Farmers & Merchants Bancorp Stock: Almost No Delinquent Loans (NASDAQ:FMAO)

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introduction

Farmers & Merchants Bancorp (FMAO) is an Ohio-based bank with roots dating back to the late 1800s when it began serving the Ohio and Indiana markets. The bank focuses on agricultural, commercial and residential loans and uses strict LTV ratios before underwriting a loan.

Underwriting policy

FMAO Investor Relations

Please note that this article is about Farmers & Merchants Bancorp trading with (FMAO) as its ticker symbol, not to be confused with other banks of the same name.

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Data by Y-Charts

A very good result in 2021

FMAO has had the rare position of seeing its interest income increase in 2021 while its interest expense has decreased. As you can see in the image below, interest income decreased from $70.2M to $76.8M, while net interest expense decreased from over $10M to less than 7, $5 million. The combination of the two elements reinforced the impact and net interest income increased by more than 15% to just under $69.5 million.

income statement

FMAO Investor Relations

The bank also reported non-interest income of $17.6 million and non-interest expense of $54.2 million, meaning the total net non-interest expense was approximately $36.5 million. That brings income before taxes and provisions for loan losses to about $33 million.

This is a good result, especially as provisions for loan losses remain relatively low. Of course, the level of provision is high compared to 2019, but the loan portfolio has grown considerably (including the acquisition of Perpetual Federal Savings Bank in the fourth quarter of 2021 for a total consideration of $100 million), so further losses are to be expected. Additionally, the bank has not made aggressive provisions in 2020, which means that unlike some other banks, it has very little provision that it can write off. Pre-tax income was $29.5 million and after making the appropriate tax payments, net income was $23.5 million or $2.01 per share.

Farmers recently increased its dividend to $0.19 on a quarterly basis (up 1 cent from the previous quarterly dividend of $0.18). The dividend of $0.76 on an annualized basis currently represents a dividend yield of 2.25%. Although this is at the lower end of the spectrum in banking, investors are giving up income in exchange for a very safe and reliable dividend, as the payout ratio is below 40% while the balance sheet looks very strong .

The most notable element of the loan book? The exceptionally low rate of “arrears”

Thanks to the rather strict loan underwriting policies I mentioned at the beginning of this article, FMAO’s loan portfolio is actually quite strong. Defaults are low, which also means that the amount of provisions for loan losses can remain very limited.

Before diving into the loan portfolio, let’s look at the asset side of the balance sheet.

On the asset side of the balance sheet

FMAO Investor Relations

As you can see, the balance sheet has a total size of $2.64 billion, of which $180 million is held in cash and federal funds. Another $11 million is invested in term deposits, while about $430 million was invested in securities (mostly government bonds, of which $250 is made up of US Treasury and government agency securities ).

Thus, around 24% of the assets are invested in assets that should be rather liquid. The rest of $1.84 billion consists mostly of commercial real estate, but as mentioned at the start of this article, FMAO has strict LTV ratios that it adheres to.

Breakdown of loans

FMAO Investor Relations

And that quality control pays off. The total provision for loan losses is less than 1% of the loan portfolio and this does not mean that the bank is underestimating its risks. Let’s take a look at past due loans.

Delinquent loans

FMAO Investor Relations

By the end of 2021, less than $1.5 million of loans had reached a delinquency stage. Indeed, less than 0.1% of loans are non-current and the total amount of provisions is more than 10 times higher. So, while exposure to commercial real estate appears to be high, the quality of the loan portfolio appears to be quite good.

Investment thesis

Understandably not everyone wants to pay 14-16 times earnings (FY2022 earnings will likely increase to $2.3-2.35/share due to broadening asset base ) for a bank and the current tangible book value premium of $217 million may also be a deterrent.

While it is indeed not easy to pay these multiples (14 times earnings and about 2 times the tangible book), FMAO seems to offer some level of security given its consistently low loan loss provisions and the amount overdue loans. I don’t currently have a position but I will add this regional bank to my shortlist.

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