FARMERS & MERCHANTS BANCORP 10-K

Item 8. Financial Statements and Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm (Moss Adams LLP, San Francisco, California, PCAOB ID: 659 ) 72 Consolidated Financial Statements Consolidated Balance Sheets as of December 31, 2021, and 2020 75 Consolidated Statements of Income for the three years ended December 31, 2021, 2020 and 2019 76 Consolidated Statements of Comprehensive Income for the three years ended December 31, 2021, 2020 and 2019 77 Consolidated Statements of Changes in Shareholders’ Equity for the three years ended December 31, 2021, 2020 and 2019 78 Consolidated Statements of Cash Flows for the three years ended December 31, 2021, 2020 and 2019 79 Notes to the Consolidated Financial Statements 80 71 Table of Contents Report of Independent Registered Public Accounting Firm To the Shareholders and the Board of Directors of Farmers & Merchants Bancorp Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Farmers & Merchants Bancorp and subsidiaries (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2021 and 2020, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO. Basis for Opinions The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting in Item 9A. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the consolidated financial statements. 72 Table of Contents Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and (1) relates to accounts or disclosures that are material to the consolidated financial statements; and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Allowance for Credit Losses As described in Notes 1 and 5 to the consolidated financial statements, the Company ’ s allowance for credit losses balance was $61 million at December 31, 2021. The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company’s loan & lease portfolio as of the balance sheet date. The overall allowance consists of three primary components: specific reserves related to impaired loans & leases; general reserves for inherent losses related to loans & leases that are not impaired; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors. The determination of the general reserve for loans & leases that are collectively evaluated for impairment is based on estimates made by management including, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole. We identified management’s risk ratings of loans and the estimation of qualitative factors, both of which are used in the allowance for credit losses calculation and require significant management judgment as critical audit matters. The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability. The qualitative factors are used to estimate losses related to factors that are not captured in the historical loss rates such as economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, and the character of the loan & lease portfolio, and are based on management’s evaluation of available internal and external data and involves significant management judgement. Auditing management’s judgments regarding the determination of risk ratings and qualitative factors applied to the allowance for credit losses involved a high degree of subjectivity and judgement. The following are the primary procedures we performed to address these critical audit matters. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s calculation of the allowance for credit losses, including: • Determination of the accuracy of risk ratings of loans • Determination of the appropriateness of the changes in risk ratings of loans • Evaluating the appropriate approval of the changes in risk ratings of loans • Identification and determination of the significant assumptions used in the measurement of the qualitative factors • Evaluation of the appropriateness of the changes made to the qualitative factors We also tested management’s process to develop the risk ratings of loans and the estimation of qualitative factors which involved the following: • Testing a risk-based targeted selection of loans to gain substantive evidence that the Company is appropriately rating these loans in accordance with its policies, and that the risk ratings for the loans are reasonable • Performing a loan grade analysis by loan type to determine whether any large fluctuations occurred that could not be reasonably explained • Obtaining management’s analysis and supporting documentation related to the qualitative factors and testing whether the qualitative factors used in the calculation of the allowance for credit losses are reasonable • Performing an independent analysis to evaluate the reasonableness of the qualitative factors used by management to account for inherent losses that are not captured in the calculation of the allowance for credit losses based on historical loss rates alone 73 Table of Contents /s/ Moss Adams LLP San Francisco, California March 16, 2022 We have served as the Company’s auditor since 2013. 74 Table of Contents Farmers & Merchants Bancorp Consolidated Balance Sheets December 31, (Dollars in thousands, except share and per share amounts) 2021 2020 ASSETS Cash and due from banks $ 52,499 $ 66,327 Interest bearing deposits with banks 662,961 317,510 Total cash and cash equivalents 715,460 383,837 Securities available for sale, at fair value 270,454 807,732 Securities held to maturity, at amortized cost 737,052 68,933 Total investment securities 1,007,506 876,665 Non-marketable securities 15,549 12,693 Loans and leases held for investment 3,237,177 3,099,592 Allowance for credit losses ( 61,007 ) ( 58,862 ) Loans held for investment, net 3,176,170 3,040,730 Bank-owned life insurance 71,411 69,235 Premises and equipment, net 47,730 50,147 Deferred income tax assets, net 25,542 17,093 Accrued interest receivable 18,098 20,333 Goodwill 11,183 11,183 Other intangibles 3,402 4,013 Other real estate owned 873 873 Other assets 84,796 63,651 TOTAL ASSETS $ 5,177,720 $ 4,550,453 LIABILITIES AND SHAREHOLDERS’ EQUITY Deposits: Noninterest bearing $ 1,750,330 $ 1,475,425 Interest bearing: Demand 1,097,337 902,487 Savings and money market 1,400,000 1,260,487 Certificate of deposits 392,485 421,868 Total interest bearing 2,889,822 2,584,842 Total deposits 4,640,152 4,060,267 Subordinated debentures 10,310 10,310 Other liabilities 64,122 56,211 TOTAL LIABILITIES 4,714,584 4,126,788 SHAREHOLDERS’ EQUITY Preferred shares, no par value, 1,000,000 shares authorized and, no ne issued or outstanding - - Common shares, $ 0.01 par value, 7,500,000 authorized, 789,646 issued and outstanding at December 31, 2021 and 2020, respectively 8 8 Additional paid in capital 77,516 77,516 Retained earnings 387,331 333,070 Accumulated other comprehensive (loss) / income ( 1,719 ) 13,071 TOTAL SHAREHOLDERS’ EQUITY 463,136 423,665 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 5,177,720 $ 4,550,453 See accompanying notes to the consolidated financial statements. 75 Table of Contents Farmers & Merchants Bancorp Consolidated Statements of Income Year Ended December 31, (Dollars in thousands, except share and per share amounts) 2021 2020 2019 Interest income Interest and fees on loans and leases $ 147,208 $ 143,383 $ 137,237 Interest and dividends on investments 17,158 14,704 12,476 Interest on deposits with others 902 1,207 4,909 Total interest income 165,268 159,294 154,622 Interest expense Deposits 4,017 9,113 12,640 Borrowed funds - - - Subordinated debentures 315 378 554 Total interest expense 4,332 9,491 13,194 Net interest income 160,936 149,803 141,428 Provision for credit losses 1,910 4,500 200 Net interest income after provision for credit losses 159,026 145,303 141,228 Noninterest income Card processing 6,959 5,536 5,120 Service charges on deposit accounts 2,972 2,637 3,673 Increase in cash surrender value of BOLI 2,175 2,088 2,031 Gain on sale of investment securities 2,554 40 1 Net gain on deferred compensation investments 2,614 1,777 2,625 Other 3,782 2,976 2,877 Total noninterest income 21,056 15,054 16,327 Noninterest expense Salaries and employee benefits 63,860 56,950 55,250 Net gain on deferred compensation benefits 2,614 1,777 2,625 Occupancy 4,675 4,640 4,295 Data Processing 4,967 4,994 4,921 FDIC insurance 1,237 517 624 Marketing 1,097 922 1,254 Legal 140 128 2,347 Other 13,171 12,478 10,926 Total noninterest expense 91,761 82,406 82,242 INCOME BEFORE INCOME TAXES 88,321 77,951 75,313 Income tax expense 21,985 19,217 19,277 NET INCOME $ 66,336 $ 58,734 $ 56,036 Earnings per common share: Basic $ 84.01 $ 74.03 $ 71.18 Diluted $ 84.01 $ 74.03 $ 71.18 See accompanying notes to the consolidated financial statements. 76 Table of Contents FARMERS & MERCHANTS BANCORP Consolidated Statements of Comprehensive Income Year Ended December 31, (Dollars in thousands) 2021 2020 2019 Net income $ 66,336 $ 58,734 $ 56,036 Other comprehensive income Unrealized holding (losses)/gains on securities available for sale ( 17,986 ) 13,905 8,936 Reclassification adjustment for (gains)/losses on available for sale securities ( 2,554 ) ( 40 ) ( 1 ) Amortization of unrealized loss on securities transferred to held to maturity ( 457 ) - - Net unrealized holding (losses)/gains on securities available for sale ( 20,997 ) 13,865 8,935 Income tax income/(expense) 6,207 ( 4,099 ) ( 2,642 ) Other comprehensive (loss)/income, net of tax ( 14,790 ) 9,766 6,293 Total comprehensive income $ 51,546 $ 68,500 $ 62,329 See accompanying notes to the consolidated financial statements. 77 Table of Contents Farmers & Merchants Bancorp Consolidated Statements of Changes in Shareholders’ Equity For the Three Years Ended December 31, 2021 (Dollars in thousands, except share amounts) Common Shares Amount Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive (Loss)/Income Total Balance as of January 1, 2019 783,721 $ 8 $ 72,974 $ 241,221 $ ( 2,988 ) $ 311,215 Net income - - - 56,036 - 56,036 Other comprehensive income, net of tax - - - - 6,293 6,293 Cash dividends declared ($ 14.20 per share) - - - ( 11,221 ) - ( 11,221 ) Issuance of common stock 9,312 - 6,973 - - 6,973 Balance as of December 31, 2019 793,033 $ 8 $ 79,947 $ 286,036 $ 3,305 $ 369,296 Net income - - - 58,734 - 58,734 Other comprehensive income, net of tax - - - - 9,766 9,766 Cash dividends declared ($ 14.75 per share) - - - ( 11,700 ) - ( 11,700 ) Issuance of common stock 523 - 403 - - 403 Repurchase of common stock ( 3,910 ) - ( 2,834 ) - - ( 2,834 ) Balance as of December 31, 2020 789,646 $ 8 $ 77,516 $ 333,070 $ 13,071 $ 423,665 Net income - - - 66,336 - 66,336 Other comprehensive loss, net of tax - - - - ( 14,790 ) ( 14,790 ) Cash dividends declared ($ 15.30 per share) - - - ( 12,075 ) - ( 12,075 ) Balance as of December 31, 2021 789,646 $ 8 $ 77,516 $ 387,331 $ ( 1,719 ) $ 463,136 See accompanying notes to the consolidated financial statements. 78 Table of Contents Farmers & Merchants Bancorp Consolidated Statements of Cash Flows Year Ended December 31, (Dollars in thousands) 2021 2020 2019 Cash flows from operating activities: Net income $ 66,336 $ 58,734 $ 56,036 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 1,910 4,500 200 Depreciation and amortization 2,632 2,769 2,756 Net amortization of securities premiums and discounts 1,446 1,159 510 Increase in cash surrender value of BOLI ( 2,176 ) ( 2,087 ) ( 2,031 ) Decrease/(increase) in deferred income taxes, net ( 880 ) ( 1,962 ) ( 3,254 ) (Gains)/losses on sale of securities available for sale ( 2,554 ) ( 40 ) ( 1 ) Net changes in: Other assets ( 12,432 ) ( 818 ) 21,659 Other liabilities 5,681 ( 4,136 ) 4,983 Net cash provided by operating activities 59,963 58,119 80,858 Cash flows from investing activities: Net change in loans held for investment ( 137,216 ) ( 427,049 ) ( 102,193 ) Purchase of available for sale securities ( 257,231 ) ( 670,550 ) ( 652,280 ) Purchase of held to maturity securities ( 395,176 ) ( 22,020 ) ( 16,376 ) Purchase of non-marketable securities ( 2,856 ) - - Maturities/sales of available for sale securities 458,855 383,257 644,244 Maturities of held to maturity securities 43,287 13,299 10,871 Purchase of premises and equipment ( 2,069 ) ( 7,709 ) ( 15,537 ) Purchase of other investments ( 8,192 ) ( 6,063 ) ( 4,400 ) Redemption of other investments 2,752 - - Proceeds from sale of assets 1,696 81 41 Net cash used in investing activities ( 296,150 ) ( 736,754 ) ( 135,630 ) Cash flows from financing activities: Net increase in deposits 579,885 782,248 215,187 Cash dividends paid ( 12,075 ) ( 11,700 ) ( 11,221 ) Net cash used in share repurchase program - ( 2,834 ) - Net provided by financing activities 567,810 767,714 203,966 Net change in cash and cash equivalents 331,623 89,079 149,194 Cash and cash equivalents, beginning of year 383,837 294,758 145,564 Cash and cash equivalents, end of year $ 715,460 $ 383,837 $ 294,758 Supplemental disclosures of cash flow information: Cash paid for interest $ 4,369 $ 10,903 $ 11,755 Income taxes paid $ 29,941 $ 9,581 $ 7,342 Issuance of common stock $ - $ 403 $ 6,973 Supplemental disclosures of non-cash transactions: Investment securities available for sale transferred to held to maturity $ 316,925 $ - $ - Unrealized (losses)/gains on securities available for sale $ 20,540 $ ( 13,865 ) $ 8,935 Lease liabilities from obtaining right-of-use assets $ 295 $ - $ 5,645 See accompanying notes to the consolidated financial statements. 79 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS Note 1—Summary of Significant Accounting Policies Nature of Operations and basis of consolidation — Farmers & Merchants Bancorp (“FMCB”) is a Delaware corporation headquartered in Lodi, California and is the bank holding company for Farmers & Merchants Bank of Central California (the “Bank” or “F&M Bank” and together with FMCB, the “Company”). The Company operates all business activities through the Bank, which was organized in 1916. F&M Bank is a California state-chartered bank. F&M Bank operates under the supervision of the California Department of Financial Protection and Innovation (“DFPI”), and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”). F&M Bank is not a member of the Federal Reserve System; however, FMCB operates as a bank holding company under the Federal Bank Holding Company Act of 1956, subject to and under the supervision of and examination by the Board of Governors of the Federal Reserve System (“FRB”) and is the sole shareholder of F&M Bank. Both FMCB and F&M Bank are subject to periodic examination by these applicable federal and state regulatory agencies and file periodic reports and other information with the agencies. The Company considers F&M Bank to be its sole operating segment. The Company’s other wholly-owned subsidiaries include F & M Bancorp, Inc. and FMCB Statutory Trust I. F & M Bancorp, Inc. was created in March 2002 to protect the name F & M Bank. During 2002, the Company completed a fictitious name filing in California to begin using the streamlined name “F & M Bank” as part of a larger effort to enhance the Company’s image and build brand name recognition. In December 2003, the Company formed a wholly owned subsidiary, FMCB Statutory Trust I, for the sole purpose of issuing Trust Preferred Securities and related subordinated debentures, in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). FMCB Statutory Trust I is a non-consolidated subsidiary. Through its network of 29 banking offices and 3 ATMs, F&M Bank emphasizes personalized service along with a broad range of banking services to businesses and individuals located in the service areas of its offices. Although the Company focuses on marketing its services to small and medium-sized businesses, a broad range of retail banking services are also made available to the local consumer market. F&M Bank branches are located through the mid Central Valley of California, including Sacramento, San Joaquin, Solano, Stanislaus and Merced counties and the east region of the San Francisco Bay Area including Napa and Contra Costa counties. F&M Bank provides a broad complement of lending products, including commercial, commercial real estate, real estate construction, agribusiness, consumer, credit card, residential real estate loans, and equipment leases. Commercial products include term loans, leases, lines of credit and other working capital financing and letters of credit. Financing products for individuals include automobile financing, lines of credit, residential real estate, home improvement and home equity lines of credit. F&M Bank also offers a wide range of deposit instruments. These include checking, savings, money market, time certificates of deposit, individual retirement accounts and online banking services for both business and personal accounts. F&M Bank offers a wide range of specialized services designed for the needs of its commercial accounts. These services include a credit card program for merchants, lockbox and other collection services, account reconciliation, investment sweep, on-line account access, and electronic funds transfers by way of domestic and international wire and automated clearinghouse. 80 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued F&M Bank makes investment products available to customers, including mutual funds and annuities. These investment products are offered through a third-party, which employs investment advisors to meet with and provide investment advice to the Company’s customers. The consolidated financial statements of the Company include the accounts of FMCB together with the Bank. All intercompany transactions and balances have been eliminated. Use of estimates — The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses (“ACL”), the determination of the fair value of certain financial instruments, and deferred income tax assets. Reclassifications — Certain amounts in the prior years’ financial statements have been reclassified to conform to the current year’s presentation. There was no impact on net income or retained earnings as a result of any reclassification. Cash and cash equivalents — Cash and cash equivalents consist of cash on hand, amounts due from banks, interest bearing deposits, and federal funds sold, all of which have original maturities of three months or less. The Company places its cash with high credit quality institutions. The amounts on deposit fluctuate and, at times, exceed the insured limit by the FDIC, which potentially subjects the Company to credit risk. For these instruments, the carrying amount is a reasonable estimate of fair value. Investment securities — Investment securities are classified as held to maturity (“HTM”) when the Company has the positive intent and ability to hold the securities to maturity. Investment securities are classified as available for sale (“AFS”) when the Company has the intent of holding the security for an indefinite period of time, but not necessarily to maturity. The Company determines the appropriate classification at the time of purchase, and periodically thereafter. Investment securities classified at HTM are carried at amortized cost. Investment securities classified at AFS are reported at fair value. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Debt securities classified as held to maturity are carried at cost. Debt securities classified as available for sale are measured at fair value. Unrealized holding gains and losses on debt securities classified as available for sale are excluded from earnings and are reported net of tax as accumulated other comprehensive income (AOCI), a component of shareholders’ equity, until realized. When AFS securities, specifically identified, are sold, the unrealized gain or loss is reclassified from AOCI to non-interest income. When the estimated fair value of a security is lower than the book value, a security is considered impaired and the Company evaluates it for other-than-temporary impairment (“OTTI”). If there is intent to sell the security, or if the Company will be required to sell the security, or if the Company believes it will not recover the entire cost basis of the security, the security is other-than-temporarily impaired and impairment is recognized. The amount of impairment resulting from credit loss is recognized in earnings and impairment related to all other factors, such as general market conditions, is recognized in AOCI. 81 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Management considers a number of factors in its analysis of whether a decline in a security’s estimated fair value is OTTI. Certain factors considered include, but are not limited to: (a) the length of time and the extent to which the security has been in an unrealized loss position, (b) changes in the financial condition of the issuer, (c) the payment structure of debt securities, (d) adverse changes in ratings issued by rating agencies, (e) and the intent and ability of the Company to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Interest income is recognized based on the coupon rate, and is increased by the accretion of discounts earned or decreased by the amortization of premiums paid. The amortization of premiums or the accretion of discounts are recognized in interest income using the effective interest method over the period of maturity. Non-marketable equity securities — Non-marketable equity securities primarily consist of Federal Home Loan Bank (“FHLB”) stock. FHLB stock is restricted because such stock may only be sold to FHLB at its par value. Due to the restrictive terms, and the lack of a readily determinable market value, FHLB stock is carried at cost. The investments in FHLB stock are required investments related to the Bank’s borrowings from FHLB. FHLB obtains its funding primarily through issuance of consolidated obligations of the FHLB system. The U.S. government does not guarantee these obligations, and each of the regional FHLBs are jointly and severally liable for repayment of each other’s debt. Loans and leases held for investment — Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance adjusted for any charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on acquired loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the effective interest method. Loans are placed on non-accrual status when they become 90 days or more past due or at such earlier time as management determines timely recognition of interest to be in doubt. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, collection efforts, and the borrower’s financial condition, that the borrower will be unable to make payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received, or payment is considered certain. Loans may be returned to accrual status when all delinquent interest and principal amounts contractually due are brought current and future payments are reasonably assured. Impaired loan and leases — The Company considers loans impaired when, based on current information and events, it is probable the Company will be unable to collect all principal and interest payments due according to the contractual terms of the loan agreement. Such loans are generally classified as Substandard or Doubtful loans. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral, if the loan is collateral dependent. Changes in these values are recorded to provision for loan losses and as adjustments to the ACL. 82 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Restructured loan and leases — A restructuring of a loan or lease constitutes a troubled debt restructuring (“TDR”) if the Company for economic or legal reasons related to the borrower’s (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction) financial difficulties grants a concession to the borrower that it would not otherwise consider. Restructured loans and leases typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans and leases that are on nonaccrual status at the time they become TDR, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment as described above. Generally, the Company will not restructure loans or leases for borrowers unless: (1) the existing loan or lease is brought current as to principal and interest payments; and (2) the restructured loan or lease can be underwritten to reasonable underwriting standards. If these standards are not met other actions will be pursued (e.g., foreclosure) to collect outstanding loan or lease amounts. After restructure, a determination is made whether the loan or lease will be kept on accrual status based upon the underwriting and historical performance of the restructured credit. On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law and was amended and extended by the Consolidated Appropriations Act of 2021 (“H.R. 133”) on December 21, 2020. The CARES Act and H.R. 133 provide financial institutions, under specific circumstances, the opportunity to temporarily suspend certain requirements under generally accepted accounting principles related to modifications for a limited period to account for the effects of COVID-19. In March 2020, a joint statement was issued by federal and state regulatory agencies, after consultation with the FASB, to clarify that short-term loan modifications are not TDRs if made on a good-faith basis in response to COVID-19 to borrowers who were current prior to any relief. Under this guidance, six months is provided as an example of short-term, and current is defined as less than 30 days past due at the time the modification program is implemented. The guidance also provides that these modified loans generally will not be classified as nonaccrual during the term of the modification. See “Note 2 – Risks and Uncertainties” for additional information on the CARES Act, H.R. 133 and the impact of COVID-19 on the Company. 83 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Allowance for credit losses — The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company’s loan & lease portfolio as of the balance sheet date. The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan & lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary components: specific reserves related to impaired loans and leases; general reserves for inherent losses related to loans and leases that are not impaired; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors. The determination of the general reserve for loans and leases that are collectively evaluated for impairment is based on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, qualitative factors that include economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole. The Company maintains a separate allowance for each portfolio segment (loan & lease type). These portfolio segments include: (1) commercial real estate; (2) agricultural real estate; (3) real estate construction (including land and development loans); (4) residential 1st mortgages; (5) home equity lines and loans; (6) agricultural; (7) commercial; (8) consumer and other; and (9) equipment leases. The allowance for credit losses attributable to each portfolio segment, which includes both individually evaluated impaired loans and leases and loans and leases that are collectively evaluated for impairment, is combined to determine the Company’s overall allowance, which is included on the consolidated balance sheet. The Company assigns a risk rating to all loans and leases and periodically performs detailed reviews of all such loans and leases over a certain threshold to identify credit risks and assess overall collectability. For smaller balance loans and leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans and leases. These credit quality indicators are used to assign a risk rating to each individual loan or lease. These risk ratings are also subject to examination by independent specialists engaged by the Company. The risk ratings can be grouped into five major categories, defined as follows: Pass and watch – A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management’s close attention. This category also includes “Watch” loans, which is a loan with an emerging weakness in either the individual credit or industry that requires additional attention. A credit may also be classified Watch if cash flows have not yet stabilized, such as in the case of a development project. Included in this category are all loans in which the Bank entered into a CARES Act modification. Special mention – A special mention loan or lease 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 loan or lease or in the Company’s credit position at some future date. Special mention loans and leases are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification. 84 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Substandard – A substandard loan or lease is not adequately protected by the current financial condition and paying capacity of the borrower or the value of the collateral pledged, if any. Loans or leases classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Well-defined weaknesses include a project’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project’s failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Doubtful – Loans or leases classified doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, highly questionable or improbable. Loss – Loans or leases classified as loss are considered uncollectible. Once a loan or lease becomes delinquent and repayment becomes questionable, the Company will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Company will estimate its probable loss and immediately charge-off some or all of the balance. The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management’s assessment of the following for each portfolio segment: (1) inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment described below: Commercial real estate – Commercial real estate mortgage loans are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans. Trends in vacancy rates of commercial properties affect the credit quality of these loans. High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flow to service debt obligations. Real estate construction – Real estate construction loans, including land loans, are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. A major risk arises from the necessity to complete projects within specified cost and time lines. Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly affect the credit quality of these loans, as property values determine the economic viability of construction projects. Commercial – These loans are generally considered to possess a moderate inherent risk of loss because they are shorter-term; typically made to relationship customers; generally underwritten to existing cash flows of operating businesses; and may be collateralized by fixed assets, inventory and/or accounts receivable. Debt coverage is provided by business cash flows and economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Agricultural real estate and agricultural – These loans are generally considered to possess a moderate inherent risk of loss since they are typically made to relationship customers and are secured by crop production, livestock and related real estate. These loans are vulnerable to two risk factors that are largely outside the control of Company and borrowers: commodity prices and weather conditions. 85 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Commercial leases – Equipment leases are generally considered to possess a moderate inherent risk of loss. As lessor, the Company is subject to both the credit risk of the borrower and the residual value risk of the equipment. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed with qualified, independent appraisers that establish the residual values the Company uses in structuring a lease. Residential 1st mortgages and home equity lines and loans – These loans are generally considered to possess a lower inherent risk of loss. The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower’s ability to repay in an orderly fashion. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers’ capacity to repay their obligations may be deteriorating. Consumer & other – A consumer installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most installment loans are made for consumer purchases. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers’ capacity to repay their obligations may be deteriorating. At least quarterly, the Board of Directors reviews the adequacy of the allowance, including consideration of the relative risks in the portfolio, current economic conditions and other factors. If the Board of Directors and management determine that changes are warranted based on those reviews, the allowance is adjusted. In addition, the Company’s and Bank’s regulators, including the Federal Reserve Board (“FRB”), the California Department of Financial Protection and Innovation (“DFPI”) and the Federal Deposit Insurance Corporation (“FDIC”), as an integral part of their examination process, review the adequacy of the allowance. These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations. Premises and equipment — Land is carried at cost. Premises and equipment are carried at cost, net of accumulated depreciation and amortization. Depreciation and amortization expense is computed using the straight-line method based on the estimated useful lives of the related assets below: Building and building improvements 30 to 40 years Leasehold improvements term of lease Furniture and equipment 3 to 7 years Computers, software and equipment 3 to 7 years Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Bank-owned life insurance (“BOLI”) — The Bank has purchased life insurance policies. These policies provide protection against the adverse financial effects that could result from the death of a key employee and provide tax-exempt income to offset expenses associated with the plans. It is the Bank’s intent to hold these policies as a long-term investment; however, there may be an income tax impact if the Bank chooses to surrender certain policies. Although the lives of individual current or former management-level employees are insured, the Bank is the owner and sole or partial beneficiary. BOLI is carried at the cash surrender value (“CSV”) of the underlying insurance contract. Changes in the CSV and any death benefits received in excess of the CSV are recognized as non-interest income. Goodwill — Goodwill represents the excess of the purchase considerations paid over the fair value of the assets acquired, net of the fair values of liabilities assumed in a business combination and is not amortized but is reviewed annually, as of December 31, or more frequently as current circumstances and conditions warrant, for impairment. An assessment of qualitative factors is completed to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative analysis concludes that further analysis is required, then a quantitative impairment test would be completed. The quantitative goodwill impairment compares the reporting unit’s estimated fair values, including goodwill, to its carrying amount. If the carrying amount exceeds its reporting unit’s fair value, then an impairment loss would be recognized as a charge to earnings but is limited by the amount of goodwill allocated to that reporting unit. 86 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Other intangible assets — Other intangible assets consist primarily of core deposit intangibles (“CDI”), which are amounts recorded in business combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the client relationships associated with the deposits. Core deposit intangibles are amortized over the estimated useful life of such deposits. These assets are reviewed at least annually for events or circumstances that could affect their recoverability. These events could include loss of the underlying core deposits, increased competition or adverse changes in the economy. To the extent other identifiable intangible assets are deemed unrecoverable; impairment losses are recorded in other non-interest expense to reduce the carrying amount of the assets. Transfers of financial assets — Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Right of use lease asset & lease liability — The Company leases retail space and office space under operating leases. Most leases require the Company to pay real estate taxes, maintenance, insurance and other similar costs in addition to the base rent. Certain leases also contain lease incentives, such as tenant improvement allowances and rent abatement. Variable lease payments are recognized as lease expense as they are incurred. We record an operating lease right of use (“ROU”) asset and an operating lease liability (lease liability) for operating leases with a lease term greater than 12 months. The ROU asset and lease liability are recorded in other assets and other liabilities, respectively, in the consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term. Accordingly, ROU assets are reduced by tenant improvement allowances from property owners plus any prepaid rent. We do not separate lease and non-lease components of contracts. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. Many of our leases contain various provisions for increases in rental rates, based either on changes in the published Consumer Price Index or a predetermined escalation schedule, which are factored into our determination of lease payments when appropriate. A majority of the leases provide the Company with the option to extend the lease term one or more times following expiration of the initial term. The ROU asset and lease liability terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. Off-balance sheet credit related financial instruments — In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded. 87 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Allowance for credit losses - unfunded loan commitments — An allowance for credit losses - unfunded loan commitments is maintained at a level that, in the opinion of management, is adequate to absorb current expected credit losses associated with the contractual life of the Banks’ commitments to lend funds under existing agreements such as letters or lines of credit. The Banks use a methodology for determining the allowance for credit losses - unfunded loan commitments that applies the same segmentation and loss rate to each pool as the funded exposure adjusted for probability of funding. Draws on unfunded loan commitments that are considered uncollectible at the time funds are advanced are charged to the allowance for credit losses on off-balance sheet exposures. Provisions for credit losses - unfunded loan commitments are recognized in non-interest expense and added to the allowance for credit losses - unfunded loan commitments, which is included in other liabilities in the consolidated balance sheets. Revenue from contracts with customers — The Company records revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the Company satisfies a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods. The Company’s primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606. The Company has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is limited judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers. Income taxes — Deferred income tax assets and deferred income tax liabilities represent the tax effect of temporary differences between financial reporting and tax reporting measured at enacted tax rates in effect for the year in which the differences are expected to reverse. The Company recognizes only the impact of tax positions that, based on their technical merits, are more likely than not to be sustained upon an audit by the taxing authority. Developing the provision for income taxes, including the effective tax rate and analysis of potential tax exposure items, if any, requires significant judgment and expertise in federal and state income tax laws, regulations and strategies, including the determination of deferred income tax assets and liabilities and any estimated valuation allowances deemed necessary to value deferred income tax assets. Judgments and tax strategies are subject to audit by various taxing authorities. While the Company believes it has no significant uncertain income tax positions in the consolidated financial statements, adverse determinations by these taxing authorities could have a material adverse effect on the consolidated financial positions, result of operations, or cash flows. 88 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Basic and diluted earnings per common share — The Company’s common stock is not traded on any exchange. However, trades are reported on the OTCQX under the symbol “FMCB”. The shares are primarily held by local residents and are not actively traded. Basic earnings per common share amounts are computed by dividing net income by the weighted average number of common shares outstanding for the period. There are no common stock equivalent shares. Therefore, there is no difference between presentation of diluted and basic earnings per common share. Comprehensive income — The “Comprehensive Income” topic of the FASB ASC establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Other comprehensive income refers to revenues, expenses, gains, and losses that U.S. GAAP recognize as changes in value to an enterprise but are excluded from net income. For the Company, comprehensive income includes net income and changes in fair value of its available-for-sale investment securities and amortization of net unrealized gains or losses on securities transferred from available-for-sale to held-to-maturity, net of related taxes. Segment reporting — The “Segment Reporting” topic of the FASB ASC requires that public companies report certain information about operating segments. It also requires that public companies report certain information about their products and services, the geographic areas in which they operate, and their major customers. The Company is a holding company for a community bank, which offers a wide array of products and services to its customers. Pursuant to its banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, the Company is not organized around discernible lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change. Loss contingencies — Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the consolidated financial statements. Advertising costs — Advertising costs are expensed when incurred and totaled $ 1.1 million in 2021, $ 0.9 million in 2020, and $ 1.3 million in 2019. 89 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Impact of recent authoritative accounting guidance — The Accounting Standards Codification™ (“ASC”) is the FASB officially recognized source of authoritative GAAP applicable to all public and non-public non-governmental entities. Periodically, the FASB will issue Accounting Standard updates (“ASU”) to its ASC. Rules and interpretive releases of the SEC under the authority of the federal securities laws are also sources of authoritative GAAP for the Company as an SEC registrant. All other accounting literature is non-authoritative. In June 2016, FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The ASU affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial asset not excluded from the scope that have the contractual right to receive cash. The ASU replaced the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU requires a financial asset (or group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses will be based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This ASU broadens the information that an organization must use to develop its expected credit loss estimate for assets measured either collectively or individually. The new guidance had been effective on January 1, 2020. However, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) and H.R. 133, resulted in federal banking regulators issuing an interim final rule allowing banks the option of delaying the implementation of CECL until January 1, 2022. In addition, the national banking regulators have issued a joint statement allowing financial institutions to mitigate the effects of CECL in their regulatory capital calculations for up to two years. The Company elected to delay CECL adoption, but continued to run its CECL model quarterly to accumulate data for the ultimate implementation. The Company adopted this ASU effective January 1, 2022. The Company formed an internal committee to oversee the project and engaged a third-party software vendor in the development of its model. The Company developed a reasonable and supportable forecast based upon economic forecast scenarios and incorporated the reasonable and supportable forecast into the models. The Company also developed a qualitative factor methodology and incorporated the qualitative factors into the models. The Company expects greater volatility in its earnings after adoption due to the nature and time horizon used to calculate CECL, the mode sensitivity to changes in economic forecasts, and other factors. Lastly, the Company expects a lack of comparability with financial performance to its peers as it adopts this ASU, due to delayed adoption for some public companies and the varying methodologies utilized by its peers. The Company is in the process of finalizing its review of the model results related to the adoption of this ASU. Based on our most recently determined model results, we expect the combined adjustment to our Allowance for Credit Loss and Reserve for Unfunded Loan Commitments could be within ( 5.00 %) to 5.00 % upon the adoption. Based on the credit quality of debt securities held-to-maturity, the allowance for credit losses recorded at adoption on this portfolio is expected to be nominal. In addition, the current accounting policy and procedures for other-than-temporary impairment on investment securities available-for-sale will be replaced with an allowance approach. 90 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Subsequent events — The Company has evaluated events occurring subsequent to December 31, 2021 for disclosure in the consolidated financial statements. The Company repurchased 4,500 shares of common stock in February 2022. The Company originated $ 497 million in SBA PPP loans, which has declined to $ 32.4 million at February 28, 2022. Note 2—Risks and Uncertainties The COVID-19 pandemic has affected the economy and businesses throughout the U.S., in California and in the markets served by the Company. Designated as an “essential business”, the Company’s subsidiary, Farmers & Merchants Bank of Central California, has kept all branches open and maintained regular business hours during the COVID-19 pandemic. Our staffing levels have remained stable during the COVID-19 pandemic. Through the CARES Act and H.R. 133, as well as related federal and state regulatory actions, the federal government has taken extraordinary efforts to provide financial assistance to individuals and companies to help them move through these difficult times. However, there are no guarantees how long the COVID-19 virus may continue to impact our economy, and therefore, the Company. While we expect the effects of COVID-19 could have an adverse future impact on our business, financial condition and results of operations, we are unable to predict the full extent or nature of these impacts at the current time. Note 3 — Investment Securities The amortized cost, fair values, and unrealized gains and losses of the securities available-for-sale are as follows: Available-for-Sale Securities Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value As of December 31, 2021 U.S. Treasury notes $ 9,938 $ 151 $ - $ 10,089 U.S. Government-sponsored securities 6,351 62 39 6,374 Mortgage-backed securities (1) 253,300 3,200 5,380 251,120 Collateralized Mortgage Obligations 2,412 24 - 2,436 Other 435 - - 435 Total available-for-sale securities $ 272,436 $ 3,437 $ 5,419 $ 270,454 (1) All mortgage-backed securities were issued by an agency or government sponsored entity of the U.S. Government. 91 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 3—Investment Securities—Continued Available-for-Sale Securities Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value As of December 31, 2020 U.S. Treasury notes $ 14,859 $ 429 $ - $ 15,288 U.S. Government-sponsored securities 8,252 1 93 8,160 Mortgage-backed securities (1) 715,523 17,245 48 732,720 Collateralized Mortgage Obligations 5,039 114 - 5,153 Corporate securities 45,010 927 18 45,919 Other 492 - - 492 Total available-for-sale securities $ 789,175 $ 18,716 $ 159 $ 807,732 (1) All mortgage-backed securities were issued by an agency or government sponsored entity of the U.S. Government. The book values, estimated fair values and unrealized gains and losses of investments classified as held-to-maturity are as follows: Held-to-Maturity Securities Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value As of December 31, 2021 Municipal securities $ 66,496 $ 701 $ - $ 67,197 Mortgage-backed securities (1) 596,775 45 11,764 585,056 Collateralized Mortgage Obligations 73,781 36 229 73,588 Total held-to-maturity securities $ 737,052 $ 782 $ 11,993 $ 725,841 (1) All mortgage-backed securities were issued by an agency or government sponsored entity of the U.S. Government. Held-to-Maturity Securities Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value As of December 31, 2020 Municipal securities $ 68,933 $ 1,116 $ - $ 70,049 Total held-to-maturity securities $ 68,933 $ 1,116 $ - $ 70,049 Fair values are based on quoted market prices or dealer quotes. If a quoted market price or dealer quote is not available, fair value is estimated using quoted market prices for similar securities. 92 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 3—Investment Securities—Continued The following tables show the gross unrealized losses for available-for-sale securities that are less than 12 months and 12 months or more: Available-for-Sale Securities December 31, 2021 Less Than 12 Months 12 Months or More Total (Dollars in thousands) Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses As of December 31, 2021 U.S. Government-sponsored securities $ 183 $ - $ 2,007 $ 39 $ 2,190 $ 39 Mortgage-backed securities (1) 61,469 1,192 104,489 4,188 165,958 5,380 Total available-for-sale securities $ 61,652 $ 1,192 $ 106,496 $ 4,227 $ 168,148 $ 5,419 (1) All mortgage-backed securities were issued by an agency or government sponsored entity of the U.S. Government. Available-for-Sale Securities December 31, 2020 Less Than 12 Months 12 Months or More Total (Dollars in thousands) Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses As of December 31, 2020 U.S. Government-sponsored securities $ 1,741 $ 3 $ 6,126 $ 90 $ 7,867 $ 93 Mortgage-backed securities (1) 20,142 45 177 3 20,319 48 Corporate securities 4,041 18 - - 4,041 18 Total available-for-sale securities $ 25,924 $ 66 $ 6,303 $ 93 $ 32,227 $ 159 (1) All mortgage-backed securities were issued by an agency or government sponsored entity of the U.S. Government. 93 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 3—Investment Securities—Continued The following tables show the gross unrealized losses for held-to-maturity securities that are less than 12 months and 12 months or more: Held-to-Maturity Securities December 31, 2021 (Dollars in thousands) Less Than 12 Months 12 Months or More Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses As of December 31, 2021 Mortgage-backed securities (1) $ 570,119 $ 11,764 $ - $ - $ 570,119 $ 11,764 Collateralized Mortgage Obligations 58,977 229 - - 58,977 229 Total held-to-maturity securities $ 629,096 $ 11,993 $ - $ - $ 629,096 $ 11,993 (1) All mortgage-backed securities were issued by an agency or government sponsored entity of the U.S. Government. There were no HTM investments with gross unrealized losses at December 31, 2020. As of December 31, 2021, the Company held 654 investment securities of which 82 were in an unrealized loss position for less than twelve months and 71 securities were in an unrealized loss position for twelve months or more. Management periodically evaluates each investment security for other-than-temporary impairment relying primarily on industry analyst reports and observations of market conditions and interest rate fluctuations. The Company does not intend to sell the securities and believes it is able to more likely than not collect all amounts due according to the contractual terms of the underlying investment securities. Management believes its debt securities are not OTTI. Proceeds from sales and calls of these securities were as follows: (Dollars in thousands) Gross Proceeds Gross Gains Gross Losses 2021 $ 301,320 $ 5,570 $ 3,016 2020 $ 5,080 $ 40 $ - 2019 $ 5,300 $ 1 $ - 94 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 3—Investment Securities—Continued The amortized cost and estimated fair values of investment securities at December 31, 2021 by contractual maturity are shown in the following tables: Available-for-Sale Held-to-Maturity (Dollars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Securities maturing in: One year or less $ 5,430 $ 5,465 $ 308 $ 308 After one year through five years 5,094 5,209 8,487 8,528 After five years through ten years 510 512 18,433 19,072 After ten years 5,690 5,711 39,268 39,288 $ 16,724 $ 16,897 $ 66,496 $ 67,196 Securities not due at a single maturity date: Mortgage-backed securities 253,300 251,120 596,775 585,056 Collateralized mortgage obligations 2,412 2,437 73,781 73,589 Total $ 272,436 $ 270,454 $ 737,052 $ 725,841 Expected maturities of mortgage-backed and CMO securities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Pledged Securities As of December 31, 2021, securities carried at $ 426 million were pledged to secure public deposits, Federal Home Loan Bank (“FHLB”) borrowings, and other government agency deposits as required by law. This amount was $ 439.7 million at December 31, 2020. Note 4—Federal Home Loan Bank Stock and Other Non-Marketable Securities The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock and other equity securities are carried at cost, classified as restricted securities, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. FHLB stock and other equity securities are reported in Non-Marketable Securities on the Company’s Consolidated Balance Sheets and totaled $ 15.5 million and $ 12.9 at December 31, 2021 and 2020, respectively. 95 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases Loans and leases as of the dates indicated consisted of the following: December 31, (Dollars in thousands) 2021 2020 Loans and leases held-for-investment, net Real estate: Commercial real estate $ 1,167,516 $ 971,326 Agricultural 672,830 643,014 Residential and home equity 350,581 333,618 Construction 177,163 185,741 Total real estate 2,368,090 2,133,699 Commercial & Industrial 427,799 374,816 Agricultural 276,684 264,372 Commercial leases 96,971 103,117 Consumer and other (1) 78,367 235,529 Total gross loans and leases 3,247,911 3,111,533 Unearned income ( 10,734 ) ( 11,941 ) Total net loans and leases 3,237,177 3,099,592 Allowance for credit losses ( 61,007 ) ( 58,862 ) Total loans and leases held-for-investment, net $ 3,176,170 $ 3,040,730 (1) Includes SBA PPP loans. Paycheck Protection Program (“PPP”) … Under the CARES Act and H.R. 133 (see “Note 2 – Risks and Uncertainties”) the Small Business Administration (“SBA”) was directed by Congress to provide loans to small businesses with less than 500 employees to assist these businesses in meeting their payroll and other financial obligations during the COVID-19 pandemic. These government guaranteed loans are made with an interest rate of 1%, a risk weight of 0% under risk-based capital rules, have a term of 2 to 5 years, and under certain conditions the SBA will forgive them. The Bank actively participated in the PPP, and since April 2020, the Bank has funded $ 494.39 million of loans for 2,680 small business customers. As of December 2021 and 2020, PPP loans outstanding were $ 70.8 million and $ 224.3 million, respectively. At December 31, 2021, the portion of loans that were approved for pledging as collateral on borrowing lines with the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank (“FRB”) were $ 1.1 billion and $ 767 million, respectively. The borrowing capacity on these loans was $ 837.1 million from FHLB and $ 480.4 million from the FRB. 96 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases —Continued The following tables show an aging analysis of the loan & lease portfolio, including unearned income, by the time past due at December 31, 2021 and 2020: December 31, 2021 (Dollars in thousands) Current 30-89 Days Past Due 90+ Days Past Due Non-accrual Total Past Due Total Loans and leases held-for-investment, net Real estate: Commercial real estate $ 1,156,879 $ 459 $ - $ - $ 459 $ 1,157,338 Agricultural 672,812 - - 18 18 672,830 Residential and home equity 350,492 89 - - 89 350,581 Construction 177,163 - - - - 177,163 Total real estate 2,357,346 548 - 18 566 2,357,912 Commercial & Industrial 427,799 - - - - 427,799 Agricultural 276,186 - - 498 498 276,684 Commercial leases 96,415 - - - - 96,415 Consumer and other 78,363 4 - - 4 78,367 Total loans and leases, net $ 3,236,109 $ 552 $ - $ 516 $ 1,068 $ 3,237,177 December 31, 2020 (Dollars in thousands) Current 30-89 Days Past Due 90+ Days Past Due Non-accrual Total Past Due Total Loans and leases held-for-investment, net Real estate: Commercial real estate $ 958,980 $ - $ - $ - $ - $ 958,980 Agricultural 643,014 - - - - 643,014 Residential and home equity 333,618 - - - - 333,618 Construction 185,741 - - - - 185,741 Total real estate 2,121,353 - - - - 2,121,353 Commercial & Industrial 374,816 - - - - 374,816 Agricultural 263,877 - - 495 495 264,372 Commercial leases 103,522 - - - - 103,522 Consumer and other 235,518 11 - - 11 235,529 Total loans and leases, net $ 3,099,086 $ 11 $ - $ 495 $ 506 $ 3,099,592 97 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases —Continued Non-accrual loans are summarized as follows: December 31, (Dollars in thousands) 2021 2020 Non-accrual loans and leases: Non-accrual loans and leases, not TDRs Real estate: Commercial real estate $ - $ - Agricultural 18 - Residential and home equity - - Construction - - Total real estate 18 - Commercial & Industrial - - Agricultural - - Commercial leases - - Consumer and other - - Subtotal 18 - Non-accrual loans and leases, are TDRs Real estate: Commercial real estate $ - $ - Agricultural - - Residential and home equity - - Construction - - Total real estate - - Commercial & Industrial - - Agricultural 498 495 Commercial leases - - Consumer and other - - Subtotal 498 495 Total non-accrual loans and leases $ 516 $ 495 98 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases —Continued Not included in the table below, but relevant to a discussion of asset quality are loans that were granted some form of relief because of COVID-19 and are not considered TDRs because of the CARES Act and H.R. 133. Since April 2020, we have restructured $ 278.1 million of loans under the CARES Act and H.R. 133 guidelines. As of December 31, 2021, all loans that were restructured as part of the CARES Act and H.R. 133 have returned to the contractual terms and conditions of the loans, without exception. The following table lists total troubled debt restructured loans that the Company is either accruing or not accruing interest by loan category: December 31, (Dollars in thousands) 2021 2020 Troubled debt restructured loans and leases: Accruing TDR loans and leases Real estate: Commercial real estate $ 41 $ 84 Agricultural - 5,629 Residential and home equity 1,522 1,731 Construction - - Total real estate 1,563 7,444 Commercial & Industrial 260 233 Agricultural - - Commercial leases - - Consumer and other 1 190 Subtotal 1,824 7,867 Non-accruing TDR loans and leases Real estate: Commercial real estate $ - $ - Agricultural - - Residential and home equity - - Construction - - Total real estate - - Commercial & Industrial - - Agricultural 498 495 Commercial leases - - Consumer and other - - Subtotal 498 495 Total TDR loans and leases $ 2,322 $ 8,362 99 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases —Continued Outstanding loan balances (accruing and non-accruing) categorized by these credit quality indicators are summarized as follows: December 31, 2021 (Dollars in thousands) Pass Special Mention Sub- standard Doubtful Total Loans & Leases Total Allowance for Credit Losses Loans and leases held-for-investment, net Real estate: Commercial real estate $ 1,142,175 $ 6,903 $ 8,260 $ - $ 1,157,338 $ 28,536 Agricultural 663,157 3,292 6,381 - 672,830 9,613 Residential and home equity 350,148 - 433 - 350,581 2,847 Construction 177,163 - - - 177,163 1,456 Total real estate 2,332,643 10,195 15,074 - 2,357,912 42,452 Commercial & Industrial 417,806 9,321 672 - 427,799 11,489 Agricultural 275,206 958 520 - 276,684 5,465 Commercial leases 96,415 - - - 96,415 938 Consumer and other 78,181 - 186 - 78,367 263 Unallocated - - - - - 400 Total loans and leases, net $ 3,200,251 $ 20,474 $ 16,452 $ - $ 3,237,177 $ 61,007 December 31, 2020 (Dollars in thousands) Pass Special Mention Sub- standard Doubtful Total Loans & Leases Total Allowance for Credit Losses Loans and leases held-for-investment, net Real estate: Commercial real estate $ 946,621 $ 7,849 $ 4,510 $ - $ 958,980 $ 27,679 Agricultural 631,043 400 11,571 - 643,014 8,633 Residential and home equity 332,747 - 871 - 333,618 2,984 Construction 185,741 - - - 185,741 1,643 Total real estate 2,096,152 8,249 16,952 - 2,121,353 40,939 Commercial & Industrial 373,038 1,060 718 - 374,816 9,961 Agricultural 263,781 96 495 - 264,372 4,814 Commercial leases 103,522 - - - 103,522 1,731 Consumer and other 235,063 - 466 - 235,529 333 Unallocated - - - - - 1,084 Total loans and leases, net $ 3,071,556 $ 9,405 $ 18,631 $ - $ 3,099,592 $ 58,862 100 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases —Continued Changes in the allowance for credit losses are as follows: Year Ended December 31, 2021 (Dollars in thousands) Commercial & Agricultural R/E Construction Residential & Home Equity Commercial & Agricultural Commercial Leases Consumer & Other Unallocated Total Allowance for credit losses: Balance at beginning of year $ 36,312 $ 1,643 $ 2,984 $ 14,775 $ 1,731 $ 333 $ 1,084 $ 58,862 Provision / (recapture) for credit losses 1,837 ( 187 ) ( 235 ) 2,025 ( 793 ) ( 53 ) ( 684 ) 1,910 Charge-offs - - - - - ( 44 ) - ( 44 ) Recoveries - - 98 154 - 27 - 279 Net (charge-offs) / recoveries - - 98 154 - ( 17 ) - 235 Balance at end of year $ 38,149 $ 1,456 $ 2,847 $ 16,954 $ 938 $ 263 $ 400 $ 61,007 Year Ended December 31, 2020 (Dollars in thousands) Commercial & Agricultural R/E Construction Residential & Home Equity Commercial & Agricultural Commercial Leases Consumer & Other Unallocated Total Allowance for credit losses: Balance at beginning of year $ 26,181 $ 1,949 $ 3,530 $ 19,542 $ 3,162 $ 456 $ 192 $ 55,012 Provision / (recapture) for credit losses 10,050 ( 306 ) ( 669 ) ( 3,946 ) ( 1,431 ) ( 90 ) 892 4,500 Charge-offs - - ( 7 ) ( 1,101 ) - ( 66 ) - ( 1,174 ) Recoveries 81 - 130 280 - 33 - 524 Net (charge-offs) / recoveries 81 - 123 ( 821 ) - ( 33 ) - ( 650 ) Balance at end of year $ 36,312 $ 1,643 $ 2,984 $ 14,775 $ 1,731 $ 333 $ 1,084 $ 58,862 Year Ended December 31, 2019 (Dollars in thousands) Commercial & Agricultural R/E Construction Residential & Home Equity Commercial & Agricultural Commercial Leases Consumer & Other Unallocated Total Allowance for credit losses: Balance at beginning of year $ 25,701 $ 1,249 $ 3,641 $ 19,898 $ 4,022 $ 494 $ 261 $ 55,266 Provision / (recapture) for credit losses 442 700 ( 152 ) 146 ( 860 ) ( 7 ) ( 69 ) 200 Charge-offs - - - ( 592 ) - ( 83 ) - ( 675 ) Recoveries 38 - 41 90 - 52 - 221 Net (charge-offs) / recoveries 38 - 41 ( 502 ) - ( 31 ) - ( 454 ) Balance at end of year $ 26,181 $ 1,949 $ 3,530 $ 19,542 $ 3,162 $ 456 $ 192 $ 55,012 101 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases —Continued The ACL and outstanding loan balances reviewed according to the Company’s estimated credit loss methods were summarized as follows: December 31, 2021 (Dollars in thousands) Commercial & Agricultural R/E Construction Residential & Home Equity Commercial & Agricultural Commercial Leases Consumer & Other Unallocated Total Allowance for credit losses: Total loans and leases Collectively evaluated for impairment $ 1,824,517 $ 177,163 $ 348,729 $ 703,725 $ 96,415 $ 78,193 $ - $ 3,228,742 Individually evaluated for impairment 5,651 - 1,852 758 - 174 - 8,435 Total loans and leases $ 1,830,168 $ 177,163 $ 350,581 $ 704,483 $ 96,415 $ 78,367 $ - $ 3,237,177 Allowance for credit losses: Collectively evaluated for impairment $ 38,149 $ 1,456 $ 2,755 $ 16,937 $ 938 $ 227 $ 400 $ 60,862 Individually evaluated for impairment - - 92 17 - 36 - 145 Total allowance for credit losses $ 38,149 $ 1,456 $ 2,847 $ 16,954 $ 938 $ 263 $ 400 $ 61,007 December 31, 2020 (Dollars in thousands) Commercial & Agricultural R/E Construction Residential & Home Equity Commercial & Agricultural Commercial Leases Consumer & Other Unallocated Total Allowance for credit losses: Total loans and leases Collectively evaluated for impairment $ 1,596,261 $ 185,741 $ 331,095 $ 638,460 $ 103,522 $ 235,275 $ - $ 3,090,354 Individually evaluated for impairment 5,733 - 2,523 728 - 254 - 9,238 Total loans and leases $ 1,601,994 $ 185,741 $ 333,618 $ 639,188 $ 103,522 $ 235,529 $ - $ 3,099,592 Allowance for credit losses: Collectively evaluated for impairment $ 36,312 $ 1,643 $ 2,859 $ 14,663 $ 1,731 $ 281 $ 1,084 $ 58,573 Individually evaluated for impairment - - 125 112 - 52 - 289 Total allowance for credit losses $ 36,312 $ 1,643 $ 2,984 $ 14,775 $ 1,731 $ 333 $ 1,084 $ 58,862 102 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases —Continued Information on individually evaluated loans was summarized as follows: December 31, 2021 (Dollars in thousands) Unpaid Principal Balance With no Allowance With Allowance Total Recorded Investment Related Allowance Loans and leases individually evaluated: Real estate: Commercial real estate $ 45 $ 45 $ - $ 45 $ - Agricultural 5,606 5,606 - 5,606 - Residential and home equity 1,852 - 1,852 1,663 92 Construction - - - - - Total real estate 7,503 5,651 1,852 7,314 92 Commercial & Industrial 260 - 260 260 17 Agricultural 498 498 - 456 - Commercial leases - - - - - Consumer and other 174 - 174 173 36 Total gross loans and leases $ 8,435 $ 6,149 $ 2,286 $ 8,203 $ 145 December 31, 2020 (Dollars in thousands) Unpaid Principal Balance With no Allowance With Allowance Total Recorded Investment Related Allowance Loans and leases individually evaluated: Real estate: Commercial real estate $ 104 $ 104 $ - $ 104 $ - Agricultural 5,629 5,629 - 5,629 - Residential and home equity 2,523 - 2,523 2,288 125 Construction - - - - - Total real estate 8,256 5,733 2,523 8,021 125 Commercial & Industrial 233 - 233 233 20 Agricultural 495 3 492 453 92 Commercial leases - - - - - Consumer and other 254 63 191 253 52 Total gross loans and leases $ 9,238 $ 5,799 $ 3,439 $ 8,960 $ 289 103 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Loans and Leases —Continued Interest income recognized on the average recorded investment of individually evaluated loans was as follows: Year Ended December 31, 2021 2020 2019 (Dollars in thousands) Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Loans and leases individually evaluated: Real estate: Commercial real estate $ 80 $ 7 $ 812 $ 38 $ 4,595 $ 182 Agricultural 5,588 735 5,766 352 6,069 379 Residential and home equity 1,978 93 2,543 135 2,679 144 Construction - - - - - - Total real estate 7,646 835 9,121 525 13,343 705 Commercial & Industrial 232 20 500 34 1,562 54 Agricultural 585 58 907 102 195 6 Commercial leases - - - - - - Consumer and other 310 21 257 13 54 - Total loans and leases individually evaluated $ 8,773 $ 934 $ 10,785 $ 674 $ 15,154 $ 765 104 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 6—Premises and Equipment Premises and equipment consisted of the following: December 31, (Dollars in thousands) 2021 2020 Premises and equipment: Buildings and land $ 59,325 $ 60,512 Furniture, fixtures, and equipment 21,775 21,011 Leasehold improvements 3,658 3,752 Other 527 474 Subtotal 85,285 85,749 Accumulated depreciation and amortization ( 37,555 ) ( 35,602 ) Total premises and equipment $ 47,730 $ 50,147 Depreciation and amortization on premises and equipment included in occupancy and equipment expense amounted to $ 2,632 ,000, $ 2,769 ,000, and $ 2,756 ,000 for the years ended December 31, 2021, 2020 and 2019, respectively. Rental income was $ 491,000 , $ 434,000 , and $ 183,000 for the years ended December 31, 2021, 2020, and 2019, respectively and is recorded in other income. Note 7—Other Real Estate The Bank reported $ 873,000 in other real estate at December 31, 2021 and 2020, which includes property no longer utilized for business operations and property acquired through foreclosure proceedings. These properties are carried at fair value less selling costs determined at the date acquired. Losses, if any, arising from properties acquired through foreclosure are charged against the allowance for loan losses at the time of foreclosure. Subsequent declines in value, periodic holding costs, and net gains or losses on disposition are included in other operating expense as incurred. 105 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 8 — Deposits Certificate of deposits greater than and less than or equal to the FDIC insurance limit are summarized as follows: December 31, (Dollars in thousands) 2021 2020 Certificate of deposits: Certificates of deposits less than or equal to $250,000 $ 223,620 $ 235,924 Certificates of deposits greater than $250,000 168,865 185,944 Total certificate of deposits $ 392,485 $ 421,868 Scheduled maturities for certificates of deposit are as follows for the years ending December 31: (Dollars in thousands) Amount 2022 $ 354,754 2023 29,502 2024 5,171 2025 1,648 2026 and beyond 1,410 Total time deposits $ 392,485 Note 9 — Short-term borrowings As of December 31, 2021 and 2020, committed lines of credit arrangements totaling $ 1.4 billion and $ 1.3 billion were available to the Company from unaffiliated banks, respectively. The average Federal Funds interest rate as of December 31, 2021 was 0.25 %. The Company is a member of the FHLB of San Francisco and has a committed credit line of $ 837.1 million, which is secured by $ 1.14 billion in various real estate loans and investment securities pledged as collateral. Borrowings generally provide for interest at the then current published rate, which was 0.17 % as of December 31, 2021. The Company has $ 767 million in pledged loans with the Federal Reserve Bank (the “Fed”). As of December 31, 2021, the Company’s overnight borrowing capacity using the primary credit facilities from the Fed account was $ 480.4 million. The borrowing rate is 25 basis points. There were no outstanding advances on the above borrowing facilities as of December 31, 2021 and 2020. 106 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 10—Long-term Subordinated Debentures In December 2003, the Company formed a wholly owned Connecticut statutory business trust, FMCB Statutory Trust I (“Statutory Trust I”), which issued $ 10.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures (the “Trust Preferred Securities”). The Company is not considered the primary beneficiary of the trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. These debentures qualify as Tier 1 capital under current regulatory guidelines. All of the common securities of Statutory Trust I are owned by the Company. The proceeds from the issuance of the common securities and the Trust Preferred Securities were used by FMCB Statutory Trust to purchase $ 10.3 million of junior subordinated debentures of the Company, which carry a floating rate based on three-month LIBOR plus 2.85 %. The debentures represent the sole asset of Statutory Trust I. The Trust Preferred Securities accrue and pay distributions at a floating rate of three-month LIBOR plus 2.85 % per annum of the stated liquidation value of $ 1,000 per capital security. The Company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment to the extent that Statutory Trust I has funds available therefore of: (i) accrued and unpaid distributions required to be paid on the Trust Preferred Securities; (ii) the redemption price with respect to any Trust Preferred Securities called for redemption by Statutory Trust I; and (iii) payments due upon a voluntary or involuntary dissolution, winding up, or liquidation of Statutory Trust I. The Trust Preferred Securities are mandatorily redeemable upon maturity of the subordinated debentures on December 17, 2033 , or upon earlier redemption as provided in the indenture. The Company has the right to redeem the subordinated debentures purchased by Statutory Trust I, in whole or in part, on or after December 17, 2008. As specified in the indenture, if the subordinated debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest. Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock. 107 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 11—Shareholders’ Equity The Company and the Bank are subject to various federal regulatory capital requirements under the Basel III Capital Rules. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s 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 the Company and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Company believes that it is currently in compliance with all of these capital requirements and that they will not result in any restrictions on the Company’s business activity. Management believes that the Company and the Bank meet the requirements to be categorized as “well capitalized” under the FDIC regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. The Company’s actual and required capital amounts and ratios are as follows: December 31, 2021 Actual Minimum Capital Requirement Well Capitalized Requirment (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Farmers & Merchants Bancorp CET1 capital to risk-weighted assets $ 450,687 11.68 % $ 173,674 4.50 % N/A N/A Tier 1 capital to risk-weighted assets 460,687 11.94 % 231,566 6.00 % N/A N/A Risk-based capital to risk-weighted assets 509,091 13.19 % 308,755 8.00 % N/A N/A Tier 1 leverage capital ratio 460,687 8.92 % 206,606 4.00 % N/A N/A Farmers & Merchants Bank CET1 capital to risk-weighted assets $ 459,813 11.91 % $ 173,664 4.50 % $ 250,847 6.50 % Tier 1 capital to risk-weighted assets 459,813 11.91 % 231,551 6.00 % 308,735 8.00 % Risk-based capital to risk-weighted assets 508,215 13.17 % 308,735 8.00 % 385,919 10.00 % Tier 1 leverage capital ratio 459,813 8.91 % 206,426 4.00 % 258,033 5.00 % 108 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 11—Shareholders’ Equity—Continued December 31, 2020 Actual Minimum Capital Requirement Well Capitalized Requirment (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Farmers & Merchants Bancorp CET1 capital to risk-weighted assets $ 395,941 11.05 % $ 161,178 4.50 % N/A N/A Tier 1 capital to risk-weighted assets 405,941 11.33 % 214,904 6.00 % N/A N/A Risk-based capital to risk-weighted assets 450,890 12.59 % 286,539 8.00 % N/A N/A Tier 1 leverage capital ratio 405,941 9.13 % 177,820 4.00 % N/A N/A Farmers & Merchants Bank CET1 capital to risk-weighted assets $ 401,313 11.21 % $ 161,135 4.50 % $ 232,750 6.50 % Tier 1 capital to risk-weighted assets 401,313 11.21 % 214,846 6.00 % 286,462 8.00 % Risk-based capital to risk-weighted assets 446,251 12.46 % 286,462 8.00 % 358,077 10.00 % Tier 1 leverage capital ratio 401,313 9.04 % 177,605 4.00 % 222,006 5.00 % Basic and dilluted earnings per common share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Earnings per common share have been computed based on the following: Year Ended December 31, (Dollars in thousands, except share and per share amounts) 2021 2020 2019 Numerator Net income $ 66,336 $ 58,734 $ 56,036 Denominator Weighted average number of common shares outstanding 789,646 793,337 787,227 Weighted average number of dilutive shares outstanding 789,646 793,337 787,227 Basic earnings per common share $ 84.01 $ 74.03 $ 71.18 Diluted earning per commons share $ 84.01 $ 74.03 $ 71.18 The Company’s Board of Directors may declare cash or stock dividends out of retained earnings provided the regulatory minimum capital ratios are met. The Company plans to maintain capital ratios that meet the well-capitalized standards per the regulations. 109 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 12—Employee Benefit Plans Profit Sharing Plan The Company, through the Bank, sponsors a Profit Sharing Plan for substantially all full-time employees of the Company with one or more years of service. The plan assets reported at fair value are primarily invested in mutual funds and other investments, which are primarily Level 2 inputs. Participants receive up to two annual employer contributions, one is discretionary and the other is mandatory. The discretionary contributions to the Profit Sharing Plan are determined annually by the Board of Directors. The discretionary contributions totaled $ 1.6 million, $ 1.5 million, and $ 1.4 million for the years ended December 31, 2021, 2020, and 2019, respectively. The mandatory contributions to the Profit Sharing Plan are made according to a predetermined set of criteria. Mandatory contributions totaled $ 1.7 million, $ 1.7 million, and $ 1.6 million for the years ended December 31, 2021, 2020, and 2019, respectively. Company employees are permitted, within limitations imposed by tax law, to make pretax contributions and after tax (Roth) contributions to the 401(k) feature of the Profit Sharing Plan. The Company does not match employee contributions within the 401(k) feature of the Profit Sharing Plan and the Company can terminate the Profit Sharing Plan at any time. Benefits pursuant to the Profit Sharing Plan vest 0 % during the first year of participation, 25 % per full year thereafter and after five years such benefits are fully vested. Executive Retirement Plan and Life Insurance Arrangements The Company, through the Bank, sponsors an Executive Retirement Plan (“ERP”) for certain executive level employees. The ERP is a non-qualified deferred compensation plan and was developed to supplement the Company’s Profit Sharing Plan, which, as a qualified retirement plan, has a ceiling on benefits as set by the Internal Revenue Service. The ERP is comprised of: (1) a Performance Component which makes contributions based upon long-term cumulative profitability and increase in market value of the Company; (2) a Salary Component which makes contributions based upon participant salary levels; and (3) an Equity Component for which contributions are discretionary and subject to Board of Directors approval. The Company maintains a Rabbi Trust to fund, in part, the ERP. The Rabbi Trust is an irrevocable grantor trust to which the Company may contribute assets for the limited purpose of funding a nonqualified deferred compensation plan. The Company may not use the assets of the Rabbi Trust for any purpose other than meeting its obligations under the ERP; however, the assets of the Rabbi Trust remain subject to the claims of its creditors and are included in the consolidated financial statements. The Company contributes cash to the Rabbi Trust from time to time for the sole purpose of funding the ERP. The Rabbi Trust will use any cash the Company contributes to purchase shares of common stock of the Company, and other financial instruments, on the open market. ERP contributions are invested in a mix of financial instruments; however, the Equity Component contributions are invested primarily in common stock of the Company. The Company expensed $ 9.0 million to the ERP during the year ended December 31, 2021, $ 6.8 million during the year ended December 31, 2020 and $ 6.6 million during the year ended December 31, 2019. The Company’s carrying value of the liability under the ERP was $ 63.9 million as of December 31, 2021 and $ 56.7 million as of December 31, 2020. The Company’s shares of common stock held as investments in the Rabbi Trust of the ERP as of December 31, 2021 and 2020 totaled 55,436 and 52,980 with an historical cost basis of $ 33.2 million and $ 31.2 million, respectively. All amounts have been fully funded into the Rabbi Trust as of December 31, 2021 and 2020. The consolidated investments held in the Rabbi Trust are recorded at fair value with changes in unrealized gains or losses recorded within non-interest income and the equal and offsetting charges in the related liability are recorded in non-interest expense in the consolidated statements of income. Net gains on ERP plan investments were $ 2.5 million in 2021 compared to net gains of $ 1.8 million in 2020 and $ 2.6 million in 2019. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. 110 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 12—Employee Benefit Plans —Continued Senior Management Retention Plan The Company, through the Bank, sponsors a Senior Management Retention Plan (“SMRP”) for certain senior level employees. The SMRP is a non-qualified deferred compensation plan and was developed to supplement the Company’s Profit Sharing Plan, which, as a qualified retirement plan, has a ceiling on benefits as set by the Internal Revenue Service. All contributions are discretionary and subject to the Board of Directors approval. The Company maintains a Rabbi Trust to fund, in part, the SMRP. The Rabbi Trust is an irrevocable grantor trust to which the Company may contribute assets for the limited purpose of funding a nonqualified deferred compensation plan. The Company may not use the assets of the Rabbi Trust for any purpose other than meeting its obligations under the SMRP; however, the assets of the Rabbi Trust remain subject to the claims of its creditors and are included in the consolidated financial statements. The Company contributes cash to the Rabbi Trust from time to time for the sole purpose of funding the SMRP. The Rabbi Trust will use any cash the Company contributes to purchase shares of common stock of the Company, and other financial instruments, on the open market. Contributions to the SMRP are invested primarily in common stock of the Company. The Company expensed $ 2.7 million to the SMRP during the year ended December 31, 2021, $ 2.3 million during the year ended December 31, 2020 and $ 1.3 million during the year ended December 31, 2019. The Company’s carrying value of the liability under the SMRP was $ 11.1 million as of December 31, 2021 and $ 8.6 million as of December 31, 2020. The Company’s shares of stock held as investments in the Rabbi Trust of the SMRP as of December 31, 2021 and December 31, 2020 totaled 14,192 and 12,548 shares with an historical cost basis of $ 9.5 million and $ 7.9 million, respectively. All amounts have been fully funded into the Rabbi Trust as of December 31, 2021 and 2020. The consolidated investments held in the Rabbi Trust are recorded at fair value with changes in unrealized gains or losses recorded within non-interest income and the equal and offsetting charges in the related liability are recorded in non-interest expense in the consolidated statements of income. Net gains on SMRP plan investments were $ 0.1 million in 2021, $ 0.1 million in 2020 and zero in 2019. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices . 111 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 13—Fair Value Measurements The Company follows the “Fair Value Measurement and Disclosures” topic of the FASB ASC, which establishes a framework for measuring fair value in U.S. GAAP and expands disclosures about fair value measurements. This standard applies whenever other standards require, or permit assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, this standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows: Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date. Level 2 inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, the transfer is reported at the beginning of the reporting period. Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. Securities classified as available-for-sale are reported at fair value on a recurring basis utilizing Level 1, 2 and 3 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The Company does not record all loans and leases at fair value on a recurring basis. However, from time to time, a loan or lease is considered impaired and an allowance for credit losses is established. Once a loan or lease is identified as individually impaired, management measures impairment in accordance with the “Receivable” topic of the FASB ASC. The fair value of impaired loans or leases is estimated using one of several methods, including collateral value when the loan is collateral dependent, market value of similar debt, enterprise value, and discounted cash flows. Impaired loans and leases not requiring an allowance represent loans and leases for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans and leases. Impaired loans and leases where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The fair value of collateral dependent impaired loans is generally based on recent real estate appraisals. 112 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 13—Fair Value Measurements—Continued These appraisals may utilize a single valuation approach or a combination of approaches including sales comparison, cost and the income approach. Adjustments are often made in the appraisal process by the appraisers to take in to account differences between the comparable sales and income and other available data. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for Level 3 nonrecurring impaired loans is primarily the sales comparison approach less selling costs of 10 %. Other Real Estate (“ORE”) is reported at fair value on a non-recurring basis. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including sales comparison, cost and the income approach. Adjustments are often made in the appraisal process by the appraisers to take in to account differences between the comparable sales and income and other available data. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation technique used for Level 3 nonrecurring ORE is primarily the sales comparison approach less selling costs of 10 %. The following tables’ present information about the Company’s assets and liabilities measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value for the periods indicated. December 31, 2021 Fair Value Measurements (Dollars in thousands) Carrying Amount Level 1 Level 2 Level 3 Total Fair Value Financial Assets: Cash and cash equivalents $ 715,460 $ 715,460 $ - $ - $ 715,460 Investment securities available-for-sale 270,454 10,214 260,240 - 270,454 Investment securities held-to-maturity 737,052 - 681,588 44,446 726,034 Non-marketable securities 15,549 - - 15,549 15,549 Loans and leases, net 3,176,170 - - 3,179,857 3,179,857 Bank-owned life insurance 71,411 71,411 - - 71,411 Financial Liabilities: Total deposits $ 4,640,152 $ 4,247,666 $ - $ 391,732 $ 4,639,398 Subordinated debentures 10,310 - 6,890 - 6,890 December 31, 2020 Fair Value Measurements (Dollars in thousands) Carrying Amount Level 1 Level 2 Level 3 Total Fair Value Financial Assets: Cash and cash equivalents $ 383,837 $ 383,837 $ - $ - $ 383,837 Investment securities available-for-sale 807,732 15,470 792,262 - 807,732 Investment securities held-to-maturity 68,933 - 26,262 43,787 70,049 Non-marketable securities 12,693 - - 12,693 12,693 Loans and leases, net 3,040,730 - - 3,045,911 3,045,911 Bank-owned life insurance 69,235 69,235 - - 69,235 Financial Liabilities: Total deposits $ 4,060,267 $ 3,638,400 $ - $ 422,840 $ 4,061,240 Subordinated debentures 10,310 - 6,888 - 6,888 113 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 13—Fair Value Measurements—Continued Non-recurring Measurements: Impaired loans are classified with Level 3 of the fair value hierarchy. The estimated fair value of impaired loans is based on the fair value of the collateral, less estimated costs to sell. The Company receives an appraisal or performs an evaluation for each impaired loan. The key inputs used to determine the fair value of impaired loans include selling costs, and adjustment to comparable collateral. Valuations and significant inputs obtained by independent sources are reviewed by the Company for accuracy and reasonableness. Appraisals are typically obtained at least on an annual basis. The Company also considers other factors and events that may affect the fair value. The appraisals or evaluations are reviewed at least on a quarterly basis to determine if any adjustments are needed. After review and acceptance of the appraisal or evaluation, adjustments to impaired loans may occur. The following tables present information about the Bank’s assets and liabilities measured at fair value on a recurring and non-recurring basis and indicate the fair value hierarchy of the valuation techniques utilized by the Bank to determine such fair value for the periods indicated. December 31, 2021 Fair Value Measurements (Dollars in thousands) Carrying Amount Level 1 Level 2 Level 3 Total Fair Value Fair valued on a recurring basis: Investment securities available-for-sale U.S. Treasury notes $ 10,089 $ 10,089 $ - $ - $ 10,089 U.S. Government-sponsored securities 6,374 - 6,374 - 6,374 Mortgage-backed securities 251,120 - 251,120 - 251,120 Collateralized Mortgage Obligations 2,436 - 2,436 - 2,436 Other 435 125 310 - 435 Fair valued on a non-recurring basis: Individually evaluated loans $ 2,562 $ - $ - $ 2,562 $ 2,562 Other Real Estate 873 - - 873 873 December 31, 2020 Fair Value Measurements (Dollars in thousands) Carrying Amount Level 1 Level 2 Level 3 Total Fair Value Fair valued on a recurring basis: Investment securities available-for-sale U.S. Treasury notes $ 15,288 $ 15,288 $ - $ - $ 15,288 U.S. Government-sponsored securities 8,160 - 8,160 - 8,160 Mortgage-backed securities 732,720 - 732,720 - 732,720 Collateralized Mortgage Obligations 5,153 - 5,153 - 5,153 Corporate securities 45,919 - 45,919 - 45,919 Other 492 182 310 - 492 Fair valued on a non-recurring basis: Individually evaluated loans $ 3,269 $ - $ - $ 3,269 $ 3,269 Other Real Estate 873 - - 873 873 114 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 14. Commitments and Contingencies In the normal course of business, the Company enters into financial instruments with off balance sheet risk in order to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These instruments include commitments to extend credit, letters of credit, and other types of financial guarantees. The Company had the following off balance sheet commitments as of the dates indicated. December 31, (Dollars in thousands) 2021 2020 Commitments to extend credit, including unsecured commitments of $ 21,036 and $ 21,057 as of December 31, 2021 and 2020, respectively $ 937,009 $ 957,443 Stand-by letters of credit, including unsecured commitments of $ 9,091 and $ 10,945 as of December 31, 2021 and 2020, respectively 17,880 18,846 Performance guarantees under interest rate swap contracts entered into our clients and third-parties 1,433 2,786 The Company’s exposure to credit loss in the event of nonperformance by the other party with regard to standby letters of credit, undisbursed loan commitments, and financial guarantees is represented by the contractual notional amount of those instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded balance sheet items. The Company may or may not require collateral or other security to support financial instruments with credit risk. Evaluations of each customer’s creditworthiness are performed on a case-by-case basis. Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third-party. Outstanding standby letters of credit have maturity dates ranging from 1 to 60 months with final expiration in January 2027. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. In the ordinary course of business, the Company becomes involved in litigation arising out of its normal business activities. Management, after consultation with legal counsel, believes that the ultimate liability, if any, resulting from the disposition of such claims would not be material in relation to the financial position of the Company. The Company may be required to maintain average reserves on deposit with the Federal Reserve Bank primarily based on deposits outstanding. Reserve requirements are offset by the Company’s vault cash and deposit balances maintained with the Federal Reserve Bank. 115 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 15 — Leases Lessee – Operating Leases Operating leases in which we are the lessee are recorded as operating lease right-of-use (“ROU”) assets and operating lease liabilities, included in other assets and other liabilities , respectively, on our consolidated balance sheets. We do not currently have any significant finance leases in which we are the lessee. Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate at the lease commencement date. ROU assets are further adjusted for lease incentives. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded net in occupancy expense in the consolidated statements of income. Our leases relate primarily to office space and bank branches with remaining lease terms of generally 1 to 10 years. Certain lease arrangements contain extension options that typically range from 5 to 10 years at the then fair market rental rates. ASC 842 requires lessees to evaluate whether option periods, if available, will be exercised in order to determine the full life of the lease. The Company used the first option period, unless it is a relatively new lease that has a long initial lease term or other extenuating circumstances. As of December 31, 2021, operating lease ROU assets and liabilities were $ 4.05 million and $ 4.13 million, respectively. Operating lease expenses totaled $ 739,000 for the year ended December 31, 2021. As of December 31, 2020, operating lease ROU assets and liabilities were $ 4.80 million and $ 4.92 million, respectively. Operating lease expenses totaled $ 833,000 and $ 836,000 for the years ended December 31, 2020 and 2019, respectively. The table below summarizes the maturity of remaining lease liability: (Dollars in thousands) Amount 2022 $ 701 2023 712 2024 728 2025 740 2026 and beyond 1,601 Total lease payments 4,482 Discount ( 349 ) Net present value of lease liabilities $ 4,133 As of December 31, 2021, we have no additional operating leases for office space that have not yet commenced or that are anticipated to commence during the first quarter of 2022. 116 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 15—Leases — Continued Lessor - Direct Financing Leases The Company is the lessor in direct finance lease arrangements. Leases are recorded at the principal balance outstanding, net of unearned income and charge-offs. Interest income is recognized using the interest method. Leases typically have a maturity of three to ten years , and fixed rates that are most often tied to Treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed with qualified, independent appraisers that establish the residual values the Company uses in structuring a lease. Lease payments due to the Company are typically fixed and paid in equal installments over the lease term. Variable lease payments that do not depend on an index or a rate (e.g., property taxes) that are paid directly by the Company are minimal. The majority of property taxes are paid directly by the client to third-parties and are not considered part of variable payments and therefore are not recorded by the Company. As a lessor, the Company leases certain types of agriculture equipment, solar equipment, construction equipment and other equipment to its customers. The Company’s net investment in direct financing leases was $ 96.4 million at December 31, 2021 and $ 103.5 million at December 31, 2020. Note 16 — Income Taxes The components of income tax expense (benefit) are as follows: Year Ended December 31, (Dollars in thousands) 2021 2020 2019 Income tax expense / (benefit) Current: Federal $ 12,595 $ 12,174 $ 14,798 State 10,270 9,005 7,733 Total current expense 22,865 21,179 22,531 Deferred: Federal 59 ( 1,115 ) ( 3,500 ) State ( 939 ) ( 847 ) 246 Total current deferred benefit ( 880 ) ( 1,962 ) ( 3,254 ) Provision for income tax expense $ 21,985 $ 19,217 $ 19,277 117 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 16 — Income Taxes—Continued The combined federal and state income tax expense differs from that computed at the federal statutory corporate tax rate as follows: Year Ended December 31, 2021 2020 2019 (Dollars in thousands) Amount Rate Amount Rate Amount Rate Effective income tax rate Federal statutory rate $ 18,548 21.00 % $ 16,370 21.00 % $ 15,816 21.00 % State taxes, net of Federal income tax benefit 7,370 8.34 % 6,445 8.27 % 6,304 8.40 % Low-income housing tax credits ( 3,116 ) ( 3.53 %) ( 2,655 ) ( 3.41 %) ( 2,078 ) ( 2.80 %) Bank owned life insurance ( 471 ) ( 0.53 %) ( 444 ) ( 0.57 %) ( 460 ) ( 0.60 %) Tax-exempt interest income ( 347 ) ( 0.39 %) ( 350 ) ( 0.45 %) ( 358 ) ( 0.50 %) Other, net 1 ( 0 .00 %) ( 149 ) ( 0.19 %) 53 0.10 % Total provision for income tax expense and effective tax rate $ 21,985 24.89 % $ 19,217 24.65 % $ 19,277 25.60 % 118 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 16 — Income Taxes—Continued The nature and components of the Company’s net deferred income tax assets are as follows: December 31, (Dollars in thousands) 2021 2020 Deferred income tax assets: Allowance for credit losses $ 18,129 $ 17,248 Deferred compensation 15,339 13,707 Accrued liabilities 9,415 8,526 State income taxes 2,157 1,891 Lease liabilities 1,222 1,454 Unrealized losses on debt securities 945 - SBA PPP loan fee income 764 1,367 Acquired net operating losses 614 643 Low-income housing tax investments 503 384 Acquired loans fair valuation 197 237 Acquired OREO fair valuation 108 108 Other 19 7 Total deferred income tax assets 49,412 45,572 Deferred income tax liabilities: Commercial leasing $ ( 17,892 ) $ ( 17,183 ) Unrealized gains on debt securities - ( 5,156 ) Premises and equipment ( 1,860 ) ( 1,684 ) Right of use leasing asset ( 1,197 ) ( 1,428 ) Core deposit intangible asset ( 1,006 ) ( 1,186 ) Deferred loan and lease costs ( 869 ) ( 692 ) Accretion on investment securities ( 523 ) ( 588 ) FHLB dividends ( 348 ) ( 348 ) Prepaid assets ( 43 ) ( 45 ) Other ( 132 ) ( 169 ) Total deferred income tax liabilities ( 23,870 ) ( 28,479 ) Net deferred income tax assets $ 25,542 $ 17,093 The Company believes, based on available information, that more likely than not, the net deferred income tax asset will be realized in the normal course of operations. Accordingly, no valuation allowance has been recorded at December 31, 2021 and 2020. The impact of a tax position is recognized in the financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position. As of December 31, 2021 and 2020, the Company did no t have any significant uncertain tax positions. The Company includes any interest and penalties associated with unrecognized tax benefits within the provision for income taxes. The Company does not expect a material change to the total amount of unrecognized tax benefits in the next twelve months. The Company files U.S. and state income tax returns in jurisdictions with various statutes of limitations. The 2017 through 2021 tax years remain subject to selection for examination as of December 31, 2021. The Company’s California income tax returns for the years 2018, 2019 and 2020 are currently under audit. As of December 31, 2021 and 2020, the Company has net operating loss of $ 2.0 million and $ 2.1 million carry-forwards and no tax credit carry-forwards. Note 17 — Condensed Financial Statements of Parent Company Financial information pertaining only to Farmers and Merchants Bancorp (“FMCB”), on a parent-only basis, is as follows: December 31, (Dollars in thousands) 2021 2020 Balance Sheets Assets Cash and cash equivalents $ 1,535 $ 4,551 Investment in subsidiaries 472,573 429,347 Other assets 241 956 Total assets $ 474,349 $ 434,854 Liabilities and shareholders’ equity Subordinated debentures $ 10,310 $ 10,310 Other liabilities 903 879 Shareholders’ equity 463,136 423,665 Total liabilities and shareholders’ equity $ 474,349 $ 434,854 119 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 17 — Condensed Financial Statements of Parent Company —Continued Year Ended December 31, (Dollars in thousands) 2021 2020 2019 Statements of Income Dividend and other income from subsidiaries $ 9,900 $ 19,874 $ 13,166 Interest and dividends 9 11 17 Total income 9,909 19,885 13,183 Reimbursement of expenses from subsidiaries 780 821 800 Other expenses 1,469 1,656 1,616 Total expense 2,249 2,477 2,416 Income before income taxes 7,660 17,408 10,767 Income tax benefit 660 729 698 8,320 18,137 11,465 Equity in undistributed net income of subsidiaries 58,016 40,597 44,571 Net income $ 66,336 $ 58,734 $ 56,036 (Dollars in thousands) Year Ended December 31, Statements of Cash Flows 2021 2020 2019 Cash flows from operating activities: Net income $ 66,336 $ 58,734 $ 56,036 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of the Bank ( 58,016 ) ( 40,597 ) ( 44,571 ) Change in other assets and liabilities 739 ( 393 ) 62 Net cash provided by operating activities 9,059 17,744 11,527 Cash flows from investing activities: Payments for investments in non-qualified retirement plans - ( 403 ) ( 6,273 ) Net cash used in investing activities - ( 403 ) ( 6,273 ) Cash flows from financing activities: Common stock repurchases - ( 2,834 ) - Issuance of common stock - 403 6,973 Cash dividends paid ( 12,075 ) ( 11,700 ) ( 11,221 ) Net used in financing activities ( 12,075 ) ( 14,131 ) ( 4,248 ) Net change in cash and cash equivalents ( 3,016 ) 3,210 1,006 Cash and cash equivalents, beginning of year 4,551 1,341 335 Cash and cash equivalents, end of year $ 1,535 $ 4,551 $ 1,341 120 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None