10-Q - FMFG - Equibles

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 March 31, 2023
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☐	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
---	---
For the transition period from _______________ to ________________
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Commission file number 000-55756

Farmers and Merchants Bancshares, Inc.

(Exact name of registrant as specified in its charter)

Maryland	81-3605835
(State or other jurisdiction of	(I. R. S. Employer Identification No.)
incorporation or organization)

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

(Address of principal executive offices) (Zip Code)

(410) 374-1510

(Registrant’s telephone number, including area code)

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

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

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

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

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

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

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

Yes ☐ No ☑

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,071,214 as of May 12, 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 March 31, 2023 (unaudited) and December 31, 2022	3
Consolidated statements of income (unaudited) for the three months ended March 31, 2023 and 2022	4
Consolidated statements of comprehensive income (loss) (unaudited) for the three months ended March 31, 2023 and 2022	5
Consolidated statements of changes in stockholders’ equity (unaudited) for the three months ended March 31, 2023 and 2022	6
Consolidated statements of cash flows (unaudited) for the three months ended March 31, 2023 and 2022	7
Notes to financial statements (unaudited)	9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3. Quantitative and Qualitative Disclosures About Market Risk	43
Item 4. Controls and Procedures	43
PART II – OTHER INFORMATION	44
Item 1. Legal Proceedings	44
Item 1A. Risk Factors	44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	44
Item 3. Defaults upon Senior Securities	44
Item 4. Mine Safety Disclosures	44
Item 5. Other Information	44
Item 6. Exhibits	44
SIGNATURES	45

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

			December 31,
			2022
Assets
Cash and due from banks	8,295,466		$	6,414,822
Federal funds sold and other interest-bearing deposits	1,270,888			848,715
Cash and cash equivalents	9,566,354			7,263,537
Certificates of deposit in other banks	100,000			100,000
Securities available for sale, at fair value	125,822,067			126,314,449
Securities held to maturity, at amortized cost less allowance for credit losses of 60,592 and 0	20,478,223			20,508,997
Equity security, at fair value	497,812			489,145
Restricted stock, at cost	907,500			1,332,500
Mortgage loans held for sale	-			428,355
Loans, less allowance for credit losses of 4,589,232 and 4,150,198	520,895,600			516,920,540
Premises and equipment, net	6,096,874			6,186,594
Accrued interest receivable	1,739,314			1,815,784
Deferred income taxes, net	7,998,178			8,392,658
Other real estate owned, net	1,242,365			1,242,365
Bank owned life insurance	14,668,447			14,585,342
Goodwill and other intangibles, net	7,040,670			7,042,752
Other assets	5,626,083			5,587,654
	722,679,487		$	718,210,672
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing	127,342,442		$	126,695,349
Interest-bearing	509,966,348			496,915,775
Total deposits	637,308,790			623,611,124
Securities sold under repurchase agreements	3,077,227			5,175,303
Federal Home Loan Bank of Atlanta advances	10,000,000			20,000,000
Long-term debt, net of issuance costs	14,624,826			15,095,642
Accrued interest payable	721,007			349,910
Other liabilities	6,190,496			6,203,730
	671,922,346			670,435,709
Commitments and contingencies
Stockholders' equity
Common stock, par value .01 per share, authorized 5,000,000 shares; issued and outstanding 3,071,214 shares in 2023 and 2022	30,712			30,712
Additional paid-in capital	29,549,914			29,549,914
Retained earnings	36,851,782			35,300,166
Accumulated other comprehensive loss	(15,675,267	)		(17,105,829	)
	50,757,141			47,774,963
	722,679,487		$	718,210,672

All values are in US Dollars.

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

	Three months ended
	March 31,
	2023			2022
Interest income	****	****	****	****	****	****
Loans, including fees	$	6,045,548		$	5,683,362
Investment securities - taxable		762,208			644,461
Investment securities - tax exempt		139,844			149,487
Federal funds sold and other interest earning assets		104,929			12,415
Total interest income		7,052,529			6,489,725
Interest expense	****	****	****	****	****	****
Deposits		1,034,851			338,560
Securities sold under repurchase agreements		4,338			3,251
Federal Home Loan Bank advances and long-term debt		356,272			183,825
Total interest expense		1,395,461			525,636
Net interest income		5,657,068			5,964,089
Recovery of credit losses		(270,000	)		-
Net interest income after recovery of credit losses		5,927,068			5,964,089
Noninterest income	****	****	****	****	****	****
Service charges on deposit accounts		186,707			181,466
Mortgage banking income		25,293			122,688
Bank owned life insurance income		83,105			52,990
Fair value adjustment on equity security		5,767			(26,817	)
Gain on sale of SBA loans		-			93,600
Other fees and commissions		81,542			71,880
Total noninterest income		382,414			495,807
Noninterest expense	****	****	****	****	****	****
Salaries		1,876,444			1,740,395
Employee benefits		594,057			511,792
Occupancy		214,116			228,427
Furniture and equipment		239,727			214,615
Other		833,091			1,104,369
Total noninterest expense		3,757,435			3,799,598
Income before income taxes		2,552,047			2,660,298
Income taxes		651,196			609,496
Net income	$	1,900,851		$	2,050,802
Earnings per share - basic and diluted	$	0.62		$	0.68

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

	Three Months Ended
	March 31,
	2023		2022
Net income	$	1,900,851	$	2,050,802
Other comprehensive income (loss), net of income taxes:
Securities available for sale
Net unrealized gain (loss) arising during the period		1,973,665		(8,920,463	)
Total unrealized gain (loss) on investment securities available for sale		1,973,665		(8,920,463	)
Income tax expense (benefit)		543,103		(2,454,690	)
Total other comprehensive income (loss)		1,430,562		(6,465,773	)
Total comprehensive income (loss)	$	3,331,413	$	(4,414,971	)

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three months Ended March 31, 2023 and 2022

(Unaudited)

					Additional					Accumulated other			Total
	Common stock				paid-in		Retained			comprehensive			stockholders'
	Shares		Par value		capital		earnings			income (loss)			equity
Balance, December 31, 2021		3,037,137	$	30,372	$	28,857,422	$	29,128,600		$	(1,394,936	)	$	56,621,458
Net income		-		-		-		2,050,802			-			2,050,802
Other comprehensive loss		-		-		-		-			(6,465,773	)		(6,465,773	)
Balance, March 31, 2022		3,037,137	$	30,372	$	28,857,422	$	31,179,402		$	(7,860,709	)	$	52,206,487
Balance, December 31, 2022		3,071,214	$	30,712	$	29,549,914	$	35,300,166		$	(17,105,829	)	$	47,774,963
Net income		-		-		-		1,900,851			-			1,900,851
Other comprehensive income		-		-		-		-			1,430,562			1,430,562
Reclassification due to the adoption of ASU 2016-13		-		-		-		(341,392	)		-			(341,392	)
Dividend adjustment		-		-		-		(7,843	)		-			(7,843	)
Balance, March 31, 2023		3,071,214	$	30,712	$	29,549,914	$	36,851,782		$	(15,675,267	)	$	50,757,141

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Three Months Ended March 31,	2023			2022
Reconciliation of net income to net cash provided by operating activities	****	****	****	****	****	****
Net income	$	1,900,851		$	2,050,802
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		127,908			116,110
Recovery of credit losses		(270,000	)		-
Amortization of right of use asset		(927	)		2,177
Equity security dividends reinvested		(2,900	)		(1,303	)
Unrealized loss on equity security		(5,767	)		26,817
Gain on sale of SBA loans		-			(93,600	)
Gain on sale of premises and equipment		(9,000	)		-
Gain on fair value hedge		(34,113	)		-
Amortization of debt issuance costs		1,406			1,406
Amortization of premiums and accretion of discounts, net		(808	)		(212,443	)
Bank owned life insurance cash surrender value		(83,105	)		(52,990	)
Increase (decrease) in
Deferred loan fees and costs, net		(12,202	)		(112,930	)
Accrued interest payable		371,097			(19,337	)
Other liabilities		(249,840	)		106,030
Decrease (increase) in
Mortgage loans held for sale		428,355			(158,500	)
Accrued interest receivable		76,470			47,049
Other assets		(86,736	)		(127,624	)
Net cash provided by operating activities		2,150,689			1,571,664

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (Continued)

(Unaudited)

Three Months Ended March 31,	2023			2022
Cash flows from investing activities	****	****	****	****	****	****
Proceeds from maturity and call of securities
Available for sale		2,615,824			6,232,740
Held to maturity		-			535,000
Purchase of securities
Available for sale		-			(11,776,091	)
Loans made to customers, net of principal collected		(4,020,500	)		(2,067,575	)
Proceeds from sale of SBA loans		-			664,650
Redemption (purchase) of stock in FHLB of Atlanta		425,000			(19,600	)
Proceeds from sale of premises and equipment		9,000			-
Purchases of premises, equipment and software		(27,243	)		(116,388	)
Net cash used in investing activities		(997,919	)		(6,547,264	)
Cash flows from financing activities	****	****	****	****	****	****
Net increase (decrease) in
Noninterest-bearing deposits		647,093			8,453,893
Interest-bearing deposits		13,081,095			(1,043,666	)
Securities sold under repurchase agreements		(2,098,076	)		(1,330,319	)
Federal Home Loan Bank of Atlanta advances		(10,000,000	)		-
Long-term debt principal payments		(472,222	)		(427,221	)
Dividends paid, net of reinvestments		(7,843	)		-
Net cash provided by financing activities		1,150,047			5,652,687
Net decrease in cash and cash equivalents		2,302,817			677,087
Cash and cash equivalents at beginning of period		7,263,537			26,462,106
Cash and cash equivalents at end of period	$	9,566,354		$	27,139,193
Supplementary disclosure of cash flow information:
Cash paid during the period for interest	$	1,051,398		$	585,729
Cash paid during the period for income taxes		-			-
Supplementary disclosure of noncash investing and financing activities:
Net unrealized gain (loss) on securities available for sale	$	2,187,186		$	(8,920,461	)
Cumulative effect adjustment for implemenation of ASU 2016-13		341,392			-

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

1.	Principles of consolidation

The consolidated financial statements include the accounts of Farmers and Merchants Bancshares, Inc. and its wholly owned subsidiaries, Farmers and Merchants Bank (the “Bank”), and Series Protected Cell FCB-4 (the “Insurance Subsidiary”), and one subsidiary of the Bank, Reliable Community Financial Services, Inc. (collectively the “Company”, “we”, “us”, or “our”). The Insurance Subsidiary constitutes an investment by Farmers and Merchants Bancshares, Inc. in 100% of a series of membership interests 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 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 (“GAAP”) 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 month period ended March 31, 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 FASB and would apply to the Company if the Company entered into an applicable activity.

In March 2020, the Financial Accounting Standards Board (“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 March 31, 2023, the Company has converted all its LIBOR loans to an alternative reference rate.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2.	Basis of Presentation (continued)

In December 2022, the 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 Topic 848. The objective of the guidance in 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 London Interbank Offered Rate (LIBOR) would cease being published. In 2021, the UK Financial Conduct Authority (FCA) delayed the intended cessation date of certain tenors of USD LIBOR to June 30, 2023. To ensure the relief in Topic 848 covers the period of time during which a significant number of modifications may take place, the ASU defers the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848.

The ASU is effective for all entities upon issuance. As of March 31, 2023, the Company has converted all 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 $470,999. The adjustment net of tax recorded to shareholders’ equity totaled $341,392.

The Company is utilizing a third-party model to tabulate its estimate of current expected credit losses, using an average charge off or loss rate methodology. In accordance with ASC 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 current expected credit losses, 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.

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 TDRs, 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. 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 $470,999. The adjustment net of tax recorded to shareholders’ equity totaled $341,392.

In March 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2022-01, “Derivatives and Hedging (Topic 815), Fair Value Hedging—Portfolio Layer Method.” ASU 2022-01 clarifies the guidance in ASC 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. The Company entered into a fair value hedge in February 2023 with a notional amount of $10,000,000. As of March 31, 2023, there was no material impact to the Company’s financial condition or results of operations.

Summary of Significant Accounting Policies

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, 2020. Accounting Standards Codification (“ASC”) Topic 326 (“ASC 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 current expected credit loss (“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 326, we revised certain accounting policies and implemented certain accounting policy elections. The revised accounting policies are described below.

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 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 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 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 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.

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 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.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2.	Basis of Presentation (continued)

The Company will be utilizing 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 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 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.

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 326:

	January 1, 2023
	As Reported<br> <br>Under ASC 326		Pre-ASC 326<br> <br>Adoption		Impact of<br> <br>ASC 326<br> <br>Adoption
Assets:
Allowance for credit losses on debt securities held to maturity	$	51,990	$	-	$	51,990
Loans
Real estate:
Commercial		2,467,744		2,818,582		(350,838	)
Construction and land development		285,572		164,596		120,976
Residential		1,258,146		793,919		464,227
Commercial		472,503		337,303		135,200
Consumer		169		4,706		(4,537	)
Unallocated		-		31,092		(31,092	)
Allowance for credit losses on loans		4,484,134		4,150,198		333,936
Liabilities
Allowance for credit losses on off balance sheet credit exposures		85,073		-		85,073

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 (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) 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”), or (3) 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, 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 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.

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.

The accounting policies adopted by management are consistent with authoritative GAAP and are consistent with those followed by our peers.

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
March 31, 2023	cost		gains		losses		value		Credit Losses		Amount
Available for sale	******	******	******	******	******	******	******	******	******	******	******	******
State and municipal	$	500,000	$	15	$	13,167	$	486,848	$	-	$	486,848
SBA pools		952,033		1,556		13,700		939,889		-		939,889
Corporate bonds		10,398,704		-		978,981		9,419,723		-		9,419,723
Mortgage-backed securities		135,384,087		-		20,408,480		114,975,607		-		114,975,607
	$	147,234,824	$	1,571	$	21,414,328	$	125,822,067	$	-	$	125,822,067
Held to maturity	******	******	******	******	******	******	******	******	******	******	******	******
State and municipal	$	20,538,815	$	14,857	$	1,317,685	$	19,235,987	$	60,592	$	20,478,223
	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

Farmers and Merchants Bancshares, Inc. and Subsidiaries ****

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.	Investment Securities (continued)

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 and other held-to-maturity securities, 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. 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 March 31, 2023 at amortized cost:

	March 31, 2023
AAA		2,774,579
AA		10,371,643
A		4,126,007
BAA		246,355
Not rated		3,020,231
Total		20,538,815

Historical loss rates associated with securities having similar grades as those in our portfolio have generally not been significant. Furthermore, as of March 31, 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:

	March 31, 2023
Beginning balance	$	-
Impact of adopting ASC 326		51,990
Credit loss expense		8,602
Ending balance	$	60,592

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
March 31, 2023	cost		value		cost		value
Within one year	$	1,014,934	$	985,535	$	330,000	$	330,198
Over one to five years		2,561,931		2,427,580		476,355		473,747
Over five to ten years		7,321,839		6,493,456		3,493,376		3,423,349
Over ten years		-		-		16,178,492		15,008,693
		10,898,704		9,906,571		20,478,223		19,235,987
Mortgage-backed securities and SBA pools, due in monthly installments		136,336,120		115,915,496		-		-
	$	147,234,824	$	125,822,067	$	20,478,223	$	19,235,987

Securities with a carrying value of $24,184,578 and $24,258,980 as of March 31, 2023 and December 31, 2022, respectively, were pledged as collateral for government deposits and securities sold under repurchase agreements.

During the three months ended March 31, 2023 and 2022, there were no sales of securities.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3.	Investment Securities (continued)

The following table sets forth the Company’s gross unrealized losses on a continuous basis for investments in debt securities, by category and length of time, at March 31, 2023 and December 31, 2022.

March 31, 2023	Less than 12 months				12 months or more				Total
Description of investments	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
State and municipal	$	-	$	-	$	236,833	$	13,167	$	236,833	$	13,167
SBA pools		-		-		778,455		13,700		778,455		13,700
Corporate bonds		1,776,149		130,322		7,643,574		848,659		9,419,723		978,981
Mortgage-backed securities		14,930,119		945,787		100,045,490		19,462,693		114,975,609		20,408,480
Total	$	16,706,268	$	1,076,109	$	108,704,352	$	20,338,219	$	125,410,620	$	21,414,328
December 31, 2022	Less than 12 months				12 months or more				Total
---	---	---	---	---	---	---	---	---	---	---	---	---
Description of investments	Fair value		Unrealized loss		Fair value		Unrealized loss		Fair value		Unrealized loss
State and municipal	$	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
4.	Loans and allowance for credit losses
---	---

Major categories of loans are as follows:

	March 31,		December 31,
	2023		2022
Real estate:
Commercial	$	357,768,606	$	351,794,702
Construction and land development		24,911,711		23,978,373
Residential		113,384,265		114,683,149
Commercial		29,876,303		31,066,497
Consumer		140,150		156,422
		526,081,035		521,679,143
Less: Allowance for credit losses		4,589,232		4,150,198
Deferred origination fees net of costs		596,203		608,405
	$	520,895,600	$	516,920,540

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans and allowance for credit losses (continued)

The following tables present the amortized cost basis of loans on nonaccrual status and loans past due over 89 days still accruing as of March 31, 2023 and December 31, 2022:

	Nonaccrual				Loans Past
	With No				Due 90 Days
	Allowance				or More and
	for Credit Loss		Nonaccrual		Still Accruing
March 31, 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 recognized no interest income on nonaccrual loans during the three months ended March 31, 2023 nor during the year ended December 31. 2022.

At March 31, 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 $11,307 would have been recorded for the three months ended March 31, 2023 had these nonaccrual loans 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.

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.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans and allowance for credit losses (continued)

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
March 31, 2023
Real estate:
Commercial	$	-	$	-	$	502,961	$	502,961	$	357,265,645	$	357,768,606
Construction and land development		-		-		-		-		24,911,711		24,911,711
Residential		312,897		-		-		312,897		113,071,368		113,384,265
Commercial		-		-		152,449		152,449		29,723,854		29,876,303
Consumer		-		-		-		-		140,150		140,150
Total	$	312,897	$	-	$	655,410	$	968,307	$	525,112,728	$	526,081,035
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 March 31, 2023:

Real estate:
Commercial	$	502,961
Construction and land development		-
Residential		-
Commercial		152,449
Consumer		-
	$	655,410

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

These were the disclosures under the incurred method as of December 31, 2022 prior to adopting CECL.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans and allowance for credit losses (continued)

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 three months ended March 31, 2023.

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.

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.

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 are as follows:

	Term Loans Amortized Cost Basis by Origination
March 31, 2023
													Revolving
	2023		2022		2021		2020		2019		Prior		Loans		Total
Commercial Real Estate
Pass	$	8,969,175	$	74,007,568	$	56,544,303	$	20,357,085	$	28,243,488	$	153,922,978	$	2,627,248	$	344,671,845
Special Mention		-		-		-		-		-		3,512,960		-		3,512,960
Substandard		-		-		-		-		-		9,583,801		-		9,583,801
Doubtful		-		-		-		-		-		-		-		-
Total	$	8,969,175	$	74,007,568	$	56,544,303	$	20,357,085	$	28,243,488	$	167,019,739	$	2,627,248	$	357,768,606
Construction and Land Development
Pass	$	328,076	$	6,138,120	$	4,518,090	$	4,641,615	$	428,050	$	8,368,598	$	489,162	$	24,911,711
Special Mention		-		-		-		-		-		-		-		-
Substandard		-		-		-		-		-		-		-		-
Doubtful		-		-		-		-		-		-		-		-
Total	$	328,076	$	6,138,120	$	4,518,090	$	4,641,615	$	428,050	$	8,368,598	$	489,162	$	24,911,711
Residential Real Estate
Pass	$	2,892,774	$	20,094,724	$	10,204,311	$	8,805,836	$	15,721,924	$	45,455,511	$	7,161,690	$	110,336,770
Special Mention		-		-		-		-		1,385,519		-		-		1,385,519
Substandard		-		-		-		-		-		1,661,976		-		1,661,976
Doubtful		-		-		-		-		-		-		-		-
Total	$	2,892,774	$	20,094,724	$	10,204,311	$	8,805,836	$	17,107,443	$	47,117,487	$	7,161,690	$	113,384,265
Commercial
Pass	$	862,177	$	9,218,002	$	4,751,596	$	3,358,986	$	1,465,317	$	1,293,980	$	8,199,107	$	29,149,165
Special Mention		-		-		574,689		-		-		-		-		574,689
Substandard		-		-		-		-		152,449		-		-		152,449
Doubtful		-		-		-		-		-		-		-		-
Total	$	862,177	$	9,218,002	$	5,326,285	$	3,358,986	$	1,617,766	$	1,293,980	$	8,199,107	$	29,876,303
Consumer
Pass	$	15,000	$	50,701	$	10,659	$	16,506	$	18,164	$	2	$	-	$	111,032
Special Mention		-		-		-		-		-		-		-		-
Substandard		-		-		-		-		-		-		-		-
Doubtful		-		-		2,119		-		-		-		26,999		29,118
Total	$	15,000	$	50,701	$	12,778	$	16,506	$	18,164	$	2	$	26,999	$	140,150
Aggregate total
Pass	$	13,067,202	$	109,509,115	$	76,028,959	$	37,180,028	$	45,876,943	$	209,041,069	$	18,477,207	$	509,180,523
Special Mention		-		-		574,689		-		1,385,519		3,512,960		-		5,473,168
Substandard		-		-		-		-		152,449		11,245,777		-		11,398,226
Doubtful		-		-		2,119		-		-		-		26,999		29,118
Total	$	13,067,202	$	109,509,115	$	76,605,767	$	37,180,028	$	47,414,911	$	223,799,806	$	18,504,206	$	526,081,035

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4.	Loans and allowance for credit losses (continued)
			Above						Pass		Special
---	---	---	---	---	---	---	---	---	---	---	---	---	---	---	---	---	---	---
December 31, 2022	Excellent		average		Average		Acceptable		watch		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 three-month periods ended March 31, 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						Outstanding loan balances
						Provision for									balance evaluated for impairment:						evaluated:
	Beginning		Impact of ASC			(recovery of)			Charge				Ending		Purchase Credit						Purchase Credit
March 31, 2023	balance		326 Adoption			credit losses			offs		Recoveries		balance		Individually		Deteriorated		Collectively		Individually		Deteriorated		Collectively
Real estate:
Commercial	$	2,818,582	$	(350,838	)	$	1,218		$	-	$	-	$	2,468,962	$	129,461	$	-	$	2,339,501	$	502,961	$	-	$	357,265,645
Construction and land development		164,596		120,976			(401	)		-		4,050		289,221		-		-		289,221		-		366,449		24,545,262
Residential		793,919		464,227			(369,453	)		-		371,048		1,259,741		-		-		1,259,741		-		207,854		113,176,411
Commercial		337,303		135,200			(15,444	)		-		-		457,059		152,449		-		304,610		152,449		-		29,723,854
Consumer		4,706		(4,537	)		3,367			-		-		3,536		-		-		3,536		-		-		140,150
Unallocated		31,092		(31,092	)		110,713			-		-		110,713		-		-		110,713		-		-		-
	$	4,150,198	$	333,936		$	(270,000	)	$	-	$	375,098	$	4,589,232	$	281,910	$	-	$	4,307,322	$	655,410	$	574,303	$	524,851,322
												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
March 31, 2022	balance		loan losses			offs		Recoveries		balance		Individually		Impaired		Collectively		Individually		Impaired		Collectively
Real estate:
Commercial	$	2,482,930	$	63,130		$	-	$	-	$	2,546,060	$	129,461	$	-	$	2,416,599	$	6,781,030	$	32,991	$	322,365,691
Construction and land development		214,547		(97,873	)		-		4,050		120,724		-		-		120,724		-		379,349		19,946,051
Residential		603,558		51,081			-		-		654,639		-		-		654,639		37,341		244,789		111,711,532
Commercial		255,413		12,276			-		-		267,689		152,449		-		115,240		152,449		-		26,222,436
Consumer		4,370		(738	)		-		-		3,632		-		-		3,632		-		-		296,151
Unallocated		89,450		(27,876	)		-		-		61,574		-		-		61,574		-		-		-
	$	3,650,268	$	-		$	-	$	4,050	$	3,654,318	$	281,910	$	-	$	3,372,408	$	6,970,820	$	657,129	$	480,541,861

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		112,233
Balance at March 31, 2023	$	818,740

At March 31, 2023, the nonaccretable discount on purchased impaired loans was $233,411. At March 31, 2023, the remaining yield premium on purchased loans was $772,817. At March 31, 2023, the principal balance of purchased loans was $84,517,255 and the carrying value was $84,237,921.

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

	March 31, 2023
Beginning balance	$	-
Impact of adopting ASC 326		85,073
Credit loss recovery		(8,602	)
Ending balance	$	76,471
5.	Goodwill and Other Intangibles
---	---

The 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		-		(2,082	)		(2,082	)
Balance at March 31, 2023	$	6,978,208	$	62,462		$	7,040,670

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

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 March 31, 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.

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 March 31, 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 March 31, 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
March 31, 2023	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital (to risk-weighted assets)	$	77,752		13.13	%	$	62,181		10.50	%	$	59,220		10.00	%
Tier 1 capital (to risk-weighted assets)		73,026		12.33	%		50,337		8.50	%		47,376		8.00	%
Common equity tier 1 (to risk- weighted assets)		73,026		12.33	%		41,454		7.00	%		38,493		6.50	%
Tier 1 leverage (to average assets)		73,026		9.97	%		29,311		4.00	%		36,639		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 March 31, 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.

7.	Derivative Financial Instrument

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 $10 million as of March 31, 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.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7.	Derivative Financial Instrument (continued)

The following table presents the amounts recorded on the balance sheet related to cumulative basis adjustments for fair value hedges as of March 31, 2023:

Line Item in the	Carrying Amount
Balance Sheet in	of the Hedged		Cumulative Amount of Fair
Which the Hedged	Assets		Value Hedging Adjustment
Item is Included	March 31, 2023		March 31, 2023
Securities available for sale	$	22,146,372	$	232,536

The Company presents derivative position gross on the balance sheet. The following table reflects the derivatives recorded on the balance sheet as of March 31, 2023:

	March 31, 2023
	Fair
	Value
Included in other liabilities:
Derivatives designated as hedges:
Interest rate swaps related to securities available for sale	$	198,424
Total included in other liabilities	$	198,424

The effect of fair value hedge accounting on the statement of income for the three months ended March 31, 2023 are as follows:

	Location and Amount of Gain or Loss Recognized in Income on
	Fair Value Hedging Relationships
	Three Months Ended
	March 31, 2023
	Interest
	Income
Total amounts of income and expense line items presented in the statement of income in which the effects of the fair value hedge is recorded
The effects of fair value hedging:
Gain on fair value hedging relationships:
Hedged items	$	232,536
Interest rate contracts desigianted as hedging instruments		(198,424	)
		34,112

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	Fair Value

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

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

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

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

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	Fair Value (continued)

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. Since 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.
---	---

The following table summarizes financial assets measured at fair value on a recurring and nonrecurring basis as of March 31, 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:
	Level 1		Level 2		Level 3		Total
March 31, 2023
Recurring:
Available for sale securities
State and municipal	$	-	$	486,848	$	-	$	486,848
SBA pools		-		939,889		-		939,889
Corporate bonds		-		9,419,723		-		9,419,723
Mortgage-backed securities		-		114,975,607		-		114,975,607
	$	-	$	125,822,067	$	-	$	125,822,067
Fair value hedge		-	$	198,424		-	$	198,424
Equity security at fair value
Mutual fund	$	497,812	$	-	$	-	$	497,812
Nonrecurring:
Other real estate owned, net	$	-	$	-	$	1,242,365	$	1,242,365
Collateral-dependent loans, net	$	-	$	-	$	373,500	$	373,500

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	Fair Value (continued)
	Carrying Value:
---	---	---	---	---	---	---	---	---
	Level 1		Level 2		Level 3		Total
December 31, 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
Collateral-dependent loans, net	****	-	****	-		373,500		373,500

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

March 31, 2023:
Assets	Fair Value		Valuation Technique	Unobservable Inputs	Range (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%)
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%)

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8.	Fair Value
Reconciliation of Level 3 Inputs
---	---	---	---
	Corporate
	Bonds
December 31, 2022 fair value	$	400,000
Additions	****	-
Principal payments received	****	-
Transfer to level 2	****	(400,000	)
March 31, 2023 fair value	$	-

The transfer to level 2 occurred because a third party market value was available for this bond at March 31, 2023.

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

	March 31, 2023				December 31, 2022
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Financial assets
Level 1 inputs
Cash and cash equivalents	$	9,566,354	$	9,566,354	$	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		1,739,314		1,739,314		1,815,784		1,815,784
Securities held to maturity		17,506,603		16,264,367		17,537,377		15,908,175
Mortgage loans held for sale		-		-		428,355		434,271
Restricted stock, at cost		907,500		907,500		1,332,500		1,332,500
Bank owned life insurance		14,668,447		14,668,447		14,585,342		14,585,342
Level 3 inputs
Securities held to maturity		2,971,620		2,971,620		2,971,620		2,971,620
Loans, net		520,895,600		507,013,897		516,920,540		503,144,771
Financial liabilities
Level 1 inputs
Noninterest-bearing deposits	$	127,342,442	$	127,342,442	$	126,695,349	$	126,695,349
Securities sold under repurchase agreements		3,077,227		3,077,227		5,175,303		5,175,303
Level 2 inputs
Interest-bearing deposits		509,966,348		506,448,348		496,915,775		492,769,775
Federal Home Loan Bank advances		10,000,000		9,682,000		20,000,000		19,622,000
Long-term debt		14,624,826		13,797,069		15,095,642		14,241,237
Accrued interest payable		721,007		721,007		349,910		349,910
Fair value hedge		198,424		198,424		-		-

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

9.	Earnings per Share

Basic earnings per share is determined by dividing net income available to stockholders by the weighted-average number of shares of common stock outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents, giving retroactive effect to stock dividends declared during the period. Diluted earnings per share is determined in the same manner, except that the weighted-average number of shares of common stock outstanding is adjusted for the dilutive effect of outstanding common stock equivalents. The following table sets forth the calculation of basic and diluted earnings per share for the three month periods ended March 31, 2023 and 2022. There were no common stock equivalents outstanding during the three month periods ended March 31, 2023 or 2022.

	Three Months Ended
	March 31,
	2023		2022
Net income	$	1,900,851	$	2,050,802
Weighted average shares outstanding		3,071,214		3,037,137
Earnings per share - basic and diluted	$	0.62	$	0.68
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 $77,675 and $79,740 for the three-month periods ended March 31, 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 March 31, 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 in December 31, 2022 and will begin receiving payments in 2023.The Company recorded expenses related to these plans, including interest, of $72,600 and $45,000 for the three-month periods ended March 31, 2023 and 2022, respectively.

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

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

Introduction

The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of Farmers and Merchants Bancshares, Inc. and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, and with Management’s Discussion and Analysis of Financial Condition and Results of Operations, the audited consolidated financial statements and notes thereto, and the other statistical information contained in the Annual Report of Farmers and Merchants Bancshares, Inc. on Form 10-K for the year ended December 31, 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, including those impacted and/or driven by the geopolitical activity and COVID-19 pandemic; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risks are discussed in detail in the registration statements and periodic reports that Farmers and Merchants Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

Farmers and Merchants Bancshares, Inc.

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

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

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

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

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

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, 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 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, expected losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet.

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

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2022 other than the change to ASC 326 as described in footnote 2.

Financial Condition

Total assets increased by $4,392,344, or 0.6%, to $722,603,016 at March 31, 2023 from $718,210,672 at December 31, 2022. The increase in total assets was due primarily to an increase of $3,898,589 in loans, and an increase in cash and cash equivalents of $2,302,817, offset by a decrease of $523,156 in debt securities.

Total liabilities increased $1,410,166, or 0.2%, to $671,845,875 at March 31, 2023 from $670,435,709 at December 31, 2022. The increase was due primarily to a $13,697,666 increase in deposits, offset by a $10,000,000 decrease in FHLB advances and a $2,098,076 decrease in securities sold under repurchase agreements.

Stockholders’ equity increased by $2,982,178 to $50,757,141 at March 31, 2023 from $47,774,963 at December 31, 2022. The increase was due primarily to net income of $1,900,851 and a decrease of $1,430,562 in accumulated other comprehensive loss, offset by a $341,392 adjustment for the adoption of ASU 2016-13.

Loans

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

	March 31,				December 31,
	2023				2022
Real estate:
Commercial	$	357,768,606	68	%	$	351,794,702	67	%
Construction/Land development		24,911,711	5	%		23,978,373	5	%
Residential		113,384,265	22	%		114,683,149	22	%
Commercial		29,876,303	5	%		31,066,497	6	%
Consumer		140,150	0	%		156,422	0	%
		526,081,035	100	%		521,679,143	100	%
Less: Allowance for credit losses		4,665,703				4,150,198
Deferred origination fees net of costs		596,203				608,405
	$	520,819,129			$	516,920,540

Loans increased by $3,898,589, or 0.8%, to $520,819,129 at March 31, 2023 from $516,920,540 at December 31, 2022. The increase was due primarily to increases of $5,973,904 in commercial real estate loans and $933,338 in construction/land development loans, offset by decreases of $1,190,194 in commercial loans and $1,298,884 in residential loans. The allowance for credit losses increased by $515,505 to $4,589,232 at March 31, 2023 from $4,150,198 at December 31, 2022. Deferred origination fees, net of costs, decreased to $596,203 at March 31, 2023 from $608,405 at December 31, 2022, due primarily to the forgiveness of PPP loans.

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. 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.

There was a recovery for credit losses of $270,000 recorded for the three-month period ended March 31, 2023. No provision or recovery was recorded for the three-month period ended March 31, 2022.

During the three-month periods ended March 31, 2023 and 2022, the Company had recoveries from loans written off in prior periods totaling $375,098 and $4,050, respectively, and no charge-offs.

Watch list loans include loans classified as Special Mention, Substandard, and Doubtful. As of March 31, 2023, the Company had $16,814,745 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. The increase is due primarily to three loans totaling $6.5 million that were classified as collateral dependent at December 31, 2022, but are not collateral dependent at March 31, 2023.

Management believes that the $4.7 million reserve at March 31, 2023 and the $270,000 recovery for the three-month period ended March 31, 2023 are appropriate to adequately cover the expected losses inherent in the loan portfolio. The reserve was increased by $0.5 million from December 31, 2022 due primarily to the CECL adjustment effective January 1, 2023. The Company’s loan portfolio grew by $4.4 million during the first three months of 2023.

Investment Securities

Investments in debt securities decreased by $523,156, or 0.4%, to $146,300,290 at March 31, 2023 from $146,823,446 at December 31, 2022. At March 31, 2023 and December 31, 2022, the Company had classified 86% of the investment portfolio as available for sale. The balance of the portfolio was classified as held to maturity.

Securities classified as available for sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the Company’s asset/liability management strategy. Available for sale debt securities are carried at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of income taxes. Securities classified as held to maturity, which 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.

Other Real Estate Owned

Other real estate owned (“OREO”) at March 31, 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 second quarter. The other property is land in Cecil County, Maryland with a carrying value of $0. It was acquired through foreclosure in 2007. The latter property consists of 10.43 acres and is currently under contract for a gross sales price of $295,000 with closing expected in 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 $13,697,666, or 2.2%, to $637,308,790 at March 31, 2023 from $623,611,124 at December 31, 2022. The increase in deposits was due to a $42,194,528 increase in time deposits and a $647,093 increase in noninterest-bearing accounts, offset by a $4,865,269 decrease in savings accounts, a $17,513,417 decrease in money market accounts, and a $6,765,269 decrease in interest bearing checking accounts.

The following table shows the average balances and average costs of deposits for the three months ended March 31, 2023 and 2022:

	March 31, 2023					March 31, 2022
	Average					Average
	Balance		Cost			Balance		Cost
Noninterest bearing demand deposits	$	125,019,656		0.00	%	$	124,549,116		0.00	%
Interest bearing demand deposits		130,576,396		0.33	%		130,071,359		0.16	%
Savings and money market deposits		190,483,431		0.24	%		191,851,324		0.11	%
Time deposits		180,125,426		1.81	%		176,031,048		0.53	%
	$	626,204,909		0.66	%	$	622,502,847		0.22	%

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 $48.5 million under a secured line of credit with the Federal Home Loan Bank (“FHLB”). The Bank also has a facility with the Federal Reserve Bank of Richmond (the “Reserve Bank”) under which the Bank can borrow approximately $27.0 million. Finally, the Bank has $23,500,000 ($14,500,000 unsecured and $9,000,000 secured) of overnight federal funds lines of credit available from commercial banks. FHLB advances of $10,000,000 and $20,000,000 were outstanding as of March 31, 2023 and December 31, 2022, respectively. The Company borrowed $17,000,000 to facilitate the acquisition of Carroll Bancorp, Inc. (“Carroll”) in 2020 as more fully described below. There were no borrowings from the Reserve Bank or our commercial bank lenders at March 31, 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 $139,675,000 or 22% of total deposits at March 31, 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 merger consideration that was paid to the stockholders of Carroll when it was merged with and into the Company on October 1, 2020. Net of issuance costs, the amount of the net long-term debt was $14,624,826 and $15,095,642 as of March 31, 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 $646,472, which will be based on a nine-year straight-line amortization schedule. The remaining balance of approximately $9,916,667 will be due at maturity. To secure its obligations under this loan, the Company pledged all of its shares of common stock of the Bank to FHN.

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:

		March 31,			December 31,
		2023			2022
Amount oustanding at period-end:
Securities sold under repurchase agreements		$	3,077,227		$	5,175,303
Federal Home Loan Bank advances			10,000,000			20,000,000
Federal Home Loan Bank advances mature in:	2023		5,000,000			15,000,000
	2025		5,000,000			5,000,000
Long-term debt (net of issuance costs)			14,624,826			15,095,642
Weighted average rate paid at period-end:
Securites sold under repurchase agreements			0.30	%		0.30	%
Federal Home Loan Bank advances			3.03	%		1.55	%
Long-term debt			4.10	%		4.10	%

The Federal Home Loan Bank advances and the long-term debt outstanding at March 31, 2023 will require the following principal payments:

Year ending December 31, 2023	1,416,667
Year ending December 31, 2024	1,888,889
Year ending December 31, 2025	16,333,333

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 March 31, 2023 and December 31, 2022 are as follows:

	March 31,		December 31,
	2023		2022
Loan commitments
Construction and land development	$	1,975,275	$	911,500
Commercial		5,225,955		398,046
Commercial real estate		4,248,474		9,264,000
Residential		1,903,300		3,402,371
	$	13,353,004	$	13,975,917
Unused lines of credit
Home-equity lines	$	12,729,774	$	12,086,758
Commercial lines		30,604,363		25,464,025
	$	43,334,137	$	37,550,783
Letters of credit	$	1,367,788	$	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 Three Months Ended March 31, 2023 and 2022

General

Net income for the three months ended March 31, 2023 was $1,900,851, compared to $2,050,802 for the same period of 2022. The decrease of $149,951, or 7.3%, was due to a $307,021 decrease in net interest income, a $113,393 decrease in noninterest income, and a $41,700 increase in income taxes, offset by a $270,000 decrease in the credit loss provision and a $42,163 decrease in noninterest expenses.

Net Interest Income

Net interest income was $5,657,068 for the three months ended March 31, 2023, compared to $5,964,089 for the same period of 2022. The net yield on interest earning assets decreased to 3.24% for the three months ended March 31, 2023 compared to 3.56% for the same period last year.

Total interest income for the three months ended March 31, 2023 was $7,052,529, compared to $6,489,725 for the same period of 2022, an increase of $562,804, or 8.7%.

Total interest income on loans for the three months ended March 31, 2023 increased by $362,186 when compared to the same period of 2022 due to a $40.7 million higher average loan balance for the three months ended March 31, 2023 when compared to the same period of 2022, offset by a lower loan yield of 4.60% for the three months ended March 31, 2023 versus 4.69% for the same period of 2022. The yield decrease is due to a $548,000 decrease in PPP fee recognition and other one-time loan related revenue during the three months ended March 31, 2023 compared to the same period last year. Investment income for the three months ended March 31, 2023 increased by $108,104, or 13.6%, when compared to the same period of 2022 due to an increase in fully-taxable equivalent yield to 2.22% for the three months ended March 31, 2023, compared to 1.95% 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 16 basis points to 4.03% for the three months ended March 31, 2023, compared to 3.87% for the same period of 2022. The average balance of total interest-earning assets increased by $29.4 million to $704.1 million for the three months ended March 31, 2023, compared to $674.7 million for the same period of 2022.

Total interest expense for the three months ended March 31, 2023 was $1,395,461 compared to $525,636 for the same period of 2022, an increase of $869,825, or 165.5%. The increase was due to a higher overall cost of funds on interest bearing deposits and borrowings of 1.03% for the three months ended March 31, 2023, compared to 0.40% for the same period of 2022 and a $19.2 million increase in the average balance of interest-bearing liabilities to $543.2 million for the three months ended March 31, 2023, compared to $524.0 million in the same period of 2022. Cost of funds for time deposits increased to 1.81% for the three months ended March 31, 2023 from 0.53% for the same period of 2022. Securities sold under repurchase agreements cost of funds was 0.30% for the three months ended March 31, 2023 and 2022.

Average noninterest-earning assets decreased by $16.8 million to $19.0 million for the three months ended March 31, 2023, compared to $35.8 million in the same period of 2022. Average noninterest-bearing deposits increased by $0.5 million to $125.0 million during the three months ended March 31, 2023, compared to $124.5 million in the same period of 2022. The average balance in stockholders’ equity decreased by $7.3 million for the three months ended March 31, 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 March 31, 2023 and 2022. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Three Months Ended							Three Months Ended
	March 31, 2023							March 31, 2022
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	525,515,876	$	6,045,548		4.60	%	$	484,840,152	$	5,683,362		4.69	%
Securities, taxable (1)		151,487,864		763,420		2.02	%		152,685,500		645,744		1.69	%
Securities, tax exempt (1)		18,385,556		178,477		3.88	%		19,650,625		192,698		3.92	%
Federal funds sold and other interest-earning assets		8,718,634		108,732		4.99	%		17,541,166		13,117		0.30	%
Total interest-earning assets		704,107,930		7,096,177		4.03	%		674,717,443		6,534,921		3.87	%
Noninterest-earning assets		18,997,676							35,830,220
Total assets	$	723,105,606						$	710,547,663
Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	321,059,827		221,392		0.28	%	$	321,922,683		104,877		0.13	%
Certificates of deposit		180,125,426		813,459		1.81	%		176,031,048		233,683		0.53	%
Securities sold under repurchase agreements		5,863,801		4,338		0.30	%		4,395,100		3,251		0.30	%
Long-term debt		14,742,179		151,563		4.11	%		16,659,192		171,375		4.11	%
FHLB advances and other borrowings		21,422,222		204,709		3.82	%		5,000,000		12,450		1.00	%
Total interest-bearing liabilities		543,213,455		1,395,461		1.03	%		524,008,023		525,636		0.40	%
Noninterest-bearing deposits		125,019,656							124,549,116
Noninterest-bearing liabilities		5,801,886							5,620,689
Total liabilities		674,034,997							654,177,828
Stockholders' equity		49,070,609							56,369,835
Total liabilities and stockholders' equity	$	723,105,606						$	710,547,663
Net interest income			$	5,700,716						$	6,009,285
Interest rate spread						3.00	%						3.47	%
Net yield on interest-earning assets						3.24	%						3.56	%
Ratio of average interest-earning assets to average interest-bearing liabilities						129.62	%						128.76	%
(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 March 31, 2023 was $382,414, compared to $495,807 for the same period of 2022, a decrease of $113,393, or 22.9%. The decrease was due primarily to a $97,395 decrease in mortgage banking income as a result of residential refinance activity declining due to rising interest rates and a $93,600 decrease in the gain on the sale of SBA loans.

Noninterest Expense

Noninterest expense for the three months ended March 31, 2023 totaled $3,757,435, compared to $3,799,598 for the same period of 2022, a decrease of $42,163, or 1.1%. The decrease was due primarily to a decrease in other expenses of $271,278, offset by an increase in salaries and benefits of $218,314. The other expense decrease was due primarily to a decrease in professional fees incurred in the first quarter of 2023. 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.

Income Tax Expense

Income tax expense for the three months ended March 31, 2023 was $651,196 compared to $609,496 for the same period of 2022. The effective tax rate was 25.5% for the three months ended March 31, 2023, compared to 22.9% for the same period of 2022. The increase is due to lower tax exempt revenue in 2022 versus 2021 as 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 March 31, 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 March 31, 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 with the exception of new or revised internal controls in connection with the implementation of ASC 326 as described in footnote 2.

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. Except as set forth below, management does not believe that any material changes in our risk factors have occurred since they were last disclosed.

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

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

None.

Item 6. Exhibits

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

Exhibit	Description
31.1	Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)
31.2	Certifications of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)
32	Certification of the Principal Executive Officer and the Principal Financial Office pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith)
101	Inline 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 March 31, 2023 formatted in Inline XBRL, included within the Exhibit 101 attachments (filed herewith).

SIGNATURES

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

	FARMERS AND MERCHANTS BANCSHARES, INC.
Date: May 15, 2023	/s/ Gary A. Harris
	Gary A. Harris
	Chief Executive Officer
	(Principal Executive Officer)
Date May 15, 2023	/s/ Mark C. Krebs
	Mark C. Krebs
	Treasurer and Chief Financial Officer
	(Principal Financial Officer & Principal Accounting Officer)

ex_517833.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: May 15, 2023	/s/ Gary A. Harris
---	---
	Gary A. Harris
	Chief Executive Officer
	(Principal Executive Officer)

ex_517834.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.;

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
---	---

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 May 15, 2023	/s/ Mark C. Krebs
---	---
	Mark C. Krebs
	Treasurer and Chief Financial Officer
	(Principal Financial Officer)

ex_517835.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 March 31, 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: May 15, 2023	/s/ Gary A. Harris
	Gary A. Harris
	Chief Executive Officer
	(Principal Executive Officer)
Date: May 15, 2023	/s/ Mark C. Krebs
	Mark C. Krebs
	Treasurer and Chief Financial Officer
	(Principal Financial Officer)