - $ 502,961 $ -
Construction and land development - - -
Residential - - -
Commercial - 152,449 -
Consumer - - -
$ - $ 655,410 $ -

The Company did not recognize any interest income on nonaccrual loans during the nine months ended September 30, 2023 or during the year ended December 31. 2022.

- 20 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans and allowance for credit losses (continued)

At September 30, 2023, the Company had one nonaccrual commercial real estate loan totaling $502,961 and one nonaccrual commercial loan totaling $152,449. The commercial loan was secured by business assets and was personally guaranteed. Gross interest income of $34,110 would have been recorded for the nine months ended September 30, 2023 if these nonaccrual loans had been current and performing in accordance with their original terms. The Company allocated $402,449 of its allowance for credit losses to these nonaccrual loans.

At December 31, 2022, the Company had one nonaccrual commercial real estate loan totaling $502,961 and one nonaccrual commercial loan totaling $152,449. The commercial loan was secured by business assets and was personally guaranteed. Gross interest income of $45,856 would have been recorded in 2022 if these nonaccrual loans had been current and performing in accordance with their original terms. The Company allocated $281,910 of its allowance for credit losses to these nonaccrual loans.

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

90 Days
30 - 59 Days 60 - 89 Days or More Total Total
Past Due Past Due Past Due Past Due Current Loans
September 30, 2023
Real estate:
Commercial $ - $ 2,014,587 $ 502,961 $ 2,517,548 $ 364,742,517 $ 367,260,065
Construction and land development - - - - 21,137,478 21,137,478
Residential 1,363,125 - - 1,363,125 110,705,820 112,068,945
Commercial - - 152,449 152,449 30,460,337 30,612,786
Consumer - - - - 171,426 171,426
Total $ 1,363,125 $ 2,014,587 $ 655,410 $ 4,033,122 $ 527,217,578 $ 531,250,700
December 31, 2022
Real estate:
Commercial $ - $ - $ 502,961 $ 502,961 $ 351,291,741 $ 351,794,702
Construction and land development - - - - 23,978,373 23,978,373
Residential 311,409 - - 311,409 114,371,740 114,683,149
Commercial - - 152,449 152,449 30,914,048 31,066,497
Consumer - - - - 156,422 156,422
Total $ 311,409 $ - $ 655,410 $ 966,819 $ 520,712,324 $ 521,679,143

The following table presents the amortized cost basis of collateral-dependent loans by class of loans as of September 30, 2023:

Real estate:
Commercial $ 502,961
Construction and land development -
Residential 277,083
Commercial 152,449
Consumer -
$ 932,493

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans and allowance for credit losses (continued)

Impaired loans, segregated by class of loans with average recorded investment and interest recognized for the year ended December 31, 2022, 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
December 31, 2022
Commercial real estate $ 7,019,415 $ 6,516,454 $ 502,961 $ 7,019,415 $ 129,461 $ 6,920,174 $ 223,476
Residential real estate 256,350 256,350 - 256,350 - 147,789 10,594
Commercial 152,449 - 152,449 152,449 152,449 152,449 -
$ 7,428,214 $ 6,772,804 $ 655,410 $ 7,428,214 $ 281,910 $ 7,220,412 $ 234,070

From time to time, loans to borrowers experiencing financial difficulty may be modified. Generally, the modifications we grant are extensions of terms, deferrals of payments for an extended period or interest rate reductions. Occasionally, we may modify a loan by providing principal forgiveness. In some cases, we will modify a loan by providing multiple types, or combinations, of concessions.

There were no modifications to borrowers experiencing financial distress during the nine months ended September 30, 2023.

Accrued interest receivable on loans totaled $1,508,780 and $1,373,078 at September 30, 2023 and December 31, 2022, respectively, and is included accrued interest receivable on the balance sheet.

Credit Quality Indicators

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, Acceptable, and Pass/Watch 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:

Special Mention

A special mention loan is a loan that management believes 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.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans and allowance for credit losses (continued)

Substandard

A substandard loan is a loan that management believes is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Such 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. Substandard loans require more intense supervision by Company management.

Doubtful

A doubtful loan is a loan that management believes has all of 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.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans and allowance for credit losses (continued)

Loans by credit grade, segregated by loan type, and year originated as of September 30, 2023 are as follows:

Term Loans Amortized Cost Basis by Origination
Revolving
2023 2022 2021 2020 2019 Prior Loans Total
Commercial Real Estate
Pass $ 25,578,156 $ 73,506,121 $ 55,639,050 $ 20,700,351 $ 27,783,136 $ 151,986,106 $ 2,592,579 $ 357,785,499
Special Mention - - - - - - - -
Substandard - - - - - 9,474,566 - 9,474,566
Doubtful - - - - - - - -
Total $ 25,578,156 $ 73,506,121 $ 55,639,050 $ 20,700,351 $ 27,783,136 $ 161,460,672 $ 2,592,579 $ 367,260,065
Construction and Land Development
Pass $ 3,529,997 $ 6,547,341 $ 4,666,960 $ 1,023,473 $ 310,473 $ 4,563,609 $ 495,625 $ 21,137,478
Special Mention - - - - - - - -
Substandard - - - - - - - -
Doubtful - - - - - - - -
Total $ 3,529,997 $ 6,547,341 $ 4,666,960 $ 1,023,473 $ 310,473 $ 4,563,609 $ 495,625 $ 21,137,478
Residential Real Estate
Pass $ 8,193,778 $ 19,215,459 $ 10,164,483 $ 7,928,227 $ 16,384,047 $ 41,565,486 $ 6,916,677 $ 110,368,157
Special Mention - - - - - - - -
Substandard - - - - - 1,700,788 - 1,700,788
Doubtful - - - - - - - -
Total $ 8,193,778 $ 19,215,459 $ 10,164,483 $ 7,928,227 $ 16,384,047 $ 43,266,274 $ 6,916,677 $ 112,068,945
Commercial
Pass $ 6,673,664 $ 8,391,841 $ 3,666,005 $ 1,406,393 $ 1,033,154 $ 1,053,104 $ 8,236,176 $ 30,460,337
Special Mention - - - - - - - -
Substandard - - - - 152,449 - - 152,449
Doubtful - - - - - - - -
Total $ 6,673,664 $ 8,391,841 $ 3,666,005 $ 1,406,393 $ 1,185,603 $ 1,053,104 $ 8,236,176 $ 30,612,786
Consumer
Pass $ 61,054 $ 40,655 $ 5,252 $ 5,169 $ 9,850 $ 2 $ 23,000 $ 144,982
Special Mention - - - - - - - -
Substandard 11,680 - 1,789 - - - - 13,469
Doubtful - - - - - - 12,975 12,975
Total $ 72,734 $ 40,655 $ 7,041 $ 5,169 $ 9,850 $ 2 $ 35,975 $ 171,426
Aggregate total
Pass $ 44,036,649 $ 107,701,417 $ 74,141,750 $ 31,063,613 $ 45,520,660 $ 199,168,307 $ 18,264,057 $ 519,896,453
Special Mention - - - - - - - -
Substandard 11,680 - 1,789 - 152,449 11,175,354 - 11,341,272
Doubtful - - - - - - 12,975 12,975
Total $ 44,048,329 $ 107,701,417 $ 74,143,539 $ 31,063,613 $ 45,673,109 $ 210,343,661 $ 18,277,032 $ 531,250,700

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans and allowance for credit losses (continued)
December 31, 2022 Excellent Above<br> <br>average Average Acceptable Pass<br> <br>watch Special<br> <br>mention Substandard Doubtful Total
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
Real estate:
Commercial $ - $ - $ 65,908,980 $ 201,854,424 $ 70,826,837 $ 3,558,954 $ 9,645,507 $ - $ 351,794,702
Construction and land development - - 3,845,351 12,087,402 8,045,620 - - - 23,978,373
Residential 15,613 573,108 35,774,807 63,833,864 10,815,681 1,397,282 2,272,794 - 114,683,149
Commercial 178,916 - 4,347,337 16,039,145 9,773,961 574,689 152,449 - 31,066,497
Consumer 722 15,715 93,684 4,439 6,481 - - 35,381 156,422
$ 195,251 $ 588,823 $ 109,970,159 $ 293,819,274 $ 99,468,580 $ 5,530,925 $ 12,070,750 $ 35,381 $ 521,679,143

The following table details activity in the allowance for credit losses and loan balances by portfolio as of and for the nine-month periods ended September 30, 2023 and 2022 and for the year ended December 31, 2022. 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 credit losses ending<br> <br>balance evaluated for impairment: Outstanding loan balances<br> <br>evaluated:
September 30, 2023 Beginning balance Impact of ASC 326 Adoption Provision for (recovery of) credit losses Charge offs Recoveries Ending balance Individually Collectively Individually Collectively
Real estate:
Commercial $ 2,818,582 $ (350,838 ) $ 132,908 $ - $ - $ 2,600,652 $ 250,000 $ 2,350,652 $ 502,961 $ 366,757,104
Construction and land development 164,596 280,179 (193,495 ) - 11,925 263,205 - 263,205 - 21,137,478
Residential 793,919 538,435 (658,628 ) - 381,048 1,054,774 - 1,054,774 277,083 111,791,862
Commercial 337,303 135,200 4,122 - - 476,625 152,449 324,176 152,449 30,460,337
Consumer 4,706 (4,537 ) 1,739 - - 1,908 - 1,908 - 171,426
Unallocated 31,092 (31,092 ) 119,238 - - 119,238 - 119,238 - -
$ 4,150,198 $ 567,347 $ (594,116 ) $ - $ 392,973 $ 4,516,402 $ 402,449 $ 4,113,953 $ 932,493 $ 530,318,207
Allowance for loan losses ending<br> <br>balance evaluated for impairment: Outstanding loan balances<br> <br>evaluated for impairment:
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
Purchase Credit Purchase Credit
September 30, 2022 Beginning balance Provision for (recovery of) loan losses Charge offs Recoveries Ending balance Individually Impaired Collectively Individually Impaired Collectively
Real estate:
Commercial $ 2,482,930 $ 126,385 $ (7,772 ) $ - $ 2,601,543 $ 129,461 $ - $ 2,472,082 $ 7,210,361 $ - $ 335,409,719
Construction and land development 214,547 (69,938 ) - 12,150 156,759 - - 156,759 - - 24,416,365
Residential 603,558 67,729 - - 671,287 - - 671,287 34,954 375,844 113,024,489
Commercial 255,413 35,949 (2,468 ) - 288,894 152,449 - 136,445 152,449 242,382 28,490,571
Consumer 4,370 (383 ) - - 3,987 - - 3,987 - - 368,607
Unallocated 89,450 (64,742 ) - - 24,708 - - 24,708 - - -
$ 3,650,268 $ 95,000 $ (10,240 ) $ 12,150 $ 3,747,178 $ 281,910 $ - $ 3,465,268 $ 7,397,764 $ 618,226 $ 501,709,751

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans and allowance for credit losses (continued)
Allowance for loan losses ending Outstanding loan balances
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
Provision for balance evaluated for impairment: evaluated for impairment:
Beginning (recovery of) Charge Ending Purchase Credit Purchase Credit
December 31, 2022 balance loan losses offs Recoveries balance Individually Impaired Collectively Individually Impaired Collectively
Real estate:
Commercial $ 2,482,930 $ 343,424 $ (7,772 ) $ - $ 2,818,582 $ 129,461 $ - $ 2,689,121 $ 7,019,415 $ - $ 344,775,287
Construction and land development 214,547 (66,151 ) - 16,200 164,596 - - 164,596 - 369,622 23,608,751
Residential 603,558 171,391 - 18,970 793,919 - - 793,919 256,350 209,583 114,217,216
Commercial 255,413 84,358 (2,468 ) - 337,303 152,449 - 184,854 152,449 - 30,914,048
Consumer 4,370 336 - - 4,706 - - 4,706 - - 156,422
Unallocated 89,450 (58,358 ) - - 31,092 - - 31,092 - - -
$ 3,650,268 $ 475,000 $ (10,240 ) $ 35,170 $ 4,150,198 $ 281,910 $ - $ 3,868,288 $ 7,428,214 $ 579,205 $ 513,671,724

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

2023
Balance at December 31, 2022 $ 930,973
Accretion 307,635
Balance at September 30, 2023 $ 623,338

At September 30, 2023, the remaining yield premium on purchased loans was $588,377. At September 30, 2023, the principal balance of purchased loans was $78,459,282 and the carrying value was $78,424,321.

The following table details activity in the allowance for credit losses on unfunded loan commitments:

2023
Balance at December 31, 2022 $ -
Impact of adopting ASC 326 85,073
Credit loss recovery (15,939 )
Balance at September 30, 2023 $ 69,134

The following table provides a summary of all of the components of the allowance for credit losses:

Three Months Ended September 30, 2023 Nine Months Ended September 30, 2023
Held to maturity securities Loans Unfunded loan commitments Total Held to maturity securities Loans Unfunded loan commitments Total
Beginning balance $ 50,445 $ 4,646,836 $ 49,300 $ 4,746,581 $ - $ 4,150,198 $ - $ 4,150,198
Impact of adopting ASC 326 - - - - 51,990 567,347 85,073 704,410
Provision (recovery) of credit losses 41,600 (136,434 ) 19,834 (75,000 ) 40,055 (594,116 ) (15,939 ) (570,000 )
Charge-offs - - - - - - - -
Recoveries - 6,000 - 6,000 - 392,973 - 392,973
Ending balance $ 92,045 $ 4,516,402 $ 69,134 $ 4,677,581 $ 92,045 $ 4,516,402 $ 69,134 $ 4,677,581

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

5. Goodwill and Other Intangibles

The Company’s acquisition of Carroll Bancorp, Inc. in October of 2020 resulted in the recording of goodwill and core deposit intangible (“CDI”). The following table presents the changes in both assets:

Goodwill CDI Total
Balance at December 31, 2022 $ 6,978,208 $ 64,544 $ 7,042,752
Amortization - (6,246 ) (6,246 )
Balance at September 30, 2023 $ 6,978,208 $ 58,298 $ 7,036,506

The CDI is being amortized over 10 years on a straight-line basis. Annual amortization will be $8,328 per year through year nine and $6,246 in year 10. Because the acquisition constituted a tax-free reorganization, goodwill and CDI are not deductible for income tax purposes.

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.

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

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

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

The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have current applicability to the Bank. As of September 30, 2023, 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.

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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 September 30, 2023 and December 31, 2022 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2023 and December 31, 2022 based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. Capital ratios of the Company are substantially the same as the Bank’s.

Minimum To Be Well
(Dollars in thousands) Actual Capital Adequacy Capitalized
September 30, 2023 Amount Ratio Amount Ratio Amount Ratio
Total capital (to risk-weighted assets) $ 79,714 12.86 % $ 65,080 10.50 % $ 61,981 10.00 %
Tier 1 capital (to risk-weighted assets) 75,037 12.11 % 52,684 8.50 % 49,585 8.00 %
Common equity tier 1 (to risk- weighted assets) 75,037 12.11 % 43,387 7.00 % 40,288 6.50 %
Tier 1 leverage (to average assets) 75,037 9.91 % 30,295 4.00 % 37,869 5.00 %
Minimum To Be Well
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
(Dollars in thousands) Actual Capital Adequacy Capitalized
December 31, 2022 Amount Ratio Amount Ratio Amount Ratio
Total capital (to risk-weighted assets) $ 75,826 12.96 % $ 61,410 10.50 % $ 58,486 10.00 %
Tier 1 capital (to risk-weighted assets) 71,676 12.26 % 49,713 8.50 % 46,789 8.00 %
Common equity tier 1 (to risk- weighted assets) 71,676 12.26 % 40,940 7.00 % 38,016 6.50 %
Tier 1 leverage (to average assets) 71,676 9.83 % 29,167 4.00 % 36,459 5.00 %

To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. As of September 30, 2023, the most recent notification from the Federal Deposit Insurance Company (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.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7. Derivative Financial Instruments

The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. The notional amount of the interest rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and other terms of the individual interest rate swap agreements.

Fair Value Hedges: Interest rate swaps with notional amounts totaling $34.8 million as of September 30, 2023 were designated as fair value last of layer hedges of certain government agency mortgage backed securities. There were no interest rate swaps prior to 2023. The hedges were determined to be effective during all periods presented. The Company expects the hedges to remain effective during the remaining terms of the swaps.

The following table presents the amounts recorded on the balance sheet related to cumulative basis adjustments for fair value hedges as of September 30, 2023:

Line Item in the<br> <br>Balance Sheet in<br> <br>Which the Hedged<br> <br>Item is Included Carrying Amount<br> <br>of the Hedged<br> <br>Assets<br> <br>September 30, 2023 Cumulative Amount of Fair<br> <br>Value Hedging Adjustment<br> <br>September 30, 2023
Securities available for sale $ 46,052,766 $ 559,259

The Company presents derivative positions gross on the balance sheet. The following table reflects the derivatives recorded on the balance sheet as of September 30, 2023:

September 30, 2023
Fair
Value
Included in other assets:
Derivatives designated as hedges:
Interest rate swaps related to securities available for sale $ 714,649
Total included in other assets $ 714,649
Included in other liabilities:
Derivatives designated as hedges:
Interest rate swaps related to securities available for sale $ 127,257
Total included in other liabilities $ 127,257

- 29 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7. Derivative Financial Instruments (continued)

The effect of fair value hedge accounting on the statement of income for the three and nine months ended September 30, 2023 are as follows:

Location and Amount of Gain or Loss Recognized in Income on
Fair Value Hedging Relationships
Total amounts of income and expense line items presented in the statements of income in which the effects of the fair value hedge is recorded are as follows:
Three Months Ended<br> September 30, 2023 Nine Months Ended<br> September 30, 2023
Interest Interest
Income Income
The effects of fair value hedging:
Gain on fair value hedging relationships:
Hedged items $ 60,846 $ 28,133
Interest rate contracts designated as hedging instruments 66,921 141,375
Net gain on fair value hedging relationships included in interest income from fedral funds sold and other interest earning assets $ 127,767 $ 169,508
8. Fair Value
--- ---

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

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

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8. Fair Value (continued)

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

● Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
● Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.
--- ---
● Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
--- ---

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

● Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices from a nationally recognized securities pricing agent. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities.
● Equity security at fair value: The Company’s investment in an equity mutual fund is valued based on the net asset value of the fund, which is classified as Level 1.
--- ---
● 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.
--- ---
● Collateral-dependent loans: Nonrecurring fair value adjustments to collateral-dependent loans reflect full or partial write-downs and reserves that are based on the collateral-dependent loan’s observable market price or current appraised value of the collateral. Because the market for collateral-dependent 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.
--- ---
● Fair value hedges: The market value based on independent third party valuation sources that uses observable and traded prices of interest rate swaps from leading banks and brokers.
--- ---

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8. Fair Value (continued)

The following table summarizes financial assets measured at fair value on a recurring and nonrecurring basis as of September 30, 2023 and December 31, 2022, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

Carrying Value:
September 30, 2023 Level 1 Level 2 Level 3 Total
Recurring:
Available for sale securities
State and municipal $ - $ 471,035 $ - $ 471,035
SBA pools - 829,848 - 829,848
Corporate bonds - 8,924,700 - 8,924,700
Mortgage-backed securities - 126,337,637 - 126,337,637
$ - $ 136,563,220 $ - $ 136,563,220
Fair value hedge $ - $ 587,392 $ - $ 587,392
Equity security at fair value
Mutual fund $ 482,907 $ - $ - $ 482,907
Nonrecurring:
Other real estate owned, net $ - $ - $ 1,242,365 $ 1,242,365
Collateral-dependent loans, net $ - $ - $ 530,044 $ 530,044
Carrying Value:
--- --- --- --- --- --- --- --- ---
Level 1 Level 2 Level 3 Total
December 31, 2022
Recurring:
Available for sale securities
State and municipal $ - $ 552,281 $ - $ 552,281
SBA pools - 1,019,797 - 1,019,797
Corporate Bonds - 8,989,896 400,000 9,389,896
Mortgage-backed securities - 115,352,475 - 115,352,475
$ - $ 125,914,449 $ 400,000 $ 126,314,449
Equity security at fair value
Mutual fund $ 489,145 $ - $ - $ 489,145
Nonrecurring:
Other real estate owned, net $ - $ - $ 1,242,365 $ 1,242,365
Impaired loans, net **** - **** - 373,500 373,500

The following table provides information describing the unobservable inputs used in level 3 fair value measurements at September 30, 2023 and December 31, 2022:

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8. Fair Value (continued)
September 30, 2023:
--- --- --- --- --- --- --- --- --- ---
Assets Fair Value Valuation Technique Unobservable Inputs Range (Average)
Collateral-dependent loans $ 530,044 Third party appraisals and in-house real estate valuations of fair value Marketability/selling costs and current market conditions 0% to 20% (10%)
Other real estate owned $ 1,242,365 Third party appraisals and in-house real estate valuations of fair value Marketability/selling 0% to 10% (5%)
December 31, 2022:
--- --- --- --- --- --- --- --- --- ---
Assets Fair Value Valuation Techniques Unobservable Input Average
Collateral-dependent loans $ 373,500 Third party appraisals and in-house real estate valuations of fair value Marketability/selling costs and current market conditions 0% to 20% (10%)
Other real estate owned $ 1,242,365 Third party appraisals and in-house real estate valuations of fair value Marketability/selling costs and current market conditions 0% to 10% (5%)
Reconciliation of Level 3 Inputs
--- --- --- ---
Corporate
Bonds
December 31, 2022 fair value $ 400,000
Transfer to level 2 (400,000 )
September 30, 2023 fair value $ -

The transfer to level 2 occurred because a third party market value was available for this bond at September 30, 2023.

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

- 33 -

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8. Fair Value (continued)
September 30, 2023 December 31, 2022
--- --- --- --- --- --- --- --- ---
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
Financial assets
Level 1 inputs
Cash and cash equivalents $ 25,011,678 $ 25,011,678 $ 7,263,537 $ 7,263,537
Level 2 inputs
Certificates of deposit in other banks 100,000 100,000 100,000 100,000
Accrued interest receivable 2,018,786 2,018,786 1,815,784 1,815,784
Securities available for sale 136,563,220 136,563,220 126,314,449 126,314,449
Securities held to maturity 17,205,828 15,049,227 17,537,377 15,908,175
Equity security 482,907 482,907 489,145 489,145
Mortgage loans held for sale - - 428,355 434,271
Restricted stock, at cost 863,500 863,500 1,332,500 1,332,500
Bank owned life insurance 14,846,937 14,846,937 14,585,342 14,585,342
Fair value hedge 714,649 714,649 - -
Level 3 inputs
Securities held to maturity 2,928,200 2,928,200 2,971,620 2,971,620
Loans, net 526,133,041 512,295,742 516,920,540 503,144,771
Financial liabilities
Level 1 inputs
Noninterest-bearing deposits $ 113,326,966 $ 113,326,966 $ 126,695,349 $ 126,695,349
Securities sold under repurchase agreements 5,357,674 5,357,674 5,175,303 5,175,303
Level 2 inputs
Interest-bearing deposits 530,935,768 528,340,768 496,915,775 492,769,775
Federal Home Loan Bank advances 5,000,000 4,770,000 20,000,000 19,622,000
Federal Reserve Bank advances 33,000,000 32,944,196 - -
Long-term debt, net 13,683,195 12,659,692 15,095,642 14,241,237
Accrued interest payable 1,491,099 1,491,099 349,910 349,910
Fair value hedge 127,257 127,257 - -
9. Earnings per Share
--- ---

Basic earnings per share is determined by dividing net income available to stockholders by the weighted-average number of shares of common stock outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents, giving retroactive effect to stock dividends declared during the period. Diluted earnings per share is determined in the same manner, except that the weighted-average number of shares of common stock outstanding is adjusted for the dilutive effect of outstanding common stock equivalents.

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

9.         Earnings per Share (continued)

The following table shows the weighted average number of shares used in computing earnings per share and the effect of weighted average number of shares of dilutive potential common stock. Dilutive potential common stock has no effect on income available to common shareholders.  There were no anti-dilutive shares outstanding at September 30, 2023 or September 30, 2022.

Three Months Ended Nine Months Ended
September 30, September 30,
2023 2022 2023 2022
Net income $ 1,432,139 $ 1,974,310 $ 5,003,107 $ 6,075,845
Weighted average shares outstanding 3,090,542 3,053,487 3,078,429 3,043,006
Earnings per share - basic and diluted $ 0.46 $ 0.65 $ 1.63 $ 2.00

10.         Retirement Plans

The Company has a profit sharing plan qualifying under Section 401(k) of the Internal Revenue Code. All employees age 21 or older 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 $53,700 and $53,057 for the three-month periods ended September 30, 2023 and 2022, respectively, and $197,150 and $192,223 for the nine-month periods ended September 30, 2023 and 2022, 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 $1,834 and $1,702 for the three-month periods ended September 30, 2023 and 2022, respectively, and $5,503 and $5,107 for the nine-month periods ended September 30, 2023 and 2022, respectively.

The Company adopted supplemental executive retirement plans for four 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. One of the executives who was fully vested retired on December 31, 2022 and began receiving payments in 2023. The Company recorded expenses related to these plans, including interest, of $46,250 for the three-month period ended September 30, 2022, and $107,200 and $136,250 for the nine-month periods ended September 30, 2023 and 2022, respectively. The Company recorded a credit, due to a change in the discount rate, related to these plans, including interest, of $44,800 for the three-month period ended September 30, 2023.

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

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Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

11.         Borrowed Funds

Borrowed funds consist of securities sold under repurchase agreements, which represent overnight or term borrowings from customers, advances from the Federal Home Loan Bank of Atlanta (“FHLB”), advances from the Federal Reserve Bank of Richmond (“FRB”), term borrowings from a commercial bank, and overnight borrowings from commercial banks.

Additional information is as follows:

September 30, December 31,
2023 2022
Amount oustanding at period-end:
Securities sold under repurchase agreements $ 5,357,674 $ 5,175,303
Federal Home Loan Bank advances 5,000,000 20,000,000
Federal Home Loan Bank advances mature in: 2023 - 15,000,000
2025 5,000,000 5,000,000
Federal Reserve Bank advances mature in: 2024 33,000,000 -
Long-term debt (net of issuance costs) 13,683,195 15,095,642
Weighted average rate paid at period-end:
Securites sold under repurchase agreements 1.25 % 0.30 %
Federal Home Loan Bank advances 1.01 % 1.55 %
Federal Reserve Bank advances 5.43 % 0.00 %
Long-term debt 4.10 % 4.10 %

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 $66.0 million under a secured line of credit with the FHLB. The Bank also has two facilities with the Reserve Bank. Under the first facility, which has been in place for over 10 years and is collateralized by loans, the Bank can borrow approximately $25.6 million. The second facility is the Bank Term Funding Program (“BTFP”) that the Reserve Bank created in 2023. The BTFP facility allows securities to be pledged at par, provides fixed rates for up to one-year terms, and allows prepayments in whole or in part at any time. Finally, the Bank has $23,500,000 ($14,500,000 unsecured and $9,000,000 secured) of overnight federal funds lines of credit available from commercial banks.

FHLB advances of $5,000,000 and $20,000,000 were outstanding as of September 30, 2023 and December 31, 2022, respectively. BTFP advances of $33,000,000 and $0 were outstanding as of September 30, 2023 and December 31, 2022, respectively. The Company borrowed $17,000,000 to facilitate the acquisition of Carroll Bancorp, Inc. in 2020. There were no borrowings from the Reserve Bank other than the BTFP advances noted above or our commercial bank lenders at September 30, 2023 and December 31, 2022.

12.         Stock-Based Compensation

On August 22, 2023, the Board of Directors approved the Farmers and Merchants Bancshares, Inc. 2023 Equity Compensation Plan (the “Equity Plan”). Under the Equity Plan, up to 30,000 shares can be awarded to directors, officers and employees in the form of shares of stock, restricted shares of stock, and restricted stock units. During the three months ended September 30, 2023, 2,000 fully vested shares were awarded to one officer.

The compensation cost charged to income in respect of awards granted under the Plan was $38,250 for the three- and nine-month periods ended September 30, 2023.

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

Introduction

The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of Farmers and Merchants Bancshares, Inc. and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, and with Management’s Discussion and Analysis of Financial Condition and Results of Operations, the audited consolidated financial statements and notes thereto, and the other statistical information contained in the Annual Report of Farmers and Merchants Bancshares, Inc. on Form 10-K for the year ended December 31, 2022 (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; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risks are discussed in detail in the registration statements and periodic reports that Farmers and Merchants Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

Farmers and Merchants Bancshares, Inc.

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

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

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

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

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

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

Estimates and Critical Accounting Policies

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. See Note 1 of the Notes to the audited consolidated financial statements as of and for the year ended December 31, 2022, which were included in Item 8 of Part II of the Form 10-K. On an on-going basis, management evaluates estimates, including those related to credit losses and intangible assets, impairment 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 credit losses on loans represents management’s estimate of expected credit losses inherent in the loan portfolio. Determining the amount of the allowance for credit 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 collateral dependent 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.

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

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2022 other than the adoption of Accounting Standards Codification 326 as described in Note 2 of the Notes to the Consolidated Financial Statements presented elsewhere in this report.

Financial Condition

Total assets increased by $38,427,095, or 5.4%, to $756,637,767 at September 30, 2023 from $718,210,672 at December 31, 2022. The increase in total assets was due primarily to an increase of $9,212,501 in loans, an increase of $17,748,141 in cash and cash equivalents and an increase of $9,873,802 in debt securities.

Total liabilities increased $37,940,122, or 5.7%, to $708,375,831 at September 30, 2023 from $670,435,709 at December 31, 2022. The increase was due primarily to a $20,651,610 increase in deposits and a $33,000,000 increase in advances from the Federal Reserve Bank of Richmond (the “Reserve Bank”), offset by a $15,000,000 decrease in advances from the Federal Home Loan Bank (“FHLB”) and a $1,412,447 decrease in long-term debt.

Stockholders’ equity increased by $486,973 to $48,261,936 at September 30, 2023 from $47,774,963 at December 31, 2022. The increase was due to net income of $5,003,107 and an increase of $38,250 for stock-based compensation paid to an executive officer, offset by dividends paid, net of reinvestments, of $629,576, an increase of $3,583,416 in accumulated other comprehensive loss and a $341,392 adjustment for the adoption of the Financial Accounting Standards Board’s Accounting Standard Update 2016-13.

Loans

Major categories of loans at September 30, 2023 and December 31, 2022 were as follows:

September 30, December 31,
2023 2022
Real estate:
Commercial $ 367,260,065 69 % $ 351,794,702 67 %
Construction/Land development 21,137,478 4 % 23,978,373 5 %
Residential 112,068,945 21 % 114,683,149 22 %
Commercial 30,612,786 6 % 31,066,497 6 %
Consumer 171,426 0 % 156,422 0 %
531,250,700 100 % 521,679,143 100 %
Less: Allowance for credit losses on loans 4,516,402 4,150,198
Deferred origination fees net of costs 601,257 608,405
$ 526,133,041 $ 516,920,540
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Loans increased by $9,212,501, or 1.8%, to $526,133,041 at September 30, 2023 from $516,920,540 at December 31, 2022. The increase was due primarily to an increase of $15,465,363 in commercial real estate loans, offset by decreases of $2,614,204 in residential loans, 2,840,895 in construction/land development loans and $453,711 in commercial loans. The allowance for credit losses on loans increased by $366,204 to $4,516,402 at September 30, 2023 from $4,150,198 at December 31, 2022.

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 credit losses on loans. 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.

Recoveries of credit losses of $75,000 and $570,000 were recorded for the three- and nine-month periods ended September 30, 2023, respectively. A provision for credit losses of $95,000 was recorded for each of the three- and nine-month periods ended September 30, 2022.

During the nine-month periods ended September 30, 2023 and 2022, the Company had recoveries from loans written off in prior periods totaling $392,973 and $12,150, respectively, and charge-offs of $0 and $10,240, respectively.

Watch list loans include loans classified as Special Mention, Substandard, and Doubtful. As of September 30, 2023, the Company had $10,407,132 of loans on a watch list, other than collateral-dependent loans, for which the borrowers have the potential for experiencing financial difficulties. As of December 31, 2022, the Company had $9,926,932 of such loans. Watch List loans are subject to ongoing management attention and their classifications are reviewed regularly.

Management believes that the $4.5 million reserve at September 30, 2023 and the $570,000 recovery for the nine-month period ended September 30, 2023 are appropriate to adequately cover the expected losses in the loan portfolio. The recovery of credit losses was due primarily to a recovery of $381,000 from loans charged off over 10 years ago which also resulted in lower historical losses and a decrease in the required reserve for loans. The reserve was increased by $0.4 million from December 31, 2022 due primarily to the current expected credit loss (“CECL”) adjustment effective January 1, 2023. The Company’s loan portfolio grew by $9.2 million during the first nine months of 2023. The allowance for credit losses on loans was 0.85% of the loan portfolio at September 30, 2023 compared to 0.80% at December 31, 2022.

Investment Securities

Investments in debt securities decreased by $9,873,802, or 6.7%, to $156,697,248 at September 30, 2023 from $146,823,446 at December 31, 2022. At September 30, 2023 and December 31, 2022, the Company had classified 87% and 86% of the investment portfolio as available for sale, respectively. 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 the Company has both the positive intent and ability to hold to maturity, are reported at amortized cost. The Company records unrealized gains and losses on equity securities in earnings. The Company does not currently follow a strategy of making security purchases with a view to near-term sales, and, therefore, does not own trading securities. The Company manages the investment portfolio within policies that seek to achieve desired levels of liquidity, manage interest rate sensitivity, meet earnings objectives, and provide required collateral for deposit and borrowing activities.

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Other Real Estate Owned

Other real estate owned (“OREO”) at September 30, 2023 and December 31, 2022 included two properties with an aggregate carrying value of $1,242,365. The first property is an apartment building in Baltimore, Maryland with a carrying value of $1,242,365 that was acquired in the Merger. The property is under a sales contract with a projected closing in the fourth quarter of 2023. The other property is land in Cecil County, Maryland with a carrying value of $0 that was acquired through foreclosure in 2007. The latter property consists of 10.43 acres and is currently under contract for a gross sales price of $295,000 with closing expected in the fourth quarter of 2023. Due to the length of time the property has been held, Maryland banking law required a write-down of the value to $0 in 2019.

Deposits

Total deposits increased by $20,651,610, or 3.3%, to $644,262,734 at September 30, 2023 from $623,611,124 at December 31, 2022. The increase in deposits was due to a $72,235,846 increase in time deposits, offset by a $13,368,383 decrease in noninterest-bearing accounts, a $36,422,272 decrease in savings and money market accounts and a $1,793,581 decrease in interest bearing checking accounts.

The following table shows the average balances and average costs of deposits for the nine-month periods ended September 30, 2023 and 2022:

September 30, 2023 September 30, 2022
Average Average
Balance Cost Balance Cost
Noninterest bearing demand deposits $ 121,234,643 0.00 % $ 128,933,942 0.00 %
Interest bearing demand deposits 131,411,988 0.45 % 132,951,644 0.15 %
Savings and money market deposits 174,321,420 0.36 % 197,244,419 0.12 %
Time deposits 204,486,844 2.67 % 171,266,359 0.50 %
$ 631,454,895 1.06 % $ 630,396,364 0.21 %

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 $66.0 million under a secured line of credit with the FHLB. The Bank also has two facilities with the Reserve Bank. Under the first facility, which has been in place for over 10 years and is collateralized by loans, the Bank can borrow approximately $25.6 million. The second facility is the Bank Term Funding Program (“BTFP”) that the Reserve Bank created in 2023. The BTFP facility allows securities to be pledged at par, provides fixed rates for up to one-year terms, and allows prepayments in whole or in part at any time. Finally, the Bank has $23,500,000 ($14,500,000 unsecured and $9,000,000 secured) of overnight federal funds lines of credit available from commercial banks.

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FHLB advances of $5,000,000 and $20,000,000 were outstanding as of September 30, 2023 and December 31, 2022, respectively. BTFP advances of $33,000,000 and $0 were outstanding as of September 30, 2023 and December 31, 2022, respectively. The Company borrowed $17,000,000 to facilitate the Merger in 2020 as more fully described below. There were no borrowings from the Reserve Bank other than the BTFP advances noted above or our commercial bank lenders at September 30, 2023 and December 31, 2022. 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. Uninsured deposits were approximately $155,833,000 or 24% of total deposits at September 30, 2023.

Borrowings and Other Contractual Obligations

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

On September 30, 2020, the Company borrowed $17,000,000 from First Horizon Bank (“FHN”) for the purpose of funding a portion of the consideration that was payable to the stockholders of Carroll in the Merger. Net of issuance costs, the amount of the net long-term debt was $13,683,195 and $15,095,642 as of September 30, 2023 and December 31, 2022, respectively. The loan matures on September 30, 2025. The interest rate on the loan is fixed at 4.10%. Quarterly interest-only payments were made through October 1, 2021. During the remaining term of the loan, the Company is required to make quarterly interest and principal payments of approximately $615,000, which will be based on a nine-year straight-line amortization schedule. The remaining balance of approximately $9,916,667 will be due at maturity. To secure its obligations under this loan, the Company pledged all of its shares of common stock of the Bank to FHN.

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

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

September 30, December 31,
2023 2022
Amount oustanding at period-end:
Securities sold under repurchase agreements $ 5,357,674 $ 5,175,303
Federal Home Loan Bank advances 5,000,000 20,000,000
Federal Home Loan Bank advances mature in: 2023 - 15,000,000
2025 5,000,000 5,000,000
Federal Reserve Bank advances mature in: 2024 33,000,000 -
Long-term debt (net of issuance costs) 13,683,195 15,095,642
Weighted average rate paid at period-end:
Securites sold under repurchase agreements 1.25 % 0.30 %
Federal Home Loan Bank advances 1.01 % 1.55 %
Federal Reserve Bank advances 5.43 % 0.00 %
Long-term debt 4.10 % 4.10 %

The advances from the Reserve Bank and the FHLB and the long-term debt outstanding at September 30, 2023 will require the following principal payments:

Year ending December 31, 2023 $ 472,222
Year ending December 31, 2024 34,888,889
Year ending December 31, 2025 16,333,334
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Off-Balance Sheet Arrangements

In the normal course of business, the Bank makes commitments to extend credit and issues standby letters of credit. Outstanding loan commitments, unused lines of credit, and letters of credit as of September 30, 2023 and December 31, 2022 are as follows:

September 30, December 31,
2023 2022
Loan commitments
Construction and land development $ 5,200,337 $ 911,500
Commercial 6,251,001 398,046
Commercial real estate 8,700,000 9,264,000
Residential 2,652,500 3,402,371
$ 22,803,838 $ 13,975,917
Unused lines of credit
Home-equity lines $ 11,529,212 $ 12,086,758
Commercial lines 32,006,235 25,464,025
$ 43,535,447 $ 37,550,783
Letters of credit $ 1,208,609 $ 1,403,956

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 Nine Months Ended September 30, 2023 and 2022

General

Net income for the nine months ended September 30, 2023 was $5,003,107, compared to $6,075,845 for the same period of 2022. The decrease of $1,072,738, or 17.7%, was due primarily to a $1,713,139 decrease in net interest income, a $106,043 decrease in noninterest income and a $36,155 increase in noninterest expense, offset by a $665,000 decrease in the provision for credit losses.

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Net Interest Income

Net interest income was $16,114,887 for the nine months ended September 30, 2023, compared to $17,828,026 for the same period of 2022. The net yield on interest earning assets decreased to 3.04% for the nine months ended September 30, 2023 from 3.51% for the same period last year. Higher interest expense on deposits and borrowings was the driving factor in the lower net interest income. The Federal Reserve rate increases caused the cost of deposits and borrowings to increase significantly.

Total interest income for the nine months ended September 30, 2023 was $22,438,448, compared to $19,350,937 for the same period of 2022, an increase of $3,087,511, or 16.0%.

Total interest income on loans for the nine months ended September 30, 2023 increased by $2,362,683 when compared to the same period of 2022 due to a $36.9 million higher average loan balance for the nine months ended September 30, 2023 when compared to the same period of 2022 and a higher loan yield of 4.79% for the nine months ended September 30, 2023 versus 4.51% for the same period of 2022. Investment income for the nine months ended September 30, 2023 increased by $344,770, or 13.2 %, when compared to the same period of 2022 due to an increase in the fully-taxable equivalent yield to 2.36% for the nine months ended September 30, 2023, compared to 2.07% for the same period of 2022, offset by a $2.5 million lower average investment balance. The fully-taxable equivalent yield on total interest-earning assets increased 41 basis points to 4.22% for the nine months ended September 30, 2023 from 3.81% for the same period of 2022. The average balance of total interest-earning assets increased by $30.6 million to $713.2 million for the nine months ended September 30, 2023, compared to $682.6 million for the same period of 2022.

Total interest expense for the nine months ended September 30, 2023 was $6,323,561, compared to $1,522,911 for the same period of 2022, an increase of $4,800,650, or 315.2%. The increase was due to a $28.2 million increase in the average balance of interest-bearing liabilities to $554.6 million for the nine months ended September 30, 2023, compared to $526.4 million in the same period of 2022, and a higher overall cost of funds on interest bearing deposits and borrowings of 1.52% for the nine months ended September 30, 2023, compared to 0.39% for the same period of 2022. Cost of funds for time deposits increased to 2.67% for the nine months ended September 30, 2023 from 0.50% for the same period of 2022. FHLB, Reserve Bank and other borrowings cost of funds increased to 4.39% for the nine months ended September 30, 2023 from 1.01% for the same period of 2022.

Average noninterest-earning assets decreased by $12.2 million to $18.2 million for the nine months ended September 30, 2023, compared to $30.5 million in the same period of 2022. Average noninterest-bearing deposits decreased by $7.7 million to $121.2 million during the nine months ended September 30, 2023, compared to $128.9 million in the same period of 2022. The average balance in stockholders’ equity decreased by $2.6 million for the nine months ended September 30, 2023 when compared with the same period of 2022.

The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the nine-month periods ended September 30, 2023 and 2022. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

  • 44 -
Nine Months Ended Nine Months Ended
September 30, 2023 Septembr 30, 2022
Average Average
Balance Interest Yield Balance Interest Yield
Assets*:*
Loans $ 529,127,695 $ 19,023,308 4.79 % $ 492,180,338 $ 16,660,625 4.51 %
Securities, taxable 154,673,211 2,532,396 2.18 % 156,586,314 2,173,853 1.85 %
Securities, tax exempt 18,278,667 528,212 3.85 % 18,890,763 556,009 3.92 %
Federal funds sold and other interest-earning assets 11,145,233 488,811 5.85 % 14,934,097 95,357 0.85 %
Total interest-earning assets 713,224,806 22,572,727 4.22 % 682,591,512 19,485,844 3.81 %
Noninterest-earning assets 18,221,115 30,461,709
Total assets $ 731,445,921 $ 713,053,221
Liabilities and Stockholders’ Equity*:*
NOW, savings, and money market $ 305,733,408 916,917 0.40 % $ 330,196,063 332,810 0.13 %
Certificates of deposit 204,486,844 4,093,707 2.67 % 171,266,359 638,510 0.50 %
Securities sold under repurchase agreements 4,307,417 23,949 0.74 % 3,813,719 8,558 0.30 %
Long-term debt 14,440,578 444,953 4.11 % 16,162,515 505,268 4.17 %
FRB advances and other borrowings 9,622,710 391,763 5.43 % - -
FHLB advances 16,018,315 452,272 3.76 % 5,000,000 37,765 1.01 %
Total interest-bearing liabilities 554,609,272 6,323,561 1.52 % 526,438,656 1,522,911 0.39 %
Noninterest-bearing deposits 121,234,643 128,933,242
Noninterest-bearing liabilities 6,008,674 5,525,793
Total liabilities 681,852,589 660,897,691
Stockholders' equity 49,593,332 52,155,530
Total liabilities and stockholders' equity $ 731,445,921 $ 713,053,221
Net interest income $ 16,249,166 $ 17,962,933
Interest rate spread 2.70 % 3.42 %
Net yield on interest-earning assets 3.04 % 3.51 %
Ratio of average interest-earning assets to Average interest-bearing liabilities 128.60 % 129.66 %

(1) - Interest on tax-exempt securities and other tax-exempt investments are reported on a fully taxable equivalent basis.  The federal, state and combined tax rates used were 21.00%, 8.25% and 27.5175% respectively.

Noninterest Income

Noninterest income for the nine months ended September 30, 2023 was $1,168,890, compared to $1,274,933 for the same period of 2022, a decrease of $106,043, or 8.3%. The decrease was primarily a result of a $158,123 decrease in the gain on the sale of SBA loans and a $103,315 decrease in mortgage banking income as a result of residential refinance activity declining due to rising interest rates, offset by an increase of $81,860 in bank owned life insurance income and a $47,181 increase in the fair value adjustment on equity securities.

  • 45 -

Noninterest Expense

Noninterest expense for the nine months ended September 30, 2023 totaled $11,189,030, compared to $11,152,875 for the same period of 2022, an increase of $36,155, or 0.3%. The increase was due primarily to increases in salaries and benefits of $102,548, offset by a decrease in other expenses of $138,117. Salaries and benefits increased due to normal and usual annual salary increases that are effective January 1 as well as an increase in the overall headcount. The other expense decrease was due to a $198,609 decrease in professional fees as a result of recruitment fees paid to fill several positions in 2022, offset by a $117,214 increase in FDIC assessments due to an increase in the minimum assessment rate.

Income Tax Expense

Income tax expense for the nine months ended September 30, 2023 was $1,661,640, compared to $1,779,239 for the same period of 2022. The effective tax rate was 24.9% for the nine months ended September 30, 2023, compared to 22.7% for the same period of 2022. The increase in the effective tax rate is due to lower tax exempt revenue in 2023 versus 2022 as a result of the non-renewal of the captive insurance policy.

Comparison of Operating Results for the Three Months Ended September 30, 2023 and 2022

General

Net income for the three months ended September 30, 2023 was $1,432,139, compared to $1,974,310 for the same period of 2022. The decrease of $542,171, or 27.5%, was primarily due to a $904,763 decrease in net interest income, offset by a $45,741 increase in noninterest income, a $38,743 decrease in noninterest expense and a $170,000 decrease in the provision for credit losses.

Net Interest Income

Net interest income was $5,186,989 for the three months ended September 30, 2023, compared to $6,091,752 for the same period of 2022. The net yield on interest earning assets decreased to 2.88% for the three months ended September 30, 2023 from 3.60% for the same period last year. Higher interest expense on deposits and borrowings was the driving factor in the lower net interest income. The Federal Reserve rate increases caused the cost of deposits and borrowings to increase significantly.

Total interest income for the three months ended September 30, 2023 was $8,001,697, compared to $6,586,065 for the same period of 2022, an increase of $1.4 million, or 21.5%.

Total interest income on loans for the three months ended September 30, 2023 increased by $1,002,126 when compared to the same period of 2022 due to a $30.5 million higher average loan balance for the three months ended September 30, 2023 when compared to the same period of 2022 and a higher loan yield of 4.98% for the three months ended September 30, 2023 versus 4.48% for the same period of 2022. Investment income for the three months ended September 30, 2023 increased by $204,496, or 21.2%, when compared to the same period of 2022 due to an increase in the fully-taxable equivalent yield to 2.57% for the three months ended September 30, 2023, compared to 2.19% for the same period of 2022, and a $5.9 million higher average investment balance. The fully-taxable equivalent yield on total interest-earning assets increased 53 basis points to 4.42% for the three months ended September 30, 2023 from 3.89% for the same period of 2022. The average balance of total interest-earning assets increased by $45.4 million to $727.9 million for the three months ended September 30, 2023, compared to $682.5 million for the same period of 2022.

  • 46 -

Total interest expense for the three months ended September 30, 2023 was $2,814,708, compared to $494,313 for the same period of 2022, an increase of $2,320,395, or 469.4%. The increase was due to a $43.1 million increase in the average balance of interest-bearing liabilities to $571.7 million for the three months ended September 30, 2023, compared to $528.6 million in the same period of 2022, and a higher overall cost of funds on interest bearing deposits and borrowings of 1.97% for the three months ended September 30, 2023, compared to 0.37% for the same period of 2022. Cost of funds for time deposits increased to 3.28% for the three months ended September 30, 2023 from 0.47% for the same period of 2022. FHLB, Reserve Bank and other borrowings cost of funds increased to 4.86% for the three months ended September 30, 2023 from 1.02% for the same period of 2022.

Average noninterest-earning assets decreased by $14.6 million to $17.8 million for the three months ended September 30, 2023, compared to $32.4 million in the same period of 2022. Average noninterest-bearing deposits decreased by $12.9 million to $118.0 million during the three months ended September 30, 2023, compared to $130.9 million in the same period of 2022. The average balance in stockholders’ equity decreased by $207,637 for the three months ended September 30, 2023 when compared with the same period of 2022.

The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the three-month periods ended September 30, 2023 and 2022. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

  • 47 -
Three Months Ended Three Months Ended
September 30, 2023 September 30, 2022
Average Average
Balance Interest Yield Balance Interest Yield
Assets*:*
Loans $ 530,623,169 $ 6,609,039 4.98 % $ 500,169,548 $ 5,606,913 4.48 %
Securities, taxable 163,646,118 997,784 2.44 % 157,672,542 784,738 1.99 %
Securities, tax exempt 18,355,423 172,714 3.76 % 18,438,547 181,264 3.93 %
Federal funds sold and other interest-earning assets 15,323,743 270,109 7.05 % 6,246,364 59,008 3.78 %
Total interest-earning assets 727,948,453 8,049,646 4.42 % 682,527,001 6,631,923 3.89 %
Noninterest-earning assets 17,813,892 32,366,316
Total assets $ 745,762,345 $ 714,893,317
Liabilities and Stockholders’ Equity*:*
NOW, savings, and money market $ 294,227,739 389,251 0.53 % $ 337,682,240 119,062 0.14 %
Certificates of deposit 225,433,241 1,850,557 3.28 % 166,446,902 194,494 0.47 %
Securities sold under repurchase agreements 3,841,994 12,110 1.26 % 3,800,797 2,874 0.30 %
Long-term debt 13,800,547 145,001 4.20 % 15,683,811 165,156 4.21 %
FRB advances and other borrowings 27,532,609 378,500 5.50 % - - -
FHLB advances 6,847,826 39,289 2.29 % 5,000,000 12,727 1.02 %
Total interest-bearing liabilities 571,683,956 2,814,708 1.97 % 528,613,750 494,313 0.37 %
Noninterest-bearing deposits 117,985,523 130,880,729
Noninterest-bearing liabilities 6,466,054 5,564,389
Total liabilities 696,135,533 665,058,868
Stockholders' equity 49,626,812 49,834,449
Total liabilities and stockholders' equity $ 745,762,345 $ 714,893,317
Net interest income $ 5,234,938 $ 6,137,610
Interest rate spread 2.45 % 3.52 %
Net yield on interest-earning assets 2.88 % 3.60 %
Ratio of average interest-earning assets to Average interest-bearing liabilities 127.33 % 129.12 %

(1) - Interest on tax-exempt securities and other tax-exempt investments are reported on a fully taxable equivalent basis.  The federal, state and combined tax rates used were 21.00%, 8.25% and 27.5175% respectively.

Noninterest Income

Noninterest income for the three months ended September 30, 2023 was $383,226, compared to $337,485 for the same period of 2022, an increase of $45,741, or 13.6%. The increase resulted primarily from a $25,430 increase in mortgage banking income, an increase of $19,270 in bank owned life insurance income and a $3,842 increase in the fair value adjustment on equity securities.

  • 48 -

Noninterest Expense

Noninterest expense for the three months ended September 30, 2023 totaled $3,745,948, compared to $3,784,691 for the same period of 2022, a decrease of $38,743, or 1.0%. The decrease was due primarily to decreases in salaries and benefits of $141,561, offset by an increase in other expenses of $59,135. Salaries and benefits decreased due to a decrease in the overall headcount. The other expense increase was due to a $26,361 increase in the FDIC assessment due to an increase in the minimum assessment rate.

Income Tax Expense

Income tax expense for the three months ended September 30, 2023 was $467,128, compared to $575,236 for the same period of 2022. The effective tax rate was 24.6% for the three months ended September 30, 2023, compared to 22.6% for the same period of 2022. The increase in the effective tax rate is due to lower tax exempt revenue in 2023 versus 2022 as a result of the non-renewal of the captive insurance policy.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Farmers and Merchants Bancshares, Inc. is a “smaller reporting company” as defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, accordingly, is not required to include the information required by this item.

Item 4. Controls and Procedures

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

An evaluation of the effectiveness of these disclosure controls as of September 30, 2023 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended September 30, 2023, 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.

  • 49 -

Part II – OTHER INFORMATION

Item 1.         Legal Proceedings

None.

Item 1A.          Risk Factors

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

Item 2.         Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities

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
10.1 Farmers and Merchants Bancshares, Inc. 2023 Equity Compensation Plan (incorporated by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8, File No. 333-274152)
--- ---
31.1 Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)
--- ---
31.2 Certifications of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)
--- ---
32 Certification of the Principal Executive Officer and the Principal Financial Office pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith)
--- ---
101 Interactive Data Files pursuant to Rule 405 of Regulation S-T (filed herewith)
--- ---
104 The cover page of Farmers and Merchants Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2023 formatted in Inline XBRL, included within the Exhibit 101 attachments (filed herewith).
--- ---
  • 50 -

SIGNATURES

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

FARMERS AND MERCHANTS BANCSHARES, INC.
Date:         November 14, 2023 /s/ Gary A. Harris
Gary A. Harris
Chief Executive Officer<br> <br>(Principal Executive Officer)
Date         November 14, 2023 /s/ Mark C. Krebs
Mark C. Krebs<br> <br>Treasurer and Chief Financial Officer<br> <br>(Principal Financial Officer & Principal Accounting Officer)
  • 51 -

ex_593497.htm

Exhibit 31.1

Certifications of the Principal Executive Officer

Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14

As adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Gary A. Harris, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Farmers and Merchants Bancshares, Inc.;

2.    Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.    Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.    The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
--- ---
c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
--- ---
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
--- ---

5.    The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
--- ---
Date:         November 14, 2023 /s/ Gary A. Harris
--- ---
Gary A. Harris
Chief Executive Officer
(Principal Executive Officer)

ex_593498.htm

Exhibit 31.2

Certifications of the Principal Financial Officer

Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14

As adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Mark C. Krebs, certify that:

1.    I have reviewed this quarterly report on Form 10-Q of Farmers and Merchants Bancshares, Inc.;

2.    Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.    Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.    The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
--- ---
c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
--- ---
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
--- ---

5.    The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
--- ---
Date         November 14, 2023 /s/ Mark C. Krebs
--- ---
Mark C. Krebs
Treasurer and Chief Financial Officer
(Principal Financial Officer)

ex_593500.htm

Exhibit 32

Certification of Periodic Report

Pursuant to 18 U.S.C. § Section 1350

As adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to, and for purposes only of, 18 U.S.C. § 1350, each of the undersigned hereby certifies that (i) the Quarterly Report of Farmers and Merchants Bancshares, Inc. on Form 10-Q for the quarter ended September 30, 2023 filed with the Securities and Exchange Commission (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Farmers and Merchants Bancshares, Inc.

Date:         November 14, 2023 /s/ Gary A. Harris
Gary A. Harris
Chief Executive Officer
(Principal Executive Officer)
Date:         November 14, 2023 /s/ Mark C. Krebs
Mark C. Krebs
Treasurer and Chief Financial Officer
(Principal Financial Officer)

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