UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For quarterly period ended September 30, 2019

☐ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _______________ to ________________

Commission file number 000-55756

Farmers and Merchants Bancshares, Inc.

(Exact name of registrant as specified in its charter)

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

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

       (Address of principal executive offices)         (Zip Code)

(410) 374-1510

(Registrant’s telephone number, including area code)

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

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

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

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

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

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

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

Yes ☐ No ☑

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 2,959,777 as of November 7, 2019.

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Table of Contents

		Page
PART I – FINANCIAL INFORMATION		3
Item 1.	Financial Statements	3
	Consolidated balance sheets at September 30, 2019 (unaudited) and December 31, 2018	3
	Consolidated statements of income (unaudited) for the three and nine months ended September 30, 2019 and 2018	4
	Consolidated statements of comprehensive income (unaudited) for the three and nine months Ended September 30, 2019 and 2018	5
	Consolidated statements of changes in stockholders’ equity (unaudited) for the nine months ended September 30, 2019 and 2018	6
	Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2019 and 2018	7
	Notes to financial statements (unaudited)	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.	Controls and Procedures	41
PART II – OTHER INFORMATION		42
Item 1.	Legal Proceedings	42
Item 1A.	Risk Factors	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3.	Defaults upon Senior Securities	42
Item 4.	Mine Safety Disclosures	42
Item 5.	Other Information	42
Item 6.	Exhibits	43
SIGNATURES		43

2

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

	September 30,		December 31,
	2019		2018
	(Unaudited)
Assets
Cash and due from banks	$	16,281,158	$	11,480,608
Federal funds sold and other interest-bearing deposits		3,313,899		3,137,629
Cash and cash equivalents		19,595,057		14,618,237
Certificate of deposit in other bank		100,000		100,000
Securities available for sale		40,101,155		26,591,991
Securities held to maturity		19,509,907		18,127,067
Equity security at fair value		531,714		503,827
Federal Home Loan Bank stock, at cost		503,700		575,800
Mortgage loans held for sale		1,538,574		573,638
Loans, less allowance for loan losses of $2,546,114 and $2,509,334		336,748,866		340,900,635
Premises and equipment		4,913,640		5,075,310
Accrued interest receivable		978,300		990,529
Deferred income taxes		950,207		1,179,454
Other real estate owned		-		210,150
Bank owned life insurance		7,102,589		7,053,354
Other assets		1,931,803		657,885
	$	434,505,512	$	417,157,877
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing	$	58,298,592	$	62,717,520
Interest-bearing		313,897,923		291,995,483
Total deposits		372,196,515		354,713,003
Securities sold under repurchase agreements		7,583,212		11,012,000
Federal Home Loan Bank of Atlanta advances		1,000,000		3,000,000
Accrued interest payable		348,862		311,489
Other liabilities		4,382,403		2,726,678
		385,510,992		371,763,170
Stockholders' equity
Common stock, par value $.01 per share, authorized 5,000,000 shares; issued and outstanding 2,959,777 in 2019 and 1,682,997 shares in 2018		29,598		16,830
Additional paid-in capital		27,561,138		27,324,794
Retained earnings		21,276,789		18,621,382
Accumulated other comprehensive income		126,995		(568,299	)
		48,994,520		45,394,707
	$	434,505,512	$	417,157,877

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

3

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

	Three months ended						Nine months ended
	September 30,						September 30,
	2019			2018			2019			2018
Interest income
Loans, including fees	$	4,250,071		$	4,189,626		$	12,582,392		$	12,171,765
Investment securities - taxable		234,274			145,791			631,382			450,649
Investment securities - tax exempt		150,141			142,493			431,354			428,055
Federal funds sold and other interest earning assets		84,526			47,280			280,876			117,973
Total interest income		4,719,012			4,525,190			13,926,004			13,168,442
Interest expense
Deposits		916,452			604,697			2,577,229			1,543,023
Securities sold under repurchase agreements		29,190			42,841			82,912			112,242
Federal Home Loan Bank advances and other borrowings		10,769			16,480			42,517			125,427
Total interest expense		956,411			664,018			2,702,658			1,780,692
Net interest income		3,762,601			3,861,172			11,223,346			11,387,750
Provision for loan losses		(13,000	)		(100,000	)		-			25,000
Net interest income after provision for loan losses		3,775,601			3,961,172			11,223,346			11,362,750
Noninterest income
Service charges on deposit accounts		176,577			160,665			494,752			496,393
Mortgage banking income		144,268			105,144			249,867			219,805
Bank owned life insurance income		39,443			40,880			321,841			121,274
Unrealized gain (loss) on equity security		3,966			(3,869	)		18,721			(15,348	)
Write down of other real estate owned		-			(55,350	)		(210,150	)		(55,350	)
Gain on sale of SBA loans		-			3,317			139,535			63,825
Other fees and commissions		28,714			21,634			94,031			73,433
Total noninterest income		392,968			272,421			1,108,597			904,032
Noninterest expense
Salaries		1,358,208			1,344,759			3,993,998			3,892,971
Employee benefits		312,119			328,258			1,008,228			1,018,280
Occupancy		189,603			168,759			594,566			535,448
Furniture and equipment		149,191			148,945			460,271			475,953
Other		673,814			606,346			1,990,354			1,932,585
Total noninterest expense		2,682,935			2,597,067			8,047,417			7,855,237
Income before income taxes		1,485,634			1,636,526			4,284,526			4,411,545
Income taxes		307,724			327,838			784,508			835,674
Net income	$	1,177,910		$	1,308,688		$	3,500,018		$	3,575,871
Earnings per share - basic and diluted	$	0.40		$	0.45		$	1.19		$	1.22

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

4

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2019		2018			2019		2018
Net income	$	1,177,910	$	1,308,688		$	3,500,018	$	3,575,871
Other comprehensive income (loss), net of income taxes:
Securities available for sale
Net unrealized gain (loss) arising during the period		113,117		(115,428	)		959,257		(534,867	)
Income tax expense (benefit)		31,127		(31,762	)		263,963		(147,181	)
Total other comprehensive income (loss)		81,990		(83,666	)		695,294		(387,686	)
Total comprehensive income	$	1,259,900	$	1,225,022		$	4,195,312	$	3,188,185

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

5

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Nine months ended September 30, 2019 and 2018

(Unaudited except for year-end amounts)

					Additional					Accumulated other			Total
	Common stock				paid-in		Retained			comprehensive			stockholders'
	Shares		Par value		capital		earnings			income			equity
Balance, December 31, 2017		1,667,813	$	16,678	$	26,869,796	$	15,306,625		$	(394,167	)	$	41,798,932
Net income		-		-		-		3,575,871			-			3,575,871
Unrealized loss on securities available for sale net of income tax benefit of $147,181		-		-		-		-			(387,686	)		(387,686	)
Reclassification due to adoption of ASU No. 2016-01		-		-		-		(10,416	)		10,416			-
Cash dividends, $0.23 per share		-		-		-		(667,192	)		-			(667,192	)
Dividends reinvested		7,337		73		215,406		-			-			215,479
Shares Issued		50		1		1,549		-			-			1,550
Balance, September 30, 2018		1,675,200	$	16,752	$	27,086,751	$	18,204,888		$	(771,437	)	$	44,536,954
Balance, December 31, 2018		1,682,997	$	16,830	$	27,324,794	$	18,621,382		$	(568,299	)	$	45,394,707
Net income		-		-		-		3,500,018			-			3,500,018
Unrealized gain on securities available for sale net of income tax expense of $263,963		-		-		-		-			695,294			695,294
Adjustment due to adoption of ASU No. 2016-02		-		-		-		(91,447	)		-			(91,447	)
Cash dividends, $0.25 per share		-		-		-		(740,477	)		-			(740,477	)
Dividends reinvested		8,095		81		236,344		-			-			236,425
Stock dividend		1,268,685		12,687		-		(12,687	)		-			-
Balance, September 30, 2019		2,959,777	$	29,598	$	27,561,138	$	21,276,789		$	126,995		$	48,994,520

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

6

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Nine Months Ended September 30,	2019			2018
Cash flows from operating activities
Interest received	$	13,871,203		$	13,200,699
Fees and commissions received		1,111,256			789,631
Interest paid		(2,665,285	)		(1,664,444	)
Proceeds from sale of mortgage loans held for sale		12,266,054			10,513,771
Origination of mortgage loans held for sale		(13,230,990	)		(10,336,071	)
Cash paid to suppliers and employees		(7,504,291	)		(7,490,137	)
Income taxes paid, net of refunds received		(761,512	)		(588,898	)
		3,086,435			4,424,551
Cash flows from investing activities
Proceeds from maturity and call of securities
Available for sale		5,103,515			3,867,038
Held to maturity		1,043,420			165,000
Purchase of securities
Available for sale		(17,761,884	)		-
Held to maturity		(2,406,339	)		(63,242	)
Purchase of certificate of deposit		-			(242,000	)
Loans made to customers, net of principal collected		2,766,804			(9,473,587	)
Proceeds from sale of loans		1,582,364			729,511
Redemption of stock in FHLB of Atlanta		72,100			487,800
Purchases of premises, equipment and software		(60,267	)		(176,346	)
		(9,660,287	)		(4,705,826	)
Cash flows from financing activities
Net increase (decrease) in
Noninterest-bearing deposits		(4,418,928	)		(4,841,569	)
Interest-bearing deposits		21,902,440			34,559,400
Securities sold under repurchase agreements		(3,428,788	)		(9,605,084	)
Federal Home Loan Bank of Atlanta advances (repayments)		(2,000,000	)		(14,000,000	)
Dividends paid, net of reinvestments		(504,052	)		(451,713	)
Common stock issued		-			1,550
		11,550,672			5,662,584
Net increase (decrease) in cash and cash equivalents		4,976,820			5,381,309
Cash and cash equivalents at beginning of period		14,618,237			7,237,385
Cash and cash equivalents at end of period	$	19,595,057		$	12,618,694

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

7

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

Nine Months Ended September 30,	2019			2018
Reconciliation of net income to net cash provided by operating activities
Net income	$	3,500,018		$	3,575,871
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		259,626			289,097
Provision for loan losses		-			25,000
Lease expense in excess of rent paid		31,403			-
Write down of other real estate owned		210,150			55,350
Equity security dividend reinvested		(9,166	)		(8,383	)
Unrealized (gain) loss on equity security		(18,721	)		15,348
Gain on sale of loans		(139,535	)		(63,825	)
Decrease (increase) in mortgage loans held for sale		(964,936	)		177,700
Amortization of premiums and accretion of discounts, net		88,541			100,989
Increase (decrease) in
Deferred loan fees		(57,864	)		(10,665	)
Accrued interest payable		37,373			116,248
Other liabilities		200,398			312,878
Decrease (increase) in
Accrued interest receivable		12,229			51,305
Bank owned life insurance cash surrender value		(49,235	)		(121,274	)
Other assets		(13,846	)		(91,088	)
	$	3,086,435		$	4,424,551

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

8

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

1. Principles of consolidation

The consolidated financial statements include the accounts of Farmers and Merchants Bancshares, Inc. and its wholly owned subsidiaries, Farmers and Merchants Bank (the “Bank”), and Series Protected Cell FCB-4 (the “Insurance Subsidiary”), and one subsidiary of the Bank, Reliable Community Financial Services, Inc. (collectively the “Company”, “we”, “us”, or “our”). The Insurance Subsidiary constitutes an investment in a series of membership interests, 100% owned by the Company, issued by First Community Bankers Insurance Co., LLC, a Tennessee “series” limited liability company and licensed property and casualty insurance company. Intercompany balances and transactions 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 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 months and nine months ended September 30, 2019 do not necessarily reflect the results that may be expected for the entire fiscal year ending December 31, 2019 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, 2018, which are included in Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K.

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases (Topic 841).” Among other things, in the amendments in ASU 2016-02, lessees are required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company adopted the provisions of ASU 2016-02, effective January 1, 2019, by recording an asset of $1,400,855, a liability of $1,527,019, a $91,447 adjustment to retained earnings, and a $34,717 adjustment to deferred income taxes.

9

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

2. Basis of Presentation (continued)

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses”. The ASU sets forth a “current expected credit loss” (CECL) model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. However, in July 2019, the FASB proposed extending the implementation date to 2023 for SEC registered smaller reporting companies and private companies. The Company is considered a smaller reporting company. The proposal is expected to be enacted before the end of 2019. The Company has engaged a third-party vendor to assist in the implementation of this ASU.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820) - Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 modifies the disclosure requirements on fair value measurements in ASC Topic 820. The amendments in this update remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 will be effective for us on January 1, 2020, with early adoption permitted, and is not expected to have a material impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-14, “Compensation - Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20).” ASU 2018-14 amends and modifies the disclosure requirements for employers that sponsor defined benefit pension or other post-retirement plans. The amendments in this update remove disclosures that no longer are considered cost beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. ASU 2018-14 will be effective for us on January 1, 2021, with early adoption permitted, and is not expected to have a material impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” ASU 2018-15 clarifies certain aspects of ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which was issued in April 2015. Specifically, ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 does not affect the accounting for the service element of a hosting arrangement that is a service contract. ASU 2018-15 will be effective for us on January 1, 2020, with early adoption permitted, and is not expected to have a material impact on the Company’s financial statements.

Subsequent Events

The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the consolidated financial statements were issued. No significant subsequent events were identified which would affect the presentation of the financial statements except as noted below.

On September 16, 2019, the Board of Directors of the Company declared a 75% stock dividend payable on October 31, 2019 to stockholders of record as of October 4, 2019. Accordingly, all per share information, including note 8, reflects the stock dividend.

10

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

3. Investment Securities

Investments in debt securities are summarized as follows:

	Amortized		Unrealized		Unrealized		Fair
September 30, 2019	cost		gains		losses		value
Available for sale
State and municipal	$	1,378,761	$	11,464	$	-	$	1,390,225
SBA pools		2,388,707		-		51,269		2,337,438
Mortgage-backed securities		36,158,480		351,762		136,750		36,373,492
	$	39,925,948	$	363,226	$	188,019	$	40,101,155
Held to maturity
State and municipal	$	19,509,907	$	644,737	$	563	$	20,154,081

	Amortized		Unrealized		Unrealized		Fair
December 31, 2018	cost		gains		losses		value
Available for sale
State and municipal	$	1,506,011	$	11,161	$	10,667	$	1,506,505
SBA pools		2,779,411		-		60,039		2,719,372
Mortgage-backed securities		23,090,618		33,594		758,098		22,366,114
	$	27,376,040	$	44,755	$	828,804	$	26,591,991
Held to maturity
State and municipal	$	18,127,067	$	115,220	$	209,194	$	18,033,093

11

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

3. Investment Securities (continued)

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

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
September 30, 2019	cost		value		cost		value
Within one year	$	-	$	-	$	258,014	$	263,101
Over one to five years		258,761		260,187		330,000		330,611
Over five to ten years		1,120,000		1,130,038		2,948,579		3,029,811
Over ten years		-		-		15,973,314		16,530,558
		1,378,761		1,390,225		19,509,907		20,154,081
Mortgage-backed securities and
SBA pools, due in monthly installments		38,547,187		38,710,930		-		-
	$	39,925,948	$	40,101,155	$	19,509,907	$	20,154,081

December 31, 2018
Within one year	$	375,000	$	375,653	$	1,009,284	$	1,011,165
Over one to five years		260,587		249,920		590,522		598,528
Over five to ten years		870,424		880,932		1,858,695		1,876,364
Over ten years		-		-		14,668,566		14,547,036
		1,506,011		1,506,505		18,127,067		18,033,093
Mortgage-backed securities and
SBA pools, due in monthly installments		25,870,029		25,085,486		-		-
	$	27,376,040	$	26,591,991	$	18,127,067	$	18,033,093

Securities with a carrying value of $7,465,493 and $11,706,765 as of September 30, 2019 and December 31, 2018, respectively, were pledged as collateral for government deposits and securities sold under repurchase agreements.

12

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 September 30, 2019 and December 31, 2018.

September 30, 2019	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	$	-	$	-	$	252,000	$	563	$	252,000	$	563
SBA pools		-		-		2,337,438		51,269		2,337,438		51,269
Mortgage-backed securities		7,726,619		41,199		8,286,586		95,551		16,013,205		136,750
Total	$	7,726,619	$	41,199	$	10,876,024	$	147,383	$	18,602,643	$	188,582

December 31, 2018	Less than 12 months				12 months or more				Total
			Unrealized				Unrealized				Unrealized
Description of investments	Fair value		losses		Fair value		losses		Fair value		losses
State and municipal	$	3,435,052	$	42,080	$	3,740,467	$	177,781	$	7,175,519	$	219,861
SBA pools		443,288		6,707		2,276,084		53,332		2,719,372		60,039
Mortgage-backed securities		596,002		6,631		17,770,790		751,467		18,366,792		758,098
Total	$	4,474,342	$	55,418	$	23,787,341	$	982,580	$	28,261,683	$	1,037,998

Management has the ability and intent to hold securities classified as held to maturity until they mature, at which time the Company should receive full value for the securities. As of September 30, 2019 and December 31, 2018, management did not have the intent to sell any of the held to maturity or available for sale securities with unrealized losses before a recovery of cost. The unrealized losses detailed in the table above were due to increases in market interest rates over the yields available at the time the underlying securities were purchased as well as other market conditions for each particular security based upon the structure and remaining principal balance. The fair values of the investment securities are expected to recover as the securities approach their maturity dates or repricing dates or if market yields for such investments decline. Based on the foregoing factors, as of September 30, 2019 and December 31, 2018, management believes that these unrealized losses are temporary and, accordingly, have not been recognized in the Company’s consolidated statement of income.

13

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans

Major categories of loans are as follows:

	September 30,		December 31,
	2019		2018
Real estate:
Commercial	$	233,140,797	$	238,834,149
Construction and land development		16,132,994		18,265,505
Residential		69,049,698		63,024,106
Commercial		21,134,598		23,323,073
Consumer		309,902		494,009
		339,767,989		343,940,842
Less: Allowance for loan losses		2,546,114		2,509,334
Deferred origination fees net of costs		473,009		530,873
	$	336,748,866	$	340,900,635

Non-accrual loans, segregated by class of loans, were as follows:

	September 30,		December 31,
	2019		2018
Commercial real estate	$	-	$	988,811

At September 30, 2019, the Company had no nonaccrual loans.

At December 31, 2018, the Company had two nonaccrual commercial real estate loans to the same borrower totaling $988,811. The loans were secured by real estate and business assets and were personally guaranteed. Gross interest income of $115,168 would have been recorded during the year ended December 31, 2018 if these nonaccrual loans had been current and performing in accordance with the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The balance of the nonaccrual loans was net of charge-offs of $690,000 at December 31, 2018. The loans paid off during the nine months ended September 30, 2019 and the Company recorded a recovery of $15,299.

14

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans (continued)

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

					90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or More		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
September 30, 2019
Real estate:
Commercial	$	-	$	-	$	-	$	-	$	233,140,797	$	233,140,797	$	-
Construction and land development		-		-		-		-		16,132,994		16,132,994		-
Residential		31,857		-		-		31,857		69,017,841		69,049,698		-
Commercial		-		-		-		-		21,134,598		21,134,598		-
Consumer		-		-		-		-		309,902		309,902		-
Total	$	31,857	$	-	$	-	$	31,857	$	339,736,132	$	339,767,989	$	-
December 31, 2018
Real estate:
Commercial	$	-	$	-	$	988,811	$	988,811	$	237,845,338	$	238,834,149	$	-
Construction and land development		-		-		-		-		18,265,505		18,265,505		-
Residential		-		-		10,507		10,507		63,013,599		63,024,106		10,507
Commercial		-		25,000		-		25,000		23,298,073		23,323,073		-
Consumer		-		-		-		-		494,009		494,009		-
Total	$	-	$	25,000	$	999,318	$	1,024,318	$	342,916,524	$	343,940,842	$	10,507

Impaired loans, segregated by class of loans with average recorded investment and interest recognized for the nine months ended September 30, 2019 and the year ended December 31, 2018, are set forth in the following table:

	Unpaid		Recorded		Recorded
	Contractual		Investment		Investment		Total				Average
	Principal		With No		With		Recorded		Related		Recorded
	Balance		Allowance		Allowance		Investment		Allowance		Investment
September 30, 2019
Real estate:
Commercial	$	2,097,690	$	2,097,690	$	-	$	2,097,690	$	-	$	2,610,536
Residential		50,790		50,790		-		50,790		-		25,395
	$	2,148,480	$	2,148,480	$	-	$	2,148,480	$	-	$	2,635,931
December 31, 2018
Real estate:
Commercial	$	3,813,381	$	3,123,381	$	-	$	3,123,381	$	-	$	4,153,282
Residential		54,000		54,000		-		54,000		-		27,000
	$	3,867,381	$	3,177,381	$	-	$	3,177,381	$	-	$	4,180,282

Impaired loans include certain loans that have been modified in troubled debt restructurings (“TDRs”) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

15

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans (continued)

At September 30, 2019, the Company had one commercial real estate loan totaling $2,097,690 and one residential real estate loan totaling $50,790 that were classified as TDRs. All are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these two loans.

At December 31, 2018, the Company had one commercial real estate loan totaling $2,134,570 and one residential real estate loan totaling $54,000 that were classified as TDRs. The $54,000 loan was restructured as a TDR during 2018. All are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these two loans.

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 and Acceptable 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:

Pass/Watch

Loans graded as Pass/Watch are secured by generally acceptable assets which reflect above-average risk. The loans warrant closer scrutiny by management than is routine, due to circumstances affecting the borrower, the borrower’s industry, or the overall economic environment. Borrowers may reflect weaknesses such as inconsistent or weak earnings, break even or moderately deficit cash flow, thin liquidity, minimal capacity to increase leverage, or volatile market fundamentals or other industry risks. Such loans are typically secured by acceptable collateral, at or near appropriate margins, with realizable liquidation values.

Special Mention

A special mention loan 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 inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard 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. These loans require more intense supervision by Company management.

16

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans (continued)

Doubtful

A doubtful loan has all 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.

Loans by credit grade, segregated by loan type, are as follows:

			Above						Pass		Special
September 30, 2019	Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total
Real estate:
Commercial	$	-	$	3,056,485	$	90,131,537	$	108,685,401	$	22,306,448	$	-	$	8,960,926	$	-	$	233,140,797
Construction and land development		-		202,500		4,820,218		8,187,688		2,922,588		-		-		-		16,132,994
Residential		37,425		1,572,805		24,944,785		33,582,371		6,372,666		-		2,539,646		-		69,049,698
Commercial		192,622		37,519		9,850,802		8,138,156		2,915,499		-		-		-		21,134,598
Consumer		2,659		102,472		98,925		63,494		20,000		-		440		21,912		309,902
	$	232,706	$	4,971,781	$	129,846,267	$	158,657,110	$	34,537,201	$	-	$	11,501,012	$	21,912	$	339,767,989

			Above						Pass		Special
December 31, 2018	Excellent		average		Average		Acceptable		watch		mention		Substandard		Doubtful		Total
Real estate:
Commercial	$	-	$	3,632,231	$	101,633,803	$	104,454,812	$	20,356,642	$	-	$	8,756,661	$	-	$	238,834,149
Construction and land development		-		-		8,190,212		7,871,642		2,203,651		-		-		-		18,265,505
Residential		35,926		1,178,899		26,856,131		30,169,305		2,093,825		-		2,690,020		-		63,024,106
Commercial		977,054		24,180		12,373,503		7,130,122		2,818,214		-		-		-		23,323,073
Consumer		3,668		80,670		266,704		63,160		-		-		1,340		78,467		494,009
	$	1,016,648	$	4,915,980	$	149,320,353	$	149,689,041	$	27,472,332	$	-	$	11,448,021	$	78,467	$	343,940,842

The Company’s allowance for loan losses is based on management’s evaluation of the risks inherent in the Company’s loan portfolio and the general economy. The allowance for loan losses is maintained at the amount management considers adequate to cover estimated losses in loans receivable that are deemed probable based on information currently known to management. The allowance is based upon a number of factors, including current economic conditions, actual loss experience by pools of similar loans, diversification and size of the portfolio, adequacy of the collateral, the amount of non-performing loans and industry trends. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to make additional provisions for estimated loan losses based upon judgments different from those of management.

17

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

4. Loans (Continued)

The following table details activity in the allowance for loan losses by portfolio for the nine months ended September 30, 2019 and 2018, and the year ended December 31, 2018. 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 loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
September 30, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively
Real estate:
Commercial	$	1,754,372	$	(47,253	)	$	-	$	19,689	$	1,726,808	$	-	$	1,726,808	$	2,097,690	$	231,043,107
Construction and land development		196,374		(34,932	)		-		10,425		171,867		-		171,867		-		16,132,994
Residential		401,626		45,242			-		-		446,868		-		446,868		50,790		68,998,908
Commercial		102,610		(14,180	)		-		6,666		95,096		-		95,096		-		21,134,598
Consumer		10,428		(5,521	)		-		-		4,907		-		4,907		-		309,902
Unallocated		43,924		56,644			-		-		100,568		-		100,568		-		-
	$	2,509,334	$	-		$	-	$	36,780	$	2,546,114	$	-	$	2,546,114	$	2,148,480	$	337,619,509

													Allowance for loan losses				Outstanding loan
			Provision										ending balance evaluated				balances evaluated
	Beginning		for loan			Charge					Ending		for impairment:				for impairment:
September 30, 2018	balance		losses			offs			Recoveries		balance		Individually		Collectively		Individually		Collectively
Real estate:
Commercial	$	1,867,397	$	(252,948	)	$	-		$	202,660	$	1,817,109	$	210,686	$	1,606,423	$	3,825,462	$	234,744,541
Construction and land development		223,274		99,933			(22,116	)		1,462		302,553		-		302,553		-		23,971,982
Residential		247,953		143,681			-			-		391,634		-		391,634		44,254		60,271,255
Commercial		87,353		1,539			-			6,667		95,559		-		95,559		-		21,238,222
Consumer		7,027		(1,523	)		-			-		5,504		-		5,504		-		467,592
Unallocated		25,907		34,318			-			-		60,225		-		60,225		-		-
	$	2,458,911	$	25,000		$	(22,116	)	$	210,789	$	2,672,584	$	210,686	$	2,461,898	$	3,869,716	$	340,693,592

													Allowance for loan losses				Outstanding loan
			Provision										ending balance evaluated				balances evaluated
	Beginning		for loan			Charge					Ending		for impairment:				for impairment:
December 31, 2018	balance		losses			offs			Recoveries		balance		Individually		Collectively		Individually		Collectively
Real estate:
Commercial	$	1,867,397	$	372,315		$	(690,000	)	$	204,660	$	1,754,372	$	-	$	1,754,372	$	3,177,381	$	235,656,768
Construction and land development		223,274		(78,496	)		(12,115	)		63,711		196,374		-		196,374		-		18,265,505
Residential		247,953		153,673			-			-		401,626		-		401,626		-		63,024,106
Commercial		87,353		6,090			-			9,167		102,610		-		102,610		-		23,323,073
Consumer		7,027		3,401			-			-		10,428		-		10,428		-		494,009
Unallocated		25,907		18,017			-			-		43,924		-		43,924		-		-
	$	2,458,911	$	475,000		$	(702,115	)	$	277,538	$	2,509,334	$	-	$	2,509,334	$	3,177,381	$	340,763,461

18

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

5. Lease Commitments

The Company and its subsidiaries are obligated under operating lease for certain office premises.

The following table shows operating lease right of use assets and operating lease liabilities as of September 30, 2019:

	Consolidated Balance
	Sheet classification	September 30, 2019
Operating lease right of use asset	Other assets	$	1,297,761
Operating lease liabilities	Other liabilities	$	1,455,327

Operating lease cost included in occupancy expense in the statement of income for the three and nine months ended September 30, 2019 was $50,630 and $144,851, respectively.

Future minimum payments under the agreements, including those option years for which the Company is reasonably certain to renew, are as follows:

Year	Amount
2019	$	35,058
2020		141,680
2021		146,120
2022		150,707
2023		155,447
Thereafter		911,770
Total lease payments		1,540,782
Less imputed interest		(85,455	)
Present value of operating lease liabilities	$	1,455,327

For operating leases as of September 30, 2019, the weighted average remaining lease term is 9.65 years and the weighted average discount rate is 3.36%. During the three and nine months ended September 30, 2019, cash paid for amounts included in the measurement of lease liabilities was $39,500 and $113,448, respectively.

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.

19

Farmers and Merchants Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

6. Capital Standards (continued)

The Basel III Capital Rules became effective for the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). 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.

Under the revised prompt corrective action requirements, as of January 1, 2015, insured depository institutions are required to meet the following in order to qualify as “well capitalized”: (i) a common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8%; (iii) a total risk-based capital ratio of 10%; and (iv) a Tier 1 leverage ratio of 5%.

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

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.

The following table presents actual and required capital ratios as of September 30, 2019 and December 31, 2018, for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2019 and December 31, 2018 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.

20

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

6. Capital Standards (continued)

						Minimum
						Capital Adequacy					To Be Well
(Dollars in thousands)	Actual					Phase-In Schedule					Capitalized
September 30, 2019	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital (to risk-weighted assets)	$	50,078		14.37	%	$	36,590		10.50	%	$	34,848		10.00	%
Tier 1 capital (to risk-weighted assets)		47,532		13.64	%		29,621		8.50	%		27,878		8.00	%
Common equity tier 1 (to risk- weighted assets)		47,532		13.64	%		24,393		7.00	%		22,651		6.50	%
Tier 1 leverage (to average assets)		47,532		11.00	%		17,280		4.00	%		21,600		5.00	%

						Minimum
						Capital Adequacy					To Be Well
(Dollars in thousands)	Actual					Phase-In Schedule					Capitalized
December 31, 2018	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital (to risk-weighted assets)	$	47,857		13.50	%	$	34,996		9.88	%	$	35,439		10.00	%
Tier 1 capital (to risk-weighted assets)		45,348		12.80	%		27,908		7.88	%		28,351		8.00	%
Common equity tier 1 (to risk- weighted assets)		45,348		12.80	%		22,593		6.38	%		23,036		6.50	%
Tier 1 leverage (to average assets)		45,348		10.86	%		16,698		4.00	%		20,872		5.00	%

To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. As of September 30, 2019, the most recent notification from the FDIC has 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. Fair Value

Accounting standards define fair value as the price that would be received upon the sale of an asset or paid upon the transfer of a liability in an orderly transaction between market participants. The price in the principal market used to measure the fair value of the asset or liability is not adjusted for transaction costs. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

The standards require the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. The standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

21

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7. Fair Value (continued)

The fair value hierarchy is as follows:

● Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

● Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

● Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

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

● Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices from a nationally recognized securities pricing agent. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities.

● 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.

● Impaired loans: Nonrecurring fair value adjustments to impaired loans reflect full or partial write-downs and reserves that are based on the impaired loan’s observable market price or current appraised value of the collateral. Since the market for impaired 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.

22

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7. Fair Value (continued)

The following table summarizes financial assets measured at fair value on a recurring and nonrecurring basis as of September 30, 2019 and December 31, 2018, 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
September 30, 2019
Recurring
Available for sale securities
State and municipal	$	-	$	1,390,225	$	-	$	1,390,225
SBA pools		-		2,337,438		-		2,337,438
Mortgage-backed securities		-		36,373,492		-		36,373,492
	$	-	$	40,101,155	$	-	$	40,101,155
Equity security at fair value
Mutual fund	$	531,714	$	-	$	-	$	531,714
Nonrecurring
Impaired loans		-		-		2,148,480		2,148,480
December 31, 2018
Recurring
Available for sale securities
State and municipal	$	-	$	1,506,505	$	-	$	1,506,505
SBA pools		-		2,719,372		-		2,719,372
Mortgage-backed securities		-		22,366,114		-		22,366,114
	$	-	$	26,591,991	$	-	$	26,591,991
Equity security at fair value
Mutual fund	$	503,827	$	-	$	-	$	503,827
Nonrecurring
Other real estate owned	$	-	$	-	$	210,150	$	210,150
Impaired loans		-		-		3,177,381		3,177,381

23

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

7. Fair Value (continued)

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:

	September 30, 2019				December 31, 2018
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Financial assets
Level 2 inputs
Securities held to maturity	$	19,509,907	$	20,154,081	$	18,127,067	$	18,033,093
Mortgage loans held for sale		1,538,574		1,558,493		573,638		582,248
Federal Home Loan Bank stock		503,700		503,700		575,800		575,800
Level 3 inputs
Loans, net		336,748,866		335,928,611		340,900,635		337,385,842
Financial liabilities
Level 1 inputs
Noninterest-bearing deposits	$	58,298,592	$	58,298,592	$	62,717,520	$	62,717,520
Securities sold under repurchase agreements		7,583,212		7,583,212		11,012,000		11,012,000
Level 2 inputs
Interest-bearing deposits		313,897,923		314,857,923		291,995,483		281,761,483
Federal Home Loan Bank advances		1,000,000		1,000,000		3,000,000		2,971,000

The fair value of mortgage loans held for sale is determined by the expected sales price. Beginning in the first quarter 2018, the fair value of loans were determined using an exit price methodology as prescribed by ASU 2016-01, which became effective in the first quarter of 2018. The exit price estimation of fair value is based on the present value of the expected cash flows. The projected cash flows are based on the contractual terms of the loans, adjusted for prepayments and use of a discount rate based on the relative risk of the cash flows, taking into account the loan type, maturity of the loan, liquidity risk, servicing costs, and a required return on debt and capital (Level 3). In addition, an incremental liquidity discount is applied to certain loans, using historical sales of loans during periods of similar economic conditions as a benchmark. 

The fair values of interest-bearing checking, savings, and money market deposit accounts are equal to their carrying amounts. The fair values of fixed-maturity time deposits are estimated based on interest rates currently offered for deposits of similar remaining maturities.

The fair value of credit commitments are considered to be the same as the contractual amounts, and are not included in the table above. These commitments generate fees that approximate those currently charged to originate similar commitments.

24

Farmers and Merchants Bancshares, Inc. and Subsidiaries 

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

8. 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 and nine months ended September 30, 2019 and 2018. There were no common stock equivalents outstanding for the three and nine months ended September 30, 2019 or 2018.

On September 16, 2019, the Board of Directors of the Company declared a 75% stock dividend payable on October 31, 2019. Accordingly, the weighted average shares and the earnings per share reflect the stock dividend for all periods presented.

	Three months ended				Nine months ended
	September 30,				September 30,
	2019		2018		2019		2018
Net income	$	1,177,910	$	1,308,688	$	3,500,018	$	3,575,871
Weighted average shares outstanding		2,959,411		2,931,602		2,950,122		2,923,102
Earnings per share - basic and diluted	$	0.40	$	0.45	$	1.19	$	1.22

9. Retirement Plans

The Company has a profit sharing plan qualifying under Section 401(k) of the Internal Revenue Code. All employees age 21 or more 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 $46,398 and $45,130 for the three months ended September 30, 2019 and 2018, respectively, and $148,991 and $133,118 for the nine months ended September 30, 2019 and 2018, 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 $1,468 and $1,418 for the three months ended September 30, 2019 and 2018, respectively, and $4,405 and $4,255 for the nine months ended September 30, 2019 and 2018, respectively.

The Company adopted supplemental executive retirement plans for three 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. The Company recorded expenses, including interest, of $30,600 and $60,457 for the three months ended September 30, 2019 and 2018, respectively, and $91,800 and $180,457 for the nine months ended September 30, 2019 and 2018, respectively, for these plans.

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

25

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, 2018. References in this report to “us”, “we”, “our”, and “the Company” are to Farmers and Merchants Bancshares, Inc. and, unless the context clearly suggests otherwise, its consolidated subsidiaries.

Forward-Looking Statements

This report may contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report should be aware of the speculative nature of “forward-looking statements.” Statements that are not historical in nature, including those that include the words “intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words, are based on current expectations, estimates and projections about, among other things, the industry and the markets in which we operate, and they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic, market, or business conditions; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risks are discussed in detail in the registration statements and periodic reports that Farmers and Merchants Bancshares, Inc. files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

Farmers and Merchants Bancshares, Inc.

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

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

26

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

The Insurance Subsidiary represents one protected cell of a protected cell captive insurance company (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.

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, 2018, which were included in Item 8 of Part II of Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2018. On an on-going basis, management evaluates estimates, including those related to loan losses and intangible assets, other-than-temporary impairment (“OTTI”) of investment securities, income taxes, and fair value of investments. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements.

The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan 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 impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet.

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2018.

27

Financial Condition

Total assets increased by $17,347,635 or 4.2% to $434,505,512 at September 30, 2019 from $417,157,877 at December 31, 2018. The increase in total assets was due primarily to increases of $4,976,820 in cash and cash equivalents and $14,892,004 in debt securities, offset by a decrease in loans of $4,151,769.

Total liabilities increased $13,747,822 or 3.7% to $385,510,992 at September 30, 2019 from $371,763,170 at December 31, 2018. The increase was due primarily to an increase of $17,483,512 in deposits and $1,655,725 in other liabilities, offset by reductions of $3,428,788 in securities sold under repurchase agreements and $2,000,000 in FHLB advances.

Stockholders’ equity increased by $3,599,813 to $48,994,520 at September 30, 2019 from $45,394,707 at December 31, 2018. The increase was due primarily to net income for the period of $3,500,018 and an increase of $695,294 in accumulated other comprehensive income, offset by dividends paid, net of reinvestments, of $504,052.

Loans

Major categories of loans at September 30, 2019 and December 31, 2018 are as follows:

	September 30,				December 31,
	2019				2018
Real estate:
Commercial	$	233,140,797	69	%	$	238,834,149	70	%
Construction/Land development		16,132,994	5	%		18,265,505	5	%
Residential		69,049,698	20	%		63,024,106	18	%
Commercial		21,134,598	6	%		23,323,073	7	%
Consumer		309,902	0	%		494,009	0	%
		339,767,989	100	%		343,940,842	100	%
Less: Allowance for loan losses		2,546,114				2,509,334
Deferred origination fees net of costs		473,009				530,873
	$	336,748,866			$	340,900,635

Loans decreased by $4,151,769 or 1.2% to $336,748,866 at September 30, 2019 from $340,900,635 at December 31, 2018. The decline was due primarily to a $5,693,352 decrease in commercial real estate loans, a $2,132,511 decrease in construction/land development loans, and a decrease in commercial loans of $2,188,475, offset by an increase in residential loans of $6,025,592. The allowance for loan losses increased $36,780 to $2,546,114 at September 30, 2019 from $2,509,334 at December 31, 2018 as a result of net recoveries.

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 loan 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.

28

An age analysis of past due loans, segregated by class of loans, as of September 30, 2019 and December 31, 2018, is as follows:

					90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or more		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
September 30, 2019
Real estate:
Commerical	$	-	$	-	$	-	$	-	$	233,140,797	$	233,140,797	$	-
Construction/Land development		-		-		-		-		16,132,994		16,132,994		-
Residential		31,857		-		-		31,857		69,017,841		69,049,698		-
Commercial		-		-		-		-		21,134,598		21,134,598		-
Consumer		-		-		-		-		309,902		309,902		-
Total	$	31,857	$	-	$	-	$	31,857	$	339,736,132	$	339,767,989	$	-

					90 Days								Past Due 90
	30 - 59 Days		60 - 89 Days		or more		Total				Total		Days or More
	Past Due		Past Due		Past Due		Past Due		Current		Loans		and Accruing
December 31, 2018
Real estate:
Commerical	$	-	$	-	$	988,811	$	988,811	$	237,845,338	$	238,834,149	$	-
Construction/Land development		-		-		-		-		18,265,505		18,265,505		-
Residential		-		-		10,507		10,507		63,013,599		63,024,106		10,507
Commercial		-		25,000		-		25,000		23,298,073		23,323,073		-
Consumer		-		-		-		-		494,009		494,009		-
Total	$	-	$	25,000	$	999,318	$	1,024,318	$	342,916,524	$	343,940,842	$	10,507

It is the Company’s policy to place a loan in nonaccrual status whenever there is substantial doubt about the ability of the borrower to pay principal or interest on any outstanding credit. Management considers such factors as payment history, the nature of the collateral securing the loan, and the overall economic situation of the borrower when making a nonaccrual decision. Management closely monitors nonaccrual loans. The Company returns a nonaccrual loan to accruing status when (i) the loan is brought current with the full payment of all principal and interest arrearages, (ii) all contractual payments are thereafter made on a timely basis for at least six months, and (iii) management determines, based on a credit review, that it is reasonable to expect that future payments will be made as and when required by the contract.

Non-accrual loans as of September 30, 2019 and December 31, 2018, segregated by class of loans, were as follows:

	September 30,		December 31,
	2019		2018
Commercial real estate	$	-	$	988,811

At September 30, 2019, the Company had no nonaccrual loans or loans that were delinquent 90 days or greater.

29

At December 31, 2018, the Company had two nonaccrual commercial real estate loans to the same borrower totaling $988,811. The loans were secured by real estate and business assets and were personally guaranteed. Gross interest income of $115,168 would have been recorded during the year ended December 31, 2018 if these nonaccrual loans had been current and performing in accordance with the original terms. The Company allocated $0 of its allowance for loan losses to these nonaccrual loans. The balance of the nonaccrual loans was net of charge-offs of $690,000 at December 31, 2018. These loans paid off during the nine months ended September 30, 2019 and the Company recorded a recovery of $15,299.

Impaired loans as of September 30, 2019 and December 31, 2018 are set forth in the following table:

	September 30,		December 31,
	2019		2018
Impaired loans with no valuation allowance	$	2,148,480	$	3,177,381
Impaired loans with a valuation allowance		-		-
Total impaired loans	$	2,148,480	$	3,177,381

Impaired loans include certain loans that have been modified in troubled debt restructurings (“TDRs”) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

At September 30, 2019, the Company had one commercial real estate loan totaling $2,097,690 and one residential real estate loan totaling $50,790 that were classified as TDRs. All are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these two loans.

At December 31, 2018, the Company had one commercial real estate loan totaling $2,134,570 and one residential real estate loan totaling $54,000 that were classified as TDRs. The $54,000 loan was restructured as a TDR during 2018. All are included in impaired loans above. Each loan is paying as agreed. There have been no charge-offs or allowances associated with these two loans.

	September 30,		December 31,
	2019		2018
Restructured loans (TDRs):
Performing as agreed	$	2,148,480	$	2,188,570
Not performing as agreed		-		-
Total TDRs	$	2,148,480	$	2,188,570

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense.  The allowance for loan losses represents an amount which, in management’s judgment, will be adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with Accounting Standards Codification (“ASC”) Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions.

30

The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, classified and criticized loans and net charge-offs or recoveries, among other factors.

Although management believes that, based on information currently available, the Company’s allowance for loan losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Company’s level of allowance for loan losses will be sufficient to cover future loan losses incurred by the Company or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions at the time management determined the current level of the allowance for loan losses.

The following table details activity in the allowance for loan losses by portfolio for the nine months ended September 30, 2019 and 2018, and for the year ended December 31, 2018. 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 loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
September 30, 2019	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively
Real estate:
Commercial	$	1,754,372	$	(47,253	)	$	-	$	19,689	$	1,726,808	$	-	$	1,726,808	$	2,097,690	$	231,043,107
Construction and land development		196,374		(34,932	)		-		10,425		171,867		-		171,867		-		16,132,994
Residential		401,626		45,242			-		-		446,868		-		446,868		50,790		68,998,908
Commercial		102,610		(14,180	)		-		6,666		95,096		-		95,096		-		21,134,598
Consumer		10,428		(5,521	)		-		-		4,907		-		4,907		-		309,902
Unallocated		43,924		56,644			-		-		100,568		-		100,568		-		-
	$	2,509,334	$	-		$	-	$	36,780	$	2,546,114	$	-	$	2,546,114	$	2,148,480	$	337,619,509

31

												Allowance for loan losses				Outstanding loan
			Provision									ending balance evaluated				balances evaluated
	Beginning		for loan			Charge				Ending		for impairment:				for impairment:
September 30, 2018	balance		losses			offs		Recoveries		balance		Individually		Collectively		Individually		Collectively
Real estate:
Commercial	$	1,867,397	$	(252,948	)	$	-	$	202,660	$	1,817,109	$	210,686	$	1,606,423	$	3,825,462	$	234,744,541
Construction and land development		223,274		99,933			22,116		1,462		302,553		-		302,553		-		23,971,982
Residential		247,953		143,681			-		-		391,634		-		391,634		44,254		60,271,255
Commercial		87,353		1,539			-		6,667		95,559		-		95,559		-		21,238,222
Consumer		7,027		(1,523	)		-		-		5,504		-		5,504		-		467,592
Unallocated		25,907		34,318			-		-		60,225		-		60,225		-		-
	$	2,458,911	$	25,000		$	22,116	$	210,789	$	2,672,584	$	210,686	$	2,461,898	$	3,869,716	$	340,693,592

													Allowance for loan losses				Outstanding loan
			Provision										ending balance evaluated				balances evaluated
	Beginning		for loan			Charge					Ending		for impairment:				for impairment:
December 31, 2018	balance		losses			offs			Recoveries		balance		Individually		Collectively		Individually		Collectively
Real estate:
Commercial	$	1,867,397	$	372,315		$	(690,000	)	$	204,660	$	1,754,372	$	-	$	1,754,372	$	3,177,381	$	235,656,768
Construction and land development		223,274		(78,496	)		(12,115	)		63,711		196,374		-		196,374		-		18,265,505
Residential		247,953		153,673			-			-		401,626		-		401,626		-		63,024,106
Commercial		87,353		6,090			-			9,167		102,610		-		102,610		-		23,323,073
Consumer		7,027		3,401			-			-		10,428		-		10,428		-		494,009
Unallocated		25,907		18,017			-			-		43,924		-		43,924		-		-
	$	2,458,911	$	475,000		$	(702,115	)	$	277,538	$	2,509,334	$	-	$	2,509,334	$	3,177,381	$	340,763,461

The provision for loan losses was $0 for the nine months ended September 30, 2019 and $25,000 for the nine months ended September 30, 2018.

During the nine months ended September 30, 2019, the Company had no loan charge-offs and had recoveries of $36,780 from loans written off in prior periods. During the nine months ended September 30, 2018, the Company had loan charge-offs of $22,116 and had recoveries of $210,789 from loans written off in prior periods.

As of September 30, 2019, the Company had $9,352,531 of loans on a watch list, other than impaired loans, for which the borrowers have the potential for experiencing financial difficulties. As of December 31, 2018, the Company had $7,079,718 of such loans. These loans are subject to ongoing management attention and their classifications are reviewed regularly.

Investment Securities

Investments in debt securities increased by $14,892,004 or 33.3% to $59,611,062 at September 30, 2019 from $44,719,058 at December 31, 2018. At September 30, 2019 and December 31, 2018, the Company had classified 67% and 59%, respectively, of the investment portfolio as available for sale. The balance of the portfolio was classified as held to maturity.

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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 management has both the positive intent and ability to hold to maturity, are reported at amortized cost. Effective January 1, 2018, the Company began recording 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.

The following table sets forth the carrying value of investments in debt securities at September 30, 2019 and December 31, 2018:

	September 30,		December 31,
	2019		2018
Available for sale
State and municipal	$	1,390,225	$	1,506,505
SBA pools		2,337,438		2,719,372
Mortgage-backed securities		36,373,492		22,366,114
	$	40,101,155	$	26,591,991
Held to maturity
State and municipal	$	19,509,907	$	18,127,067

The following table sets forth the scheduled maturities of investments in debt securities at September 30, 2019:

	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Within 1 year	$	-	$	-	$	258,014	$	263,101
Over 1 to 5 years		258,761		260,187		330,000		330,611
Over 5 to 10 years		1,120,000		1,130,038		2,948,579		3,029,811
Over 10 years		-		-		15,973,314		16,530,558
		1,378,761		1,390,225		19,509,907		20,154,081
SBA Pools		2,388,707		2,337,438		-		-
Mortgage-backed securities		36,158,480		36,373,492		-		-
	$	39,925,948	$	40,101,155	$	19,509,907	$	20,154,081

SBA pools and mortgage-backed securities are due in monthly installments.

Other Real Estate Owned

The Bank owns one property in Cecil County, Maryland that was acquired through foreclosure in 2007 and is classified as other real estate owned (“OREO”). The Bank was required by statute to write this property down to $0 due to the length of time that it has been held by the Bank. The property is under contract to be sold by the end of 2020.

Other real estate owned at December 31, 2018 included the one property discussed above and had a carrying value of $210,150.

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Deposits

Total deposits increased by $17,483,512 or 4.9% to $372,196,515 at September 30, 2019 from $354,713,003 at December 31, 2018. The increase in deposits was due to a $5,953,085 increase in savings accounts, a $3,004,524 increase in interest bearing checking accounts and a $15,695,738 increase in time deposits, offset by a $2,750,907 decrease in money market accounts and a $4,418,928 decrease in noninterest-bearing accounts.

The following table shows the average balances and average costs of deposits for the nine months ended September 30, 2019 and 2018:

	September 30, 2019					September 30, 2018
	Average					Average
	Balance		Cost			Balance		Cost
Noninterest bearing demand deposits	$	58,922,450		0.00	%	$	62,012,619		0.00	%
Interest bearing demand deposits		55,466,882		0.32	%		45,806,884		0.18	%
Savings and money market deposits		100,681,579		0.31	%		97,016,596		0.24	%
Time deposits		148,466,527		1.98	%		130,107,665		1.34	%
	$	363,537,438		0.94	%	$	334,943,764		0.61	%

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 $53.2 million under a secured line of credit with the FHLB. The Bank also has a facility with the Federal Reserve Bank of Richmond (the “Reserve Bank”) under which the Bank can borrow approximately $22.8 million. Finally, the Bank has an $18,500,000 ($9,500,000 unsecured and $9,000,000 secured) overnight federal funds line of credit available from two commercial banks. FHLB advances of $1,000,000 and $3,000,000 were outstanding as of September 30, 2019 and December 31, 2018, respectively. There were no borrowings from the Reserve Bank or our commercial bank lenders at September 30, 2019 and December 31, 2018. 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.

Borrowings and Other Contractual Obligations

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

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.

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

	September 30,			December 31,
	2019			2018
Amount oustanding at period-end:
Securities sold under repurchase agreements	$	7,583,212		$	11,012,000
Federal Home Loan Bank advances mature in 2019		1,000,000			3,000,000
Weighted average rate paid at period-end:
Securites sold under repurchase agreements		1.13	%		1.07	%
Federal Home Loan Bank advances		1.99	%		1.50	%

Capital Resources and Adequacy

The Company 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, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

The Basel III Capital Rules became effective for the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). 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).

Additional information regarding the capital requirements that apply to us can be found in Note 6 to the consolidated financial statements presented elsewhere in this report and in Item 1 of Part I of Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2018 under the heading, “Supervision and Regulation – Capital Requirements”.

35

The following table presents actual and required capital ratios as of September 30, 2019 and December 31, 2018 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2019 and December 31, 2018, 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.

						Minimum
						Capital Adequacy					To Be Well
(Dollars in thousands)	Actual					Phased In Schedule					Capitalized
September 30, 2019	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital (to risk-weighted assets)	$	50,078		14.37	%	$	37,046		10.50	%	$	35,282		10.00	%
Tier 1 capital (to risk-weighted assets)		47,532		13.64	%		29,990		8.50	%		28,226		8.00	%
Common equity tier 1 (to risk- weighted assets)		47,532		13.64	%		24,697		7.00	%		22,933		6.50	%
Tier 1 leverage (to average assets)		47,532		11.00	%		17,307		4.00	%		21,633		5.00	%
December 31, 2018
Total capital (to risk-weighted assets)	$	47,857		13.50	%	$	34,996		9.88	%	$	35,439		10.00	%
Tier 1 capital (to risk-weighted assets)		45,348		12.80	%		27,908		7.88	%		28,351		8.00	%
Common equity tier 1 (to risk- weighted assets)		45,348		12.80	%		22,593		6.38	%		23,036		6.50	%
Tier 1 leverage (to average assets)		45,348		10.86	%		16,698		4.00	%		20,872		5.00	%

The Company intends to fund future growth primarily with cash, federal funds, maturities of investment securities and deposit growth. Management knows of no other trend or event that will have a material impact on capital.

Off-Balance Sheet Arrangements

In the normal course of business, the Bank makes commitments to extend credit and issues standby letters of credit. Outstanding loan commitments, unused lines of credit, and letters of credit as of September 30, 2019 and December 31, 2018 are as follows:

	September 30,		December 31,
	2019		2018
Loan commitments
Construction and land development	$	5,625,475	$	6,800,240
Commercial		6,988,541		1,143,217
Commercial real estate		8,688,778		2,853,913
Residential		3,267,400		1,557,500
	$	24,570,194	$	12,354,870
Unused lines of credit
Home-equity lines	$	3,770,253	$	3,594,847
Commercial lines		18,955,684		23,389,326
	$	22,725,937	$	26,984,173
Letters of credit	$	2,069,910	$	1,905,553

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.

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The maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the commitment. Loan commitments, lines of credit and letters of credit are made on the same terms, including collateral, as outstanding loans. Management is not aware of any accounting loss that is likely to be incurred as a result of funding its credit commitments.

RESULTS OF OPERATIONS

Comparison of Operating Results for the Nine Months Ended September 30, 2019 and 2018

General

Net income for the nine months ended September 30, 2019 was $3,500,018, compared to $3,575,871 for the same period of 2018. The decrease of $75,853 or 2.1% was due to a $164,404 decrease in net interest income and a $192,180 increase in noninterest expense, offset by a $204,565 increase in noninterest income, a $25,000 decrease in the loan loss provision, and a $51,166 decrease in income taxes.

Net Interest Income

Net interest income, which is the difference between interest income on loans and investments and interest expense on deposits and borrowings, was $11,223,346 for the nine months ended September 30, 2019, compared to $11,387,750 for the same period of 2018.

Total interest income for the nine months ended September 30, 2019 was $13,926,004, compared to $13,168,442 for the same period of 2018, an increase of $757,562 or 5.8%.

Total interest income on loans for the nine months ended September 30, 2019 increased by $410,627 when compared to the same period of 2018 due to a higher loan yield of 4.90% for the first nine months of 2019 versus 4.73% for the same period of 2018, offset by a $0.7 million lower average loan balance for the first nine months of 2019 when compared to the same period of 2018. Investment income for the first nine months of 2019 increased by $184,032 or 20.9% when compared to the same period of 2018 due to a $6.8 million higher average investment balance and an increase in fully-taxable equivalent yield to 3.06% for nine months ended September 30, 2019, compared to 2.96% for the same period of 2018. The fully-taxable equivalent yield on total interest-earning assets increased 10 basis points to 4.58% for the nine months ended September 30, 2019, compared to 4.48% for the same period of 2018. The average balance of total interest-earning assets increased by $14.7 million to $409.8 million for the nine months ended September 30, 2019, compared to $395.1 million for the same period of 2018.

Total interest expense for the nine months ended September 30, 2019 was $2,702,658, compared to $1,780,692 for the same period of 2018, an increase of $921,966, or 51.8%. The increase was due to a higher overall cost of funds on interest bearing deposits and borrowings of 1.14% for the nine months ended September 30, 2019, compared to 0.78% for the same period of 2018, and a $13.6 million increase in the average balance of interest-bearing liabilities to $317.0 million in the first six months of 2019, compared to $303.4 million in the same period of 2018. Cost of funds for time deposits increased to 1.98% for the nine months ended September 30, 2019 from 1.34% for the same period of 2018. Securities sold under repurchase agreements cost of funds increased to 1.23% for the first nine months of 2019 from 0.77% for the first nine months of 2018. FHLB advances and other borrowings cost of funds increased to 1.66% for the first nine months of 2019 from 1.51% for the first nine months of 2018.

Average noninterest-earning assets increased by $1.3 million to $17.4 million in the first nine months of 2019, compared to $16.1 million in the same period of 2018. Average noninterest-bearing deposits decreased by $3.1 million to $58.9 million during the first nine months of 2019, compared to $62.0 million in the same period of 2018. The average balance in stockholders’ equity increased by $4.1 million for the nine months ended September 30, 2019, when compared with the same period of 2018.

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The FRB raised rates nine times from 2015 to 2018. The cost of deposits and borrowings has increased significantly over that time. However, the yields on loans and investments have increased only slightly. During 2019, the FRB has reduced rates three times and management currently anticipates that more rate cuts will occur in the near term. This should begin to reduce our cost of funds. Management will closely monitor its asset-liability position so that it can respond to any future changes in interest rates and/or changes to the Bank’s interest rate spread.

The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the nine-month periods ended September 30, 2019 and 2018. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Nine Months Ended September 30, 2019							Nine Months Ended September 30, 2018
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	342,398,030	$	12,582,392		4.90	%	$	343,101,120	$	12,171,765		4.73	%
Securities, taxable		33,467,239		636,235		2.53	%		26,976,380		455,372		2.25	%
Securities, tax exempt		17,942,912		545,007		4.05	%		17,676,548		536,856		4.05	%
Federal funds sold and other interest-earning assets		16,034,923		293,151		2.44	%		7,367,251		125,224		2.27	%
Total interest-earning assets		409,843,104		14,056,785		4.58	%		395,121,299		13,289,217		4.48	%
Noninterest-earning assets		17,395,304							16,135,350
Total assets	$	427,238,408						$	411,256,649
Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	156,148,461		370,726		0.32	%	$	142,823,480		232,740		0.22	%
Certificates of deposit		148,466,527		2,206,503		1.98	%		130,107,665		1,310,283		1.34	%
Securities sold under repurchase agreements		9,006,627		82,912		1.23	%		19,376,770		112,242		0.77	%
FHLB advances and other borrowings		3,421,989		42,517		1.66	%		11,082,051		125,427		1.51	%
Total interest-bearing liabilities		317,043,604		2,702,658		1.14	%		303,389,966		1,780,692		0.78	%
Noninterest-bearing deposits		58,922,450							62,012,619
Noninterest-bearing liabilities		3,868,457							2,574,249
Total liabilities		379,834,511							367,976,834
Stockholders' equity		47,403,897							43,279,815
Total liabilities and stockholders' equity	$	427,238,408						$	411,256,649
Net interest income			$	11,354,127						$	11,508,525
Interest rate spread						3.44	%						3.70	%
Net yield on interest-earning assets						3.69	%						3.88	%
Ratio of average interest-earning assets to
Average interest-bearing liabilities						129.27	%						130.24	%

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis.

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Noninterest Income

Noninterest income for the nine months ended September 30, 2019 was $1,108,597, compared to $904,032 for the same period of 2018, an increase of $204,565 or 22.6%. The increase was primarily a result of a $75,710 higher gain on the sale of SBA loans, a $200,567 increase in bank owned life insurance income due to proceeds received from a policy, a $30,062 increase in mortgage banking income, and a $34,069 increase in the unrealized gain on equity security, offset by a $154,800 increase in the write-down of other real estate owned required by regulation.

Noninterest Expense

Noninterest expenses for the nine months ended September 30, 2019 totaled $8,047,417 compared to $7,855,237 for the same period of 2018, an increase of $192,180 or 2.5%. The increase was due primarily to increases in salaries and benefits of $90,975, an increase in occupancy of $59,118, and an increase in other of $57,769.

Income Tax Expense

Income tax expense for the nine months ended September 30, 2019 was $784,508, compared to $835,674 for the same period of 2018. The effective tax rate was 18.3% for the nine months ended September 30, 2019, compared to 18.9% for the same period of 2018. The decrease in income tax expense was due primarily to lower income before income taxes and a higher percentage of tax exempt revenue for the nine months ended September 30, 2019 when compared to the same period in 2018.

Comparison of Operating Results for the Three Months Ended September 30, 2019 and 2018

Net income for the three months ended September 30, 2019 was $1,177,910, compared to $1,308,688 for the same period of 2018. The decrease of $130,778 or 10.0% was due to a $98,571 decrease in net interest income, an $87,000 smaller reversal of the provision for loan losses, an $85,868 increase in noninterest expense, offset by a $120,547 increase in noninterest income and a $20,114 decrease in income taxes.

Net Interest Income

Net interest income was $3,762,601 for the three months ended September 30, 2019, compared to $3,861,172 for the same period of 2018.

Total interest income for the three months ended September 30, 2019 was $4,719,012, compared to $4,525,190 for the same period of 2018, an increase of $193,822 or 4.3%.

Total interest income on loans for the three months ended September 30, 2019 increased by $60,445 when compared to the same period of 2018 due to a higher loan yield of 4.97% for the three months ended September 30, 2019 versus 4.83% for the same period of 2018, offset by a $5.1 million lower average loan balance for the three months ended September 30, 2019 when compared to the same period of 2018. Investment income for the three months ended September 30, 2019 increased by $96,131 or 33.4% when compared to the same period of 2018 due to a $13.5 million higher average investment balance. The fully-taxable equivalent yield on total interest-earning assets was 4.61% for the three months ended September 30, 2019 compared to 4.58% for the same period in 2018. The average balance of total interest-earning assets increased by $14.5 million to $413.7 million for the three months ended September 30, 2019, compared to $399.2 million for the same period of 2018.

Total interest expense for the three months ended September 30, 2019 was $956,411, compared to 664,018 for the same period of 2018, an increase of $292,393 or 44.0%. The increase was due to a higher overall cost of funds on interest bearing deposits and borrowings of 1.20% for the three months ended September 30, 2019, compared to 0.87% for the same period of 2018, and a $15.6 million increase in the average balance of interest-bearing liabilities to $320.4 million for the three months ended September 30, 2019, compared to $304.8 million in the same period of 2018. Cost of funds for time deposits increased to 2.09% for the three months ended September 30, 2019 from 1.49% for the same period of 2018. Securities sold under repurchase agreements cost of funds increased to 1.24% for the three months ended September 30, 2019 from 0.95% for the same period of 2018.

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Average noninterest-earning assets increased by $3.0 million to $18.4 million for the three months ended September 30, 2019, compared to $15.4 million in the same period of 2018. Average noninterest-bearing deposits decreased by $4.4 million to $58.5 million during the three months ended September 30, 2019, compared to $62.9 million in the same period of 2018. The average balance in stockholders’ equity increased by $4.5 million for the three months ended September 30, 2019 when compared with the same period of 2018.

The following table sets forth information regarding the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest income and interest expense and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities for the three-month periods ended September 30, 2019 and 2018. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.

	Three Months Ended							Three Months Ended
	September 30, 2019							September 30, 2018
	Average							Average
	Balance		Interest		Yield			Balance		Interest		Yield
Assets:
Loans	$	342,050,963	$	4,250,071		4.97	%	$	347,166,050	$	4,189,626		4.83	%
Securities, taxable		38,073,848		235,978		2.48	%		25,669,789		147,363		2.30	%
Securities, tax exempt		18,759,966		191,462		4.08	%		17,630,254		178,493		4.05	%
Federal funds sold and other interest-earning assets		14,790,327		88,506		2.39	%		8,748,562		50,022		2.29	%
Total interest-earning assets		413,675,104		4,766,017		4.61	%		399,214,655		4,565,504		4.58	%
Noninterest-earning assets		18,389,380							15,378,346
Total assets	$	432,064,484						$	414,593,001
Liabilities and Stockholders’ Equity:
NOW, savings, and money market	$	156,924,885		124,712		0.32	%	$	145,991,228		95,337		0.26	%
Certificates of deposit		151,279,838		791,740		2.09	%		136,310,325		509,360		1.49	%
Securities sold under repurchase agreements		9,394,922		29,190		1.24	%		18,098,334		42,841		0.95	%
FHLB advances and other borrowings		2,826,120		10,769		1.52	%		4,369,565		16,480		1.51	%
Total interest-bearing liabilities		320,425,765		956,411		1.20	%		304,769,452		664,018		0.87	%
Noninterest-bearing deposits		58,548,434							62,940,499
Noninterest-bearing liabilities		4,523,982							2,807,530
Total liabilities		383,498,181							370,517,481
Stockholders' equity		48,566,303							44,075,520
Total liabilities and stockholders' equity	$	432,064,484						$	414,593,001
Net interest income			$	3,809,606						$	3,901,486
Interest rate spread						3.41	%						3.71	%
Net yield on interest-earning assets						3.68	%						3.91	%
Ratio of average interest-earning assets to
Average interest-bearing liabilities						129.10	%						130.99	%

Interest on tax-exempt securities and other tax-exempt investments are reported on fully taxable equivalent basis.

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Noninterest Income

Noninterest income for the three months ended September 30, 2019 was $392,968, compared to $272,421 for the same period of 2018, an increase of $120,547 or 44.3%. The increase was primarily a result of an increase in mortgage banking income of $39,124, a $15,912 increase in service charges on deposit accounts, and a $55,350 reduction in the write-down of other real estate owned.

Noninterest Expense

Noninterest expenses for the three months ended September 30, 2019 totaled $2,682,935, compared to $2,597,067 for the same period of 2018, an increase of $85,868 or 3.3%. The increase was due primarily to increases in other expenses of $67,468 and occupancy expenses of $20,844.

Income Tax Expense

Income tax expense for the three months ended September 30, 2019 was $307,724, compared to $327,838 for the same period of 2018. The effective tax rate was 20.7% for the three months ended September 30, 2019, compared to 20.0% for the same period of 2018.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our primary market risk is interest rate fluctuation and we have procedures in place to evaluate and mitigate this risk. This market risk and our procedures are described in Item 7 of Part II of Farmers and Merchants Bancshares, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2018 under the heading, “Interest Rate Risk”, which provides information as of December 31, 2018. Management believes that no material changes in market risk or our procedures used to evaluate and mitigate these risks have occurred since December 31, 2018.

Item 4. Controls and Procedures

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

An evaluation of the effectiveness of these disclosure controls as of September 30, 2019 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended September 30, 2019, 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.

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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.

Our 2016 U.S. consolidated federal income tax return is currently being audited.

In April 2018, we were notified by the IRS that our 2016 U.S. consolidated federal tax return was selected for audit. As part of its audit, the IRS is reviewing the deductions related to, and the income generated by, the Insurance Subsidiary. Management cannot predict whether any of our tax positions, including those relating to the Insurance Subsidiary, will be challenged by the IRS or, if challenged, whether we will be successful in defending those tax positions. Defending our tax positions and challenging adverse IRS tax conclusions could require us to expend significant funds and there can be no assurance that we would be successful in any such defense or challenge.  If we are not successful in defending a challenge, then we may be required to amend our tax return and pay additional taxes, interest, fines and/or penalties and our taxable earnings and/or the effective tax rate on our future earnings could increase substantially, any of which could have a material adverse effect on our business, financial condition and results of operations.

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.

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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 Interactive Data Files pursuant to Rule 405 of Regulation S-T (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:     November 13, 2019	/s/ James R. Bosley, Jr.
	James R. Bosley, Jr.
	President and Chief Executive Officer
	(Principal Executive Officer)

Date     November 13, 2019	/s/ Mark C. Krebs
	Mark C. Krebs, Treasurer and Chief Financial Officer
	(Principal Financial Officer & Principal Accounting Officer)

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