8-K: Farmers and Merchants Bancshares Reports Lower Q1 Earnings Due to Rising Interest Expenses

Farmers and Merchants Bancshares reported a net income of $1.22 million, or $0.39 per share, for the first quarter of 2024, down from $1.9 million, or $0.62 per share, in the same period last year, primarily due to increased interest expenses.

Summary

• Farmers and Merchants Bancshares, Inc. announced a net income of $1,219,987, or $0.39 per share, for the three months ended March 31, 2024.
• This is a decrease compared to the net income of $1,900,851, or $0.62 per share, for the same period in 2023.
• The primary reason for the decline in net income was higher interest expenses resulting from Federal Reserve rate increases.
• The company's return on average equity decreased to 9.40% from 15.49% year-over-year.
• The return on average assets also decreased to 0.61% from 1.05% year-over-year.
• Net interest income was $482,812 lower compared to the same period in 2023 due to a decrease in the net interest margin to 2.69% from 3.24%.
• Average interest-earning assets increased by $75.8 million to $779.9 million, partially offsetting the lower net interest margin.
• The cost of deposits and borrowings increased by 145 basis points to 2.48% due to Federal Reserve rate increases of 5.25% since March 2022.
• Average interest-bearing liabilities increased by $83.7 million to $626.9 million.
• Noninterest income increased by $122,001, primarily due to a gain on insurance proceeds, while noninterest expense increased by $355,032 due to core system conversion costs and higher salaries.
• Total assets decreased slightly to $795 million, while loans increased to $537 million.
• Deposits decreased to $656 million, primarily due to a reduction in brokered deposits.
• The company's tangible equity was $46 million, and the book value per share increased to $17.03.
• The company had $54 million outstanding in borrowings from the Federal Reserve Bank's Bank Term Funding Program (BTFP) at March 31, 2024.
• The company has access to approximately $364 million of liquidity.

Sentiment

Score: 4

Explanation: The sentiment is negative due to the significant decrease in profitability and key financial metrics. While there are some positive aspects, such as loan growth and liquidity, the overall tone is cautious due to the impact of rising interest rates.

Positives

• Average interest-earning assets increased by $75.8 million to $779.9 million.
• Noninterest income increased by $122,001 due to a gain on insurance proceeds.
• Loans increased to $537 million from $523 million at the end of the previous quarter.
• The book value of the company's common stock increased to $17.03 per share from $16.74 per share at the end of the previous quarter.
• The company has access to approximately $364 million of liquidity.
• The Upperco location, which was partially closed due to storm damage, reopened in March.
• The company is planning to open a new Towson commercial loan production office in the second quarter.

Negatives

• Net income decreased to $1.22 million, or $0.39 per share, from $1.9 million, or $0.62 per share, year-over-year.
• The return on average equity fell to 9.40% from 15.49% year-over-year.
• The return on average assets decreased to 0.61% from 1.05% year-over-year.
• Net interest margin decreased to 2.69% from 3.24% year-over-year.
• Net interest income was $482,812 lower compared to the same period in 2023.
• The cost of deposits and borrowings increased by 145 basis points to 2.48%.
• Noninterest expense increased by $355,032 due to core system conversion costs and higher salaries.
• Deposits decreased to $656 million from $681 million at the end of the previous quarter.

Risks

• Higher interest expenses due to Federal Reserve rate increases are negatively impacting earnings.
• The company's net interest margin has decreased.
• The cost of deposits and borrowings has increased significantly.
• The company is facing increased noninterest expenses due to core system conversion and higher salaries.
• The company's available for sale (AFS) investment portfolio has an unrealized loss of $24 million due to rising interest rates, although this does not impact regulatory capital.

Future Outlook

Management expects that interest rates will remain high for most of 2024, which will continue to impact earnings. The company anticipates that as fixed-rate commercial real estate loans reprice, the net interest margin should improve. The company also plans to increase the diversification of its portfolio with commercial and industrial loans.

Management Comments

• Gary A. Harris, President and CEO, commented 'Higher deposit and borrowing costs continue to negatively impact earnings.'
• Gary A. Harris also stated 'Current indications are that rates will remain high for most of 2024.'
• Gary A. Harris also stated 'However, our loan portfolio had significant growth during the first quarter, our asset quality remains high, and our liquidity position remains strong.'
• Gary A. Harris also stated 'I am happy to report that our Upperco location, which was partially closed for over 18 months due to storm damage, reopened in March.'
• Gary A. Harris also stated 'In addition, we look forward to the opening of our new Towson commercial loan production office in the second quarter.'

Industry Context

The results reflect the broader challenges faced by banks in a rising interest rate environment, where the cost of funds increases faster than the yield on assets. This is particularly impacting banks with a significant portion of fixed-rate loans. The company's strategy to diversify into adjustable-rate commercial and industrial loans is a common approach to mitigate this risk.

Comparison to Industry Standards

• The decrease in net interest margin from 3.24% to 2.69% is a significant drop and indicates that the bank is struggling to maintain profitability in the current interest rate environment. This is worse than many larger banks who have been able to maintain margins closer to 3.0% or higher.
• The return on average equity of 9.40% is below the industry average for community banks, which is typically around 10-12%.
• The return on average assets of 0.61% is also below the industry average for community banks, which is typically around 1.0%.
• The increase in interest expenses due to the Federal Reserve rate hikes is a common issue across the banking sector, but the magnitude of the impact on Farmers and Merchants Bancshares appears to be more pronounced than some of its peers.
• The company's strategy to increase adjustable-rate loans is similar to what other banks are doing to improve their net interest margin in the current environment. However, the success of this strategy will depend on the company's ability to attract and originate these loans.
• The company's reliance on the Federal Reserve Bank's BTFP for liquidity is also a common practice among community banks, but the elimination of new advances on March 11, 2024, may pose a challenge for future liquidity needs.

Stakeholder Impact

• Shareholders will be negatively impacted by the decrease in earnings and profitability.
• Employees may be impacted by the increase in salaries and benefits, as well as the core system conversion.
• Customers may be impacted by the changes in interest rates and the company's focus on commercial and industrial loans.
• Creditors may be impacted by the company's reliance on the Federal Reserve Bank's BTFP for liquidity.

Next Steps

• The company plans to open a new Towson commercial loan production office in the second quarter.
• The company will continue to monitor the impact of interest rate changes on its financial performance.
• The company will focus on increasing the diversification of its loan portfolio with commercial and industrial loans.

Key Dates

Keywords

net income, interest expense, net interest margin, Federal Reserve, interest rates, loans, deposits, earnings per share, return on equity, return on assets, liquidity, BTFP