FARMERS & MERCHANTS BANCORP 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis is intended to provide a comprehensive review of the Company’s operating results and financial condition. The information contained in this section should be read in conjunction with the Audited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements in this Annual Report on Form 10-K. Information related to the comparison of the results of operations for the years December 31, 2021 to 2020 is found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2021 Annual Report on Form 10-K filed with the SEC on March 15, 2022. FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Exchange Act. These forward-looking statements reflect our current views and are not historical facts. These statements may include statements regarding projected performance for periods following the date of this report. These statements can generally be identified by use of phrases such as “believe,” “expect,” “will,” “seek,” “should,” “anticipate,” “estimate,” “intend,” “plan,” “target,” “project,” “commit” or other words of similar import. Similarly, statements that describe our future financial condition, results of operations, objectives, strategies, plans, goals or future performance and business are also forward-looking statements. Statements that project future financial conditions, results of operations and shareholder value are not guarantees of performance and many of the factors that will determine these results and values are beyond our ability to control or predict. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors, including, but not limited to, those described in the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections and other parts of this Annual Report on Form 10-K that could cause our actual results to differ materially from those anticipated in these forward-looking statements. The following is a non-exclusive list of factors, that could cause our actual results to differ materially from our forward-looking statements in this Annual Report on Form 10-K: ◾ changes in general economic conditions, either nationally, in California, or in our local markets; ◾ inflation, changes in interest rates, securities market volatility and monetary fluctuations; ◾ increases in competitive pressures among financial institutions and businesses offering similar products and services; ◾ the future impact of the COVID-19 virus; ◾ higher defaults in our loan portfolio than we expect; ◾ changes in management’s estimate of the adequacy of the allowance for credit losses; ◾ risks associated with our growth and expansion strategy and related costs; ◾ increased lending risks associated with our high concentration of real estate loans; ◾ legislative or regulatory changes or changes in accounting principles, policies or guidelines; ◾ technological changes; ◾ failure to raise the debt limit on U.S. debt; ◾ regulatory or judicial proceedings; and ◾ other factors and risks including those described under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in “Item 1A. Risk Factors” in this Annual Report on Form 10-K. Please take into account that forward-looking statements speak only as of the date of this Annual Report on Form 10-K (or documents incorporated by reference, if applicable). 40 Table of Contents The Company does not undertake any obligation to publicly correct or update any forward-looking statement if it later becomes aware that actual results are likely to differ materially from those expressed in such forward-looking statement, except as required by law. Overview Farmers & Merchants Bancorp (the “Company”, “FMCB”, or “we”) is the holding company for Farmers & Merchants Bank of Central California (the “Bank” or “FMB). The Bank is a full-service community bank providing loans, deposit and cash management services to individuals and businesses. Our primary clients are small to medium-sized businesses that require highly personalized commercial banking products and services. The Bank has 29 branch locations and 3 ATMs that have been serving communities in the mid-Central Valley and East Bay of California for over 100 years. The primary source of funding for our asset growth has been the generation of core deposits, which we raise through our existing branch locations, newly opened branch locations, or through acquisitions. Our recent loan growth is primarily the result of organic growth generated by our seasoned relationship managers and supporting associates who provide outstanding service and responsiveness to our clients or through acquisitions. Our results of operations are largely dependent on net interest income. Net interest income is the difference between interest income we earn on interest earning assets, which are comprised of loans, investment securities and short-term investments, and the interest we pay on our interest bearing liabilities, which are primarily deposits, and, to a lesser extent, other borrowings. Management strives to match the re-pricing characteristics of the interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. We measure our performance by calculating our net interest margin, return on average assets, and return on average equity. Net interest margin is calculated by dividing net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities, by average interest earning assets. Net interest income is our largest source of revenue. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income. We also measure our performance by our efficiency ratio, which is calculated by dividing non-interest expense by the sum of net interest income and non-interest income. 41 Table of Contents Selected Financial Data The following condensed consolidated statements of financial condition and operations and selected performance ratios as of December 31, 2022, 2021, and 2020 and for the years then ended have been derived from our audited consolidated financial statements. The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with this “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8, Financial Statement and Supplementary Data.” Years Ended December 31 (Dollars in thousands, except per share data) 2022 2021 2020 Selected Income Statement Information: Interest income $ 198,413 $ 165,268 $ 159,294 Interest expense 4,840 4,332 9,491 Net interest income 193,573 160,936 149,803 Provision for credit losses 6,450 1,910 4,500 Net interest income after provision for credit losses 187,123 159,026 145,303 Non-interest income 6,178 21,056 15,054 Non-interest expense 93,560 91,761 82,406 Income before income tax expense 99,741 88,321 77,951 Income tax expense 24,651 21,985 19,217 Net income $ 75,090 $ 66,336 $ 58,734 Selected financial ratios: Basic and diluted earnings per share $ 96.55 $ 84.01 $ 74.03 Cash dividends per common share 16.15 15.30 14.75 Dividend ratio 16.73 % 18.21 % 19.92 % Net interest margin 3.80 % 3.46 % 3.88 % Non-interest income to average assets 0.12 % 0.43 % 0.37 % Non-interest expense to average assets 1.75 % 1.87 % 2.00 % Efficiency ratio 46.84 % 50.42 % 49.99 % Return on average assets 1.41 % 1.35 % 1.43 % Return on average equity 16.04 % 15.00 % 14.60 % Net charge-offs (recoveries) to average loans 0.01 % (0.01 %) 0.02 % 42 Table of Contents As of December 31, (Dollars in thousands, except per share data) 2022 2021 2020 Selected Balance Sheet Information: Cash and cash equivalents $ 588,257 $ 715,460 $ 383,837 Investment securities 997,817 1,007,506 876,665 Gross loans held for investment 3,512,361 3,237,177 3,099,592 Total assets 5,327,399 5,177,720 4,550,453 Total deposits 4,759,269 4,640,152 4,060,267 Shareholders' equity 485,308 463,136 423,665 Average Balances: Average earning assets 5,091,684 4,656,337 3,861,070 Average assets 5,341,901 4,913,999 4,112,537 Average shareholders' equity 468,001 442,246 402,329 Selected financial ratios: Book value per share $ 631.63 $ 586.51 $ 536.53 Tangible book value per share $ 613.42 $ 568.04 $ 517.28 Allowance for credit losses to total loans 1.90 % 1.88 % 1.89 % Non-performing assets to total assets 0.03 % 0.03 % 0.03 % Loans held for investment to deposits 73.80 % 69.76 % 76.34 % Capital ratios: Tier 1 leverage capital 9.36 % 8.92 % 9.13 % Total risk-based capital 13.06 % 13.19 % 12.59 % Average equity to average assets 8.76 % 9.00 % 9.78 % Tangible common equity to tangible assets 8.87 % 8.69 % 9.01 % Summary of Critical Accounting Policies and Estimates In the opinion of management, the accompanying Consolidated Statements of Financial Condition and related Consolidated Statements of Operations, Comprehensive Income, Changes in Shareholders’ Equity and Cash Flows reflect all adjustments (which include reclassification and normal recurring adjustments) that are necessary for a fair presentation in conformity with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified certain accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. Management believes the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, given the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Further, subsequent changes in economic or market conditions could have a material impact on these estimates and our financial condition and operating results in future periods. For additional information concerning critical accounting policies, see the Selected Notes to the Consolidated Financial Statements and the following: Use of Estimates — The preparation of our financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates the estimates used. Estimates are based upon historical experience, current economic conditions and other factors that management considers reasonable under the circumstances and the actual results may differ from these estimates under different assumptions. The allowance for credit losses, deferred income taxes, and fair values of financial instruments are estimates, which are particularly subject to change. 43 Table of Contents Allowance for Credit Losses — The Company recognizes there is risk of credit losses with financial instruments, to include loans, and unfunded loan commitments, where the Company advances funds to a counterparty. The risk of credit losses varies with, among other things, the type of financial instrument, the creditworthiness and cash flows of the counterparty, any guarantees from government agencies, and the collateral, if any, used to secure the financial instrument. The Company maintains an allowance for credit losses on loans and unfunded commitments held in accordance with GAAP. The allowance for credit losses represents our estimate of probable losses inherent in our existing loan portfolio. The allowance for credit losses is increased by charging a provision for credit losses against income and reduced by charge-offs, net of recoveries. Under the guidance of Financial Accounting Standards Board Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“CECL”), we evaluate our allowance for credit losses quarterly based on a number of quantitative and qualitative factors, including levels and trends of past due and non-accrual loans, asset classifications, loan grades and internal loan reviews, change in volume and mix of loans, collateral value, historical loss experience, size and complexity of individual credits, loan concentrations and economic conditions. Allowance for credit losses is provided on both a specific and general basis. Specific allowances are provided for impaired credits for which the expected/anticipated loss is measurable. General valuation allowances are based on a portfolio segmentation based on risk grading, with a further evaluation of various quantitative and qualitative factors. The Company begins its determination of credit losses by evaluating historical credit loss experience by loan segment. Historical loss information may be adjusted based on specific risk characteristics by loan segment. Such risk characteristics may include, but are not necessarily limited to, changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses; changes in national and local economic conditions and forecasts; changes in the nature and volume of the loans and in the terms of such instruments; changes in the experience, ability, and depth of lending management and other relevant staff; changes in the volume and severity of past due status, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans; changes in the quality of the institution’s loan review system; changes in the value of underlying collateral for collateral-dependent loans; the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses. While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates. The estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. For additional information, see Note 4, located in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. The allowance for credit losses on unfunded loan commitments is classified in other liabilities on the Consolidated Statements of Financial Condition. The allowance for credit losses on unfunded loan commitments is increased by charging a provision for credit losses on unfunded commitments, which was reported in other non-interest expenses for 2022 and prior. We believe that our allowance for credit losses was adequate to absorb probable losses inherent in the loan portfolio as of December 31, 2022 and 2021. 44 Table of Contents 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, net of the allowance for credit losses - securities, adjusted for amortization of premiums and discounts to the earliest callable date. 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. Management measures expected credit losses on held-to-maturity debt securities on a collective basis by major security type. The Company’s HTM portfolio contains securities issued by U.S. government entities and agencies and municipalities. The Company uses industry historical credit loss information adjusted for current conditions to establish the allowance for credit losses on its HTM municipal bond portfolio. For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings. If the Company does not intend to sell the security, and it is not more likely than not that the Company will be required to sell the security, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized costs, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. Projected cash flows are discounted by the current effective interest rate. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to AOCI. Changes in the allowance for credit losses-securities are recorded as provision for (or reversal of) credit losses. Losses are charged against the allowance when management believes the non-collectability of an available-for-sale security is confirmed or when either criteria regarding intent of requirement to sell is met. At December 31, 2022, we had no investment securities that were impaired. 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 it is not amortized but is reviewed annually, 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. 45 Table of Contents Other Intangible Assets — Other intangible assets consists 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 lives 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. The amortization of our CDI is recorded in other non-interest expense. 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. Fair Value Measurements — The Company discloses the fair value of financial instruments and the methods and significant assumptions used to estimate those fair values. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period between origination of the instrument and its expected realization. For additional information, see “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” and Note 12 located in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. Income Taxes — Income taxes are filed on a consolidated basis with our subsidiaries and allocate income tax expense (benefit) based on each entity’s proportionate share of the consolidated provision for income taxes. Deferred income tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The determination of the amount of deferred income tax assets, that are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred income tax asset will not be realized. “More likely than not” is defined as greater than a 50% probability. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Only tax positions that meet the more likely than not recognition threshold are recognized. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated statements of financial condition along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest expense and penalties associated with unrecognized tax benefits are classified as income tax expense in the consolidated statements of income. 46 Table of Contents Impact of Recently Issued Accounting Standards See Note 1. “Summary of Significant Accounting Policies” to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. Results of Operations The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and its subsidiaries’ performance during each of the years in the two-year period ended December 31, 2022 and the material changes in financial condition, operating income, and expense of the Company and its subsidiaries as shown in the accompanying consolidated financial statements. Information related to the comparison of the results of operations for the years December 31, 2021 and 2020 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2021 Annual Report on Form 10-K filed with the SEC on March 15, 2022. Factors that determine the level of net income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, fee income, non-interest expense, the level of non-performing loans and other non-earning assets, and the amount of non-interest bearing liabilities supporting earning assets. Non-interest income includes card processing fees, service charges on deposit accounts, bank-owned life insurance income, gains/losses on the sale of investment securities, and gains/losses on deferred compensation investments. Non-interest expense consists primarily of salaries and employee benefits, cost of deferred compensation benefits, occupancy, data processing, FDIC insurance, marketing, legal and other expenses. 47 Table of Contents Average Balance and Yields . The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield, cost and net interest margin information for the periods presented. Average balances are derived from daily balances. Year ended December 31, 2022 2021 (Dollars in thousands) Average Balance Interest Income / Expense Average Yield / Rate Average Balance Interest Income / Expense Average Yield / Rate ASSETS Interest earnings deposits in other banks and federal funds sold $ 704,082 $ 12,102 1.72 % $ 666,167 $ 902 0.14 % Investment securities: (1) Taxable securities 1,044,954 19,678 1.88 % 838,710 14,646 1.75 % Non-taxable securities (2) 48,168 1,569 3.26 % 52,384 1,648 3.15 % Total investment securities 1,093,122 21,247 1.94 % 891,094 16,294 1.83 % Loans: (3) Real estate: Commercial 1,202,548 58,966 4.90 % 1,037,554 53,298 5.14 % Agricultural 705,222 35,010 4.96 % 641,086 29,544 4.61 % Residential and home equity 369,619 14,551 3.94 % 339,345 12,717 3.75 % Construction 182,523 9,788 5.36 % 182,722 7,965 4.36 % Total real estate 2,459,912 118,315 4.81 % 2,200,707 103,524 4.70 % Commercial & industrial 440,510 22,452 5.10 % 373,497 16,935 4.53 % Agricultural 262,461 14,084 5.37 % 233,544 10,385 4.45 % Commercial leases 94,040 5,702 6.06 % 98,056 5,485 5.59 % Consumer and other 22,008 3,469 15.76 % 178,535 10,879 6.09 % Total loans and leases 3,278,931 164,022 5.00 % 3,084,339 147,208 4.77 % Non-marketable securities 15,549 1,042 6.70 % 14,737 864 5.86 % Total interest earning assets 5,091,684 198,413 3.90 % 4,656,337 165,268 3.55 % Allowance for credit losses (62,588 ) (60,059 ) Non-interest earning assets 312,805 317,721 Total average assets $ 5,341,901 $ 4,913,999 LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing deposits: Demand $ 1,120,198 1,497 0.13 % $ 1,024,009 1,128 0.11 % Savings and money market accounts 1,542,310 1,981 0.13 % 1,352,258 1,458 0.11 % Certificates of deposit greater than $250,000 157,623 460 0.29 % 170,040 701 0.41 % Certificates of deposit less than $250,000 215,044 411 0.19 % 235,746 730 0.31 % Total interest bearing deposits 3,035,175 4,349 0.14 % 2,782,053 4,017 0.14 % Short-term borrowings 1 - 0.00 % 1 - 0.00 % Subordinated debentures 10,310 491 4.76 % 10,310 315 3.06 % Total interest bearing liabilities 3,045,486 4,840 0.16 % 2,792,364 4,332 0.16 % Non-interest bearing deposits 1,751,797 1,610,611 Total funding 4,797,283 4,840 0.10 % 4,402,975 4,332 0.10 % Other non-interest bearing liabilities 76,617 68,778 Shareholders' equity 468,001 442,246 Total average liabilities and shareholders' equity $ 5,341,901 $ 4,913,999 Net interest income $ 193,573 $ 160,936 Interest rate spread 3.74 % 3.39 % Net interest margin (4) 3.80 % 3.46 % (1) Excludes average unrealized (losses) gains of ($24.5) million and $3.4 million for the years ended December 31, 2022, and 2021, respectively, which are included in non-interest earning assets. (2) The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $415,000 and $436,000 for the years ended December 31, 2022, and 2021, respectively. (3) Loan interest income includes loan fees of $11.6 million and $17.0 million for the years ended December 31, 2022 and 2021, respectively. (4) Net interest margin is computed by dividing net interest income by average interest earning assets. 48 Table of Contents Interest-bearing deposits with banks and Federal Reserve balances are additional earning assets available to the Company. Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earned an average interest rate of 1.72% and 0.14% for the years ended December 31, 2022 and 2021, respectively. The increase was primarily the result of the FRB increasing rates by 425 basis points during 2022. Average interest-bearing deposits was $704 million and $666 million for the years ended December 31, 2022 and 2021, respectively. Interest income on interest-bearing deposits with banks was $12.1 million and $902,000 for the years ended December 31, 2022 and 2021, respectively. The investment portfolio is another main component of the Company’s earning assets. Historically, the Company invested primarily in: (1) mortgage-backed securities issued by government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times the Company selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans and leases, the yield earned on investments is generally less than that of loans and leases. Average total investment securities were $1.1 billion and $891 million for the years ended December 31, 2022 and 2021, respectively. The average yield on total investment securities were 1.94% and 1.83 % for the years ended December 31, 2022 and 2021, respectively. See “Investment Securities and Federal Reserve balances” for a discussion of the Company’s investment strategy in 2022. Average loans and leases held for investment were $3.3 billion and $3.1 billion for the years ended December 31, 2022 and 2021, respectively. The yield on the loan & lease portfolio was 5.00% and 4.77% for the years ended December 31, 2022 and 2021, respectively. The Company continues to experience aggressive competitor pricing for loans and leases to which it may need to respond in order to retain key customers. This could continue to place negative pressure on future loan & lease yields and net interest margin. Average interest-bearing liabilities was $3.0 billion and $2.8 billion for the years ended December 31, 2022 and 2021, respectively. Total interest expense on interest-bearing liabilities was $4.8 million, $4.3 million for the years ended December 31, 2022 and 2021, respectively. The average rate paid on interest-bearing liabilities was 0.16% and 0.16% for the years ended December 31, 2022 and 2021, respectively. 49 Table of Contents Rate/Volume Analysis . The following table shows the change in interest income and interest expense and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes of volume and rates. For purposes of this table, the change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of change in each. Year Ended December 31, 2022 compared with 2021 Increase (Decrease) Due to: (Dollars in thousands) Volume Rate Net Interest income: Interest earnings deposits in other banks and federal funds sold $ 54 $ 11,146 $ 11,200 Investment securities: Taxable securities 3,816 1,216 5,032 Non-taxable securities (136 ) 57 (79 ) Total investment securities 3,680 1,273 4,953 Loans: Real estate: Commercial 7,805 (2,137 ) 5,668 Agricultural 3,081 2,385 5,466 Residential and home equity 1,168 666 1,834 Construction (9 ) 1,832 1,823 Total real estate 12,045 2,746 14,791 Commercial & industrial 3,261 2,256 5,517 Agricultural 1,385 2,314 3,699 Commercial leases (231 ) 448 217 Consumer and other (1) (14,475 ) 7,065 (7,410 ) Total loans and leases 1,986 14,828 16,814 Non-marketable securities 49 129 178 Total interest income 5,769 27,376 33,145 Interest expense: Interest bearing deposits: Demand 113 256 369 Savings and money market accounts 222 301 523 Certificates of deposit greater than $250,000 (48 ) (193 ) (241 ) Certificates of deposit less than $250,000 (60 ) (259 ) (319 ) Total interest bearing deposits 227 105 332 Subordinated debentures 8 168 176 Total interest expense 235 273 508 Net interest income $ 5,534 $ 27,103 $ 32,637 (1) Consumer and other - These decreases respresent the end of the PPP loans which were $0 and $70,765 as of December 31, 2022 and 2021 respectively. 50 Table of Contents Net interest income was $193.6 million and $160.9 million for the two years ended December 31, 2022 and 2021, respectively. The increase in net interest income was driven primarily by increased interest rates and deposit growth, which we were able to partially deploy into growing our loan portfolio. The remaining increase in interest was held in interest earning deposits and investment securities. Comparison of Results of Operations for the Years Ended December 31, 2022 and 2021 Years Ended December 31 (Dollars in thousands) 2022 2021 $ Better / (Worse) % Better / (Worse) Selected Income Statement Information: Interest income $ 198,413 $ 165,268 $ 33,145 20.06 % Interest expense 4,840 4,332 (508 ) -11.73 % Net interest income 193,573 160,936 32,637 20.28 % Provision for credit losses 6,450 1,910 (4,540 ) -237.70 % Net interest income after provision for credit losses 187,123 159,026 28,097 17.67 % Non-interest income 6,178 21,056 (14,878 ) -70.66 % Non-interest expense 93,560 91,761 (1,799 ) -1.96 % Income before income tax expense 99,741 88,321 11,420 12.93 % Income tax expense 24,651 21,985 (2,666 ) -12.13 % Net income $ 75,090 $ 66,336 $ 8,754 13.20 % Net Income. For the years ended December 31, 2022 and 2021, net income was $75.1 million compared with $66.3 million, respectively. The increase in net income was primarily the result of higher net interest income of $32.6 million. This increase was offset by a decrease in non-interest income of $14.9 million, higher provision for credit losses of $4.5 million, higher income tax expense of $2.7 million and an increase in non-interest expense of $1.8 million. Net Interest Income and Net Interest Margin. For the year ended December 31, 2022, net interest income increased $32.6 million, or 20.28%, to $193.6 million compared with $160.9 million for the same period a year earlier. The increase is the result of: (1) average interest earning assets increasing $435.4 million, or 9.35%, to $5.1 billion compared with $4.7 billion for the same period a year earlier; and (2) the net interest margin increasing 34 basis points to 3.80% for all of 2022 compared with 3.46% for the same period a year earlier. The increase in the net interest margin was primarily the result of the FRB increasing the federal funds rate over the past year. Provision for Credit Losses. The provision for credit losses in each period is a charge against earnings in that period. The provision is the amount required to maintain the allowance for credit losses at a level that, in management’s judgment, is adequate to absorb expected losses over the life of the loan and HTM securities portfolios. The provision for credit losses for the year ended December 31, 2022, was $6.5 million compared with $1.9 million for the same period a year ago. For the year ended December 31, 2022, the Company incurred net charge-offs of $0.2 million compared with net recoveries of $0.2 million for the same period a year earlier. 51 Table of Contents Non-interest Income. Non-interest income decreased $14.9 million, or 70.66%, to $6.2 million for 2022 compared with $21.1 million for the same period a year earlier. The year-over-year decrease in non-interest income was primarily due to: (1) a $10.7 million loss on the sale of investment securities versus a $2.6 gain for the same period a year earlier; and (2) $2.2 million decline in gains/(losses) on deferred compensation plan investments. The Company recorded net gains on deferred compensation plan investments of $0.45 million in 2022 compared to net gains of $2.6 million in 2021. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. 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. Although GAAP requires these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no net-effect on the Company’s net income. Non-interest Expense. Non-interest expense increased $1.8 million, or 1.96%, to $93.6 million for 2022 compared with $91.8 million for the same period a year ago. The year-over-year increase was primarily comprised of: (1) a $0.4 million increase in salaries and employee benefits; (2) a $0.6 million increase in legal expenses; (3) a $0.2 million increase in FDIC insurance; (4) a $0.2 million increase in marketing expenses; and (5) an increase of $2.5 million in other miscellaneous expenses ($1.0 million of which was a provision for unused commitments). These increases were partially off-set by a $2.2 million decline in gain/(losses) on deferred compensation plan investments. For the year ended December 31, 2022, the Company’s efficiency ratio was 46.84% compared with 50.42% for the same period a year ago. Net gains on deferred compensation plan obligations were $0.4 million in 2022 compared to net gains of $2.6 million in 2021. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. 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. Although GAAP requires these gains on obligations to be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no net-effect on the Company’s net income. Income Tax Expense. For the year ended December 31, 2022, income tax expense was $24.7 million, compared with $22.0 million for the same period a year earlier. For the year ended December 31, 2022, the effective tax rate was 24.72% compared with 24.89% for the same period a year ago. Financial Condition Total assets grew $149.7 million, or 2.89%, to $5.3 billion at December 31, 2022 compared with $5.2 billion at December 31, 2021. Loans held for investment grew $275.2 million or 8.5% to $3.5 billion at December 31, 2022, compared with $3.2 billion at December 31, 2021. Exclusive of SBA PPP loans, the loan portfolio grew $346 million, or 10.69%, over December 31, 2021. This data constitutes non-GAAP financial data. The Company believes that excluding the temporary effect of the PPP loans furnishes useful information regarding the Company’s growth. Total deposits increased $119.1 million, or 2.57%, to $4.8 billion at December 31, 2022 compared with $4.6 billion at December 31, 2021. The increase in total assets and deposits was primarily the result of continued strong organic deposit growth. Investment Securities and Federal Reserve Balances The Company’s investment portfolio decreased by less than 1.0%, to $1.0 billion at December 31, 2022. This decrease is net of the impact of $47.7 million that the Company sold for interest rate risk management purposes. The Company uses its investment portfolio to manage interest rate and liquidity risks. The Company's total investment portfolio as of December 31, 2022 represents 18.72% of the Company’s total assets as compared to 19.45% at December 31, 2021. Not included in the investment portfolio are interest bearing deposits with banks and overnight investments in Federal Reserve balances. Interest bearing deposits with banks consisted primarily of FRB deposits. 52 Table of Contents The FRB currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest. Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB. Interest bearing deposits with banks totaled $515 million at December 31, 2022 and $663 million at December 31, 2021. The Company classifies its investment securities as either held-to-maturity (“HTM”) or available-for-sale (“AFS”). Securities are classified as held-to-maturity and are carried at amortized cost, net of an allowance for credit losses, when the Company has the intent and ability to hold the securities to maturity. See Note 2 “Investment Securities” to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income taxes. As of December 31, 2022, the Company held no investment securities from any issuer (other than the U.S. Treasury or an agency of the U.S. government or a government-sponsored entity) that totaled over 10% of our shareholders’ equity. The carrying value of our portfolio of investment securities was as follows: As of December 31, (Dollars in thousands) 2022 2021 Available-for-Sale Securities U.S. Treasury notes $ 4,964 $ 10,089 U.S. Government-sponsored securities 4,427 6,374 Mortgage-backed securities (1) 132,528 251,120 Collateralized mortgage obligations (1) 1,054 2,436 Corporate securities 9,581 - Other 310 435 Total available-for-sale securities $ 152,864 $ 270,454 (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. As of December 31, (Dollars in thousands) 2022 2021 Held-to-Maturity Securities Mortgage-backed securities (1) $ 702,858 $ 596,775 Collateralized mortgage obligations (1) 80,186 73,781 Municipal securities (2) 61,909 66,496 Total held-to-maturity securities $ 844,953 $ 737,052 (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. (2) Municipal securities are net of allowance for credit losses of $393 and $0, respectively. 53 Table of Contents The following table shows the carrying value for contractual maturities of investment securities and the weighted average yields of such securities, including the benefit of tax-exempt securities: Investment Securities As of December 31, 2022 Within One Year After One but Within Five Years After Five but Within Ten Years After Ten Years Total (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Debt securities available-for-sale U.S. Treasury notes $ 4,964 2.37 % $ - 0.00 % $ - 0.00 % $ - 0.00 % $ 4,964 2.37 % U.S. Government-sponsored securities 3 2.17 % 53 2.29 % 380 4.52 % 3,991 4.52 % 4,427 4.29 % Mortgage-backed securities (1) 13 2.82 % 16,460 2.31 % 15,156 2.41 % 100,899 1.82 % 132,528 1.95 % Collateralized mortgage obligations (1) - 0.00 % - 0.00 % - 0.00 % 1,054 2.35 % 1,054 2.35 % Corporate securities - 0.00 % 9,581 3.13 % - 0.00 % - 0.00 % 9,581 3.13 % Other 310 4.60 % - 0.00 % - 0.00 % - 0.00 % 310 4.60 % Total debt securities available-for-sale $ 5,290 2.50 % $ 26,094 2.61 % $ 15,536 2.46 % $ 105,944 1.93 % $ 152,864 2.11 % (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. As of December 31, 2022 Within One Year After One but Within Five Years After Five but Within Ten Years After Ten Years Total (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Securities held-to-maturity Mortgage-backed securities (1) $ - 0.00 % $ - 0.00 % $ 18,197 1.22 % $ 684,661 1.90 % $ 702,858 1.88 % Collateralized mortgage obligations (1) - 0.00 % - 0.00 % - 0.00 % 80,186 1.80 % 80,186 1.80 % Municipal securities 883 5.92 % 8,058 3.98 % 15,670 3.70 % 37,691 4.83 % 62,302 4.45 % Total securities held-to-maturity $ 883 5.92 % $ 8,058 3.98 % $ 33,867 2.37 % $ 802,538 2.03 % $ 845,346 2.07 % (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. Investment Securities As of December 31, 2021 Within One Year After One but Within Five Years After Five but Within Ten Years After Ten Years Total (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Securities available-for-sale U.S. Treasury notes $ 5,028 2.33 % $ 5,061 2.38 % $ - 0.00 % $ - 0.00 % $ 10,089 2.36 % U.S. Government-sponsored securities 2 1.80 % 148 2.29 % 512 1.55 % 5,712 1.26 % 6,374 1.30 % Mortgage-backed securities (1) 13 1.50 % 21,155 2.36 % 50,554 2.36 % 179,398 1.61 % 251,120 1.83 % Collateralized mortgage obligations (1) - 0.00 % - 0.00 % - 0.00 % 2,436 2.30 % 2,436 2.30 % Other 435 3.31 % - 0.00 % - 0.00 % - 0.00 % 435 3.31 % Total securities available-for-sale $ 5,478 2.41 % $ 26,364 2.36 % $ 51,066 2.35 % $ 187,546 1.61 % $ 270,454 1.84 % (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. As of December 31, 2021 Within One Year After One but Within Five Years After Five but Within Ten Years After Ten Years Total (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Securities held-to-maturity Mortgage-backed securities (1) $ - 0.00 % $ - 0.00 % $ 10,641 0.41 % $ 586,134 1.72 % $ 596,775 1.70 % Collateralized mortgage obligations (1) - 0.00 % - 0.00 % - 0.00 % 73,781 1.71 % 73,781 1.71 % Municipal securities 308 1.10 % 8,487 2.19 % 18,433 3.42 % 39,268 4.52 % 66,496 3.90 % Total securities held-to-maturity $ 308 1.10 % $ 8,487 2.19 % $ 29,074 2.32 % $ 699,183 1.88 % $ 737,052 1.90 % (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. Expected maturities may differ from contractual maturities because issuers may have the right to call obligations with or without penalties including prepayments on mortgage-backed securities. The Company evaluates securities for expected credit losses at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. 54 Table of Contents Loans and Leases Loans and leases can be categorized by borrowing purpose and use of funds. Common examples of loans and leases made by the Company include: Commercial and Agricultural Real Estate – These are loans secured by owner-occupied real estate, non-owner-occupied real estate, owner-occupied farmland, and multifamily residential properties. Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing, or the income will be the Bank's primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; maturities generally do not exceed 15 years (and may have pricing adjustments on a shorter timeframe) amortizations of up to 25 years (30 years for multifamily residential properties); have debt service coverage ratios of 1.00 or better with a target of 1.25 or greater; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan. Real Estate Construction – These are loans for acquisition, development and construction and are secured by commercial or residential real estate. These loans are generally made only to experienced local developers with a successful track record; for projects in our service area; with Loan to Value (LTV) below 75%; and where the property can be developed and sold within 2 years. Commercial construction loans are made only when there is an approved take-out commitment from the Bank or an acceptable financial institution or government agency. Most acquisition, development and construction loans are tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Single Family Residential Real Estate – These are loans primarily made on owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC. However, the Company will make loans on rural residential properties up to 41 acres. Most residential loans have terms from ten to thirty years and carry fixed or variable rates priced to treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income” loans. Home Equity Lines and Loans – These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $500,000; but can be made for up to $1,000,000 in high cost counties. Combined Loan To Value (CLTV) does not exceed 75%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1 st lien position Agricultural – These are non-real estate loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on livestock, crops, crop proceeds and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Commercial – These are non-real estate loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations. Lines of credit are extended to finance the seasonal working capital needs of customers during peak business periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on accounts receivable, inventory and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a plant or purchase of a business; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. 55 Table of Contents Consumer – These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit. The Company has a minimal consumer loan portfolio. Commercial Leases – These are leases primarily to businesses and farmers for financing the acquisition of equipment. They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases; or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains the tax benefits of ownership. 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. The Company accounts for leases with Investment Tax Credits (“ITC”) under the deferred method as established in ASC 740-10. ITCs are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement. Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan & lease structure. See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan & lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan & lease type. The Company’s policies require that loans and leases be approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting procedures for all loan & lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease. Most loans and leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan is made. In order to be responsive to borrower needs, the Company prices loans and leases: (1) on both a fixed rate and adjustable rate basis; (2) over different terms; and (3) based upon different rate indices as long as these structures are consistent with the Company’s interest rate risk management policies and procedures. See “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” in this Annual Report on Form 10-K for further details. Overall, the Company's loan & lease portfolio at December 31, 2022 totaled $3.5 billion, an increase of $275.2 million or 8.50% over December 31, 2021. Exclusive of SBA PPP loans, the loan portfolio grew $346.0 million, or 10.69%, over December 31, 2021. This increase in the non-PPP loans occurred as a result of: (1) the Company’s business development efforts directed toward credit-qualified borrowers; and (2) expansion of our service area into the East Bay of San Francisco and Napa County. This data constitutes non-GAAP financial data. The Company believes that excluding the temporary effect of the PPP loans furnishes useful information regarding the Company’s growth. 56 Table of Contents The following table sets forth the distribution of the loan & lease portfolio by type and percent at the end of each period presented: December 31, 2022 2021 (Dollars in thousands) Dollars Percent of Total Dollars Percent of Total Gross Loans and Leases Real estate: Commercial $ 1,328,691 37.73 % $ 1,167,516 35.95 % Agricultural 726,938 20.64 % 672,830 20.72 % Residential and home equity 387,753 11.01 % 350,581 10.79 % Construction 166,538 4.73 % 177,163 5.45 % Total real estate 2,609,920 74.11 % 2,368,090 72.91 % Commercial & industrial 478,758 13.59 % 427,799 13.17 % Agricultural 314,525 8.93 % 276,684 8.52 % Commercial leases 112,629 3.20 % 96,971 2.99 % Consumer and other (1) 5,886 0.17 % 78,367 2.41 % Total gross loans and leases $ 3,521,718 100.00 % $ 3,247,911 100.00 % (1) Includes SBA PPP loans of $0 and $70,765 as of December 31, 2022 and December 31, 2021, respectively. The following table shows the maturity distribution and interest rate sensitivity of the loan portfolio of the Company as of December 31, 2022. Loan Contractual Maturity (Dollars in thousands) One Year or Less After One But Within Five Years After Five But Within Fifteen Years After Fifteen Years Total Gross loan and leases: Real estate: Commercial $ 61,340 $ 326,671 $ 889,041 $ 51,639 $ 1,328,691 Agricultural 26,588 172,766 452,249 75,335 726,938 Residential and home equity 384 4,143 117,421 265,805 387,753 Construction 94,238 72,300 - - 166,538 Total real estate 182,550 575,880 1,458,711 392,779 2,609,920 Commercial & industrial 216,019 181,520 75,093 6,126 478,758 Agricultural 197,010 98,898 18,617 - 314,525 Commercial leases 45,503 61,377 5,749 - 112,629 Consumer and other 753 3,989 1,144 - 5,886 Total gross loans and leases $ 641,835 $ 921,664 $ 1,559,314 $ 398,905 $ 3,521,718 Rate Structure for Loans Fixed Rate $ 116,749 $ 475,248 $ 1,158,859 $ 255,628 $ 2,006,484 Adjustable Rate 525,086 446,416 400,455 143,277 1,515,234 Total gross loans and leases $ 641,835 $ 921,664 $ 1,559,314 $ 398,905 $ 3,521,718 57 Table of Contents Non-Accrual Loans and Leases - Accrual of interest on loans and leases is generally discontinued when a loan or lease becomes contractually past due by 90 days or more with respect to interest or principal. When loans and leases are 90 days past due, but in management's judgment are well secured and in the process of collection, they may not be classified as nonaccrual. When a loan or lease is placed on non-accrual status, all interest previously accrued but not collected is reversed. Income on such loans and leases is then recognized only to the extent that cash is received and where the future collection of principal is probable. Non-accrual loans and leases totaled $571,000 and $516,000 for the years ended December 31, 2022 and 2021, respectively. Restructured Loans and Leases - A restructuring of a loan or lease constitutes a TDR under ASC 310-40, if the Company for economic or legal reasons related to the debtor's financial difficulties grants a concession to the borrower that it would not otherwise consider, except when subject to the CARES Act and H.R. 133, as discussed below. Restructured loans or 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 non-accrual status at the time they become TDR loans or leases, remain on non-accrual 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 collateral dependent and are individually evaluated for impairment. At December 31, 2022, restructured loans totaled $1.3 million compared with $2.3 million at December 31, 2021, all of which were performing. See Note 4 “Loans and Leases” to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. Other Real Estate Owned – OREO represents real property taken either through foreclosure or through a deed in lieu thereof from the borrower. The Company records all OREO properties at amounts equal to or less than the fair market value of the properties based on current independent appraisals reduced by estimated selling costs. The Company reported $873,000 of foreclosed OREO at December 31, 2022, and at December 31, 2021. 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 but were not considered TDRs because of the CARES Act and H.R. 133. Since April 2020, we have restructured $304.0 million of loans under the CARES Act and H.R. 133 guidelines (see “Part I, Introduction - COVID-19 (Coronavirus) Disclosure”). At December 31, 2022, all loans that were restructured as part of the CARES Act, have returned to the contractual terms and conditions of the loans, without exception. 58 Table of Contents The following table summarizes the loans for which the accrual of interest has been discontinued and loans more than 90 days past due and still accruing interest, including those non-accrual loans that are troubled debt restructured loans, and OREO (as hereinafter defined): December 31, (Dollars in thousands) 2022 2021 Non-performing assets: Non-accrual loans and leases, not TDRs Real estate: Commercial $ 403 $ - Agricultural - 18 Residential and home equity - - Construction 168 - Total real estate 571 18 Commercial & industrial - - Agricultural - - Commercial leases - - Consumer and other - - Subtotal 571 18 Non-accrual loans and leases, are TDRs Real estate: Commercial - - Agricultural - - Residential and home equity - - Construction - - Total real estate - - Commercial & industrial - - Agricultural - 498 Commercial leases - - Consumer and other - - Subtotal - 498 Total non-performing loans and leases $ 571 $ 516 Other real estate owned ("OREO") $ 873 $ 873 Total non-performing assets $ 1,444 $ 1,389 Performing TDRs $ 1,311 $ 1,824 Selected ratios: Non-performing loans to total loans and leases 0.02 % 0.02 % Non-performing assets to total assets 0.03 % 0.03 % Although management believes that non-performing loans and leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. See Note 4. “Loans and Leases”, located in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for an allocation of the allowance classified to collateral dependent loans and leases. 59 Table of Contents Except for non-performing loans and leases discussed above, the Company’s management is not aware of any loans and leases as of December 31, 2022, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date. However: • The State of California experienced drought conditions from 2013 through most of 2016. After 2016, reasonable levels of rain and snow alleviated drought conditions in our primary service area, but the winter of 2020-2021 and 2021-2022 were once again dry (although 2023 has begun with significant levels of rain and snow). Despite this, the availability of water in our primary service area was not an issue for the 2022 growing season. However, the weather patterns over the past nine years further reinforce the fact that the long-term risks associated with the availability of water are significant. • While significant progress has been made in fighting the COVID-19 virus, particularly with the development of vaccines, the effects of COVID-19 are still with us, and it is impossible to predict the ultimate impact on classified and non-performing loans and leases (see Part I. “Introduction - COVID-19 (Coronavirus) Disclosure”). Allowance for Credit Losses—Loans and Leases The Company maintains an allowance for credit losses (“ACL”) under the guidance of Financial Accounting Standards Board Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“CECL”). 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 collateral dependent loans and leases; general reserves for current expected credit losses related to loans and leases that are not collateral dependent; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors. See Note 1, located in “Item 8. Financial Statements and Supplementary Data” for a detailed discussion on the Company’s allowance for credit losses. 60 Table of Contents The following table sets forth the activity in our ACL for the periods indicated: Year Ended December 31, (Dollars in thousands) 2022 2021 Allowance for credit losses: Balance at beginning of year $ 61,007 $ 58,862 Provision / (recapture) for credit losses 6,057 1,910 Charge-offs: Real estate: Commercial (170 ) - Agricultural - - Residential and home equity (25 ) - Construction - - Total real estate (195 ) - Commercial & industrial (324 ) - Agricultural - - Commercial leases - - Consumer and other (62 ) (44 ) Total charge-offs (581 ) (44 ) Recoveries: Real estate: Commercial - - Agricultural - - Residential and home equity 131 98 Construction - - Total real estate 131 98 Commercial & industrial 195 99 Agricultural 53 55 Commercial leases - - Consumer and other 23 27 Total recoveries 402 279 Net charge-offs / recoveries (179 ) 235 Balance at end of year $ 66,885 $ 61,007 Selected financial information: Gross loans and leases held for investment $ 3,512,361 $ 3,237,177 Average loans and leases 3,278,931 3,084,339 Non-performing loans and leases 571 516 Allowance for credit losses to non-performing loans and leases 11713.66 % 11823.06 % Net charge-offs / (recoveries) to average loans and leases 0.01 % (0.01 %) Provision for credit losses to average loans and leases 0.18 % 0.06 % Allowance for credit losses to loans and leases held for investment 1.90 % 1.88 % The increase in ACL in both 2021 and 2022 was primarily related to higher expected probable losses inherent in the loan portfolio that was directly related to quantitative and qualitative factors associated with the current economic environment and overall growth in the loan portfolio. 61 Table of Contents The following table indicates management’s allocation of the ACL by loan type as of each of the following dates: December 31, 2022 2021 (Dollars in thousands) Dollars Percent of Each Loan Type to Total Loans Dollars Percent of Each Loan Type to Total Loans Allowance for credit losses: Real estate: Commercial $ 18,055 37.73 % $ 28,536 35.95 % Agricultural 14,496 20.64 % 9,613 20.72 % Residential and home equity 7,508 11.01 % 2,847 10.79 % Construction 3,026 4.73 % 1,456 5.45 % Total real estate 43,085 74.11 % 42,452 72.91 % Commercial & industrial 11,503 13.59 % 11,489 13.17 % Agricultural 10,202 8.93 % 5,465 8.52 % Commercial leases 1,924 3.20 % 938 2.99 % Consumer and other 171 0.17 % 663 2.41 % Total allowance for credit losses $ 66,885 100.00 % $ 61,007 100.00 % Deposits Total deposits were $4.76 billion and $4.64 billion as of December 31, 2022 and 2021, respectively. In addition to the Company’s ongoing business development activities for deposits, in management’s opinion the following factors positively impacted year-over-year deposit growth: (1) the Company’s strong financial results and position and F&M Bank’s reputation as one of the most safe and sound banks in its market area; and (2) the Company’s expansion of its service area into Walnut Creek, Oakland, Concord and Napa. Non-interest bearing demand deposits increased to $1.76 billion, or 36.96% of total deposits, as of December 31, 2022 from $1.75 billion, or 37.72% of total deposits, as of December 31, 2021. Interest bearing deposits are comprised of interest-bearing transaction accounts, money market accounts, regular savings accounts, and certificates of deposit. Total deposits have increased 2.57% since December 31, 2021: • Demand and interest-bearing transaction accounts totaled $2.88 billion at December 31, 2022, an increase of $36.1 million, or 1.27% from $2.85 billion held at December 31, 2021. • Savings and money market accounts increased $144.1 million, or 10.29%, to $1.54 billion at December 31, 2022 compared with $1.40 billion at December 31, 2021. • Certificates of deposit accounts decreased $61.1 million, or 15.56%, to $331.4 million at December 31, 2022 compared with $392.5 million at December 31, 2021. 62 Table of Contents The following table shows the average amount and average rate paid on the categories of deposits for each of the periods presented: As of December 31, 2022 2021 2020 (Dollars in thousands) Average Balance Interest Expense Average Rate Average Balance Interest Expense Average Rate Average Balance Interest Expense Average Rate Total deposits: Interest bearing deposits: Demand $ 1,120,198 1,497 0.13 % $ 1,024,009 1,128 0.11 % $ 787,306 1,618 0.21 % Savings and money market 1,542,310 1,981 0.13 % 1,352,258 1,458 0.11 % 1,128,623 2,724 0.24 % Certificates of deposit greater than $250,000 157,623 460 0.29 % 170,040 701 0.41 % 220,952 2,535 1.15 % Certificates of deposit less than $250,000 215,044 411 0.19 % 235,746 730 0.31 % 268,294 2,236 0.83 % Total interest bearing deposits 3,035,175 4,349 0.14 % 2,782,053 4,017 0.14 % 2,405,175 9,113 0.38 % Non-interest bearing deposits 1,751,797 1,610,611 1,232,874 Total deposits $ 4,786,972 $ 4,349 0.09 % $ 4,392,664 $ 4,017 0.09 % $ 3,638,049 $ 9,113 0.25 % Deposits are gathered from individuals and businesses in our market areas. The interest rates paid are competitively priced for each particular deposit product and structured to meet our funding requirements. The significant increase in short-term interest rates during 2022 has placed pressure on deposit pricing, and we will continue to manage this ongoing impact through careful deposit pricing. The average cost of deposits, including non-interest bearing deposits was 0.09% for all of 2022 and all of 2021. The following table shows deposits with a balance greater than $250,000 at December 31, 2022 and 2021: December 31 (Dollars in thousands) 2022 2021 Non-Maturity Deposits greater than $250,000 $ 2,872,754 $ 2,708,576 Certificates of deposit greater than $250,000, by maturity: Less than 3 months 45,078 59,591 3 months to 6 months 30,426 37,182 6 months to 12 months 44,189 59,945 More than 12 months 9,153 12,147 Total certificates of deposit greater than $250,000 $ 128,846 $ 168,865 Total deposits greater than $250,000 $ 3,001,600 $ 2,877,441 Refer to the Year-To-Date Average Balances and Rate Schedules located in this "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for information on separate deposit categories. The Bank participates in a program wherein the State of California places time deposits with the Bank at the Bank’s option. At December 31, 2022 and 2021, the Bank had $3.0 million, of these deposits. Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings Lines of Credit with the Federal Reserve Bank and Federal Home Loan Bank are other key sources of funds to support earning assets. These sources of funds are also used to manage the Company’s interest rate risk exposure; and, as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB advances at December 31, 2022 or 2021. There were no Federal Funds purchased or advances from the FRB at December 31, 2022 or 2021. Long-Term Subordinated Debentures On December 17, 2003, the Company raised $10.0 million through the sale of subordinated debentures to an off-balance sheet trust and its sale of trust-preferred securities. See Note 9. “Long-Term Subordinated Debentures” located in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our Trust Preferred Securities will continue to qualify as regulatory capital. 63 Table of Contents These securities accrue interest at a variable rate based upon 3-month LIBOR plus 2.85%. Interest rates reset quarterly (the next reset is March 17, 2023) and the rate was 7.59% as of December 31, 2022. The average rate paid for these securities was 4.76% in 2022 and 3.06% in 2021. 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. Capital Resources The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders’ Equity totaled $485.3 million at December 31, 2022, and $463.1 million at the end of 2021. The Company and the Bank are subject to various regulatory capital adequacy guidelines as outlined under Part 324 of the FDIC Rules and Regulations. 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 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 Bank meets 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 as of December 31, 2022 and 2021. The following table sets forth our capital ratios: Minimum to be Categorized as "Well Capitalized" under Prompt Corrective Action Regulations As of December 31, (Dollars in thousands) 2022 2021 Farmers & Merchants Bancorp CET1 capital to risk-weighted assets N/A 11.57 % 11.68 % Tier 1 capital to risk-weighted assets N/A 11.80 % 11.94 % Risk-based capital to risk-weighted assets N/A 13.06 % 13.19 % Tier 1 leverage capital ratio N/A 9.36 % 8.92 % Farmers & Merchants Bank CET1 capital to risk-weighted assets 6.50% 11.79 % 11.91 % Tier 1 capital to risk-weighted assets 8.00% 11.79 % 11.91 % Risk-based capital to risk-weighted assets 10.00% 13.04 % 13.17 % Tier 1 leverage capital ratio 5.00% 9.35 % 8.91 % On November 15, 2021, the Board of Directors reauthorized the Company’s share repurchase program for up to $20.0 million of the Company’s common stock (“Repurchase Plan”), representing approximately 4% of outstanding shareholders’ equity. Repurchases by the Company under the Repurchase Plan may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means. On November 8, 2022, the Board of Directors authorized an extension to its share repurchase program through December 31, 2024 for an additional $20.0 million of the Company’s common stock (“Repurchase Plan”), which represents approximately 4% of outstanding shareholders’ equity. 64 Table of Contents During 2022, the Company repurchased 21,309 shares under the Repurchase Plan, for a total of $20.3 million. Off-Balance-Sheet Arrangements Off-balance-sheet arrangements are any contractual arrangement to which an unconsolidated entity is a party, under which the Company has: (1) any obligation under a guarantee contract; (2) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to that entity for such assets; (3) any obligation under certain derivative instruments; or (4) any obligation under a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services with the Company. The Company had the following off balance sheet commitments as of the dates indicated. The following table sets forth our off-balance sheet lending commitments as of December 31, 2022: Amount of Commitment Expiration per Period (Dollars in thousands) Total Committed Amount Less than One Year One to Three Years Three to Five Years After Five Years Off-balance sheet commitments Commitments to extend credit $ 1,141,036 $ 423,956 $ 203,186 $ 476,671 $ 37,223 Standby letters of credit 17,138 10,770 4,468 1,470 430 Total off-balance sheet commitments $ 1,158,174 $ 434,726 $ 207,654 $ 478,141 $ 37,653 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. Most 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. Additionally, the Company maintains a reserve for off balance sheet commitments, which totaled $ 2.1 million and $315,000 at December 31, 2022 and 2021, respectively. The allowance for credit losses - unfunded loan commitments was $2.1 million at December 31, 2022 compared to $0.3 million at December 31, 2021. The increase in ACL in 2022 was primarily related to higher expected probable losses inherent in the loan portfolio that was directly related to quantitative and qualitative factors associated with the current economic environment and overall growth in the loan portfolio. 65 Table of Contents Liquidity The ability to have readily available funds sufficient to repay maturing liabilities is of primary importance to depositors, creditors and regulators. Our liquidity, represented by cash borrowing lines, federal funds and available-for-sale securities, is a result of our operating, investing and financing activities and related cash flows. In order to ensure funds are available at all times, we devote resources to projecting the amount of funds that will be required and we maintain relationships with a diversified client base so funds are accessible. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets. We had the following borrowing lines available at December 31, 2022: As of December 31, 2022 (Dollars in thousands) Total Credit Line Limit Current Credit Line Available Outstanding Amount Remaining Credit Line Available Value of Collateral Pledged Additional liquidity sources: Federal Home Loan Bank $ 757,866 $ 757,866 $ - $ 757,866 $ 1,225,175 Federal Reserve BIC 650,925 650,925 - 650,925 883,754 FHLB Fed Funds 18,000 18,000 - 18,000 - US Bank Fed Funds 35,000 35,000 - 35,000 - PCBB Fed Funds 50,000 50,000 - 50,000 - Total additional liquidity sources $ 1,511,791 $ 1,511,791 $ - $ 1,511,791 $ 2,108,929 We believe our liquid assets and short-term borrowing credit lines are adequate to meet our cash flow needs for loan funding and deposit cash withdrawal for the foreseeable future. As of December 31, 2022, we had $958 million in cash and unencumbered investment securities; $2.1 million in investment securities and $2.1 billion in loans pledged as collateral on short-term borrowing credit lines. We have the option of either borrowing on our credit lines or selling these investment securities for cash flow needs. On a long-term basis, our liquidity will be met by changing the relative distribution of our asset portfolios by reducing our investment or loan volumes, or selling or encumbering assets. Further, we will increase liquidity by soliciting higher levels of deposit accounts through promotional activities and/or borrowing from our correspondent banks as well as the FHLB. At the current time, our long-term liquidity needs primarily relate to funds required to support loan originations and commitments and deposit withdrawals. We believe we can meet all of these needs from existing liquidity sources. Our liquidity is comprised of three primary classifications: cash flows from or used in operating activities; cash flows from or used in investing activities; and cash flows from or used in financing activities. Net cash provided by or used in operating activities has consisted primarily of net income adjusted for certain non-cash income and expense items such as the credit loss provision, investment and other amortization and depreciation. Our primary investing activities are the origination of loans, and purchases and sales of investment securities. As of December 31, 2022, we had unfunded loan commitments of $1.1 billion and unfunded letters of credit of $17.1 million. We anticipate that we will have sufficient funds available to meet current loan commitments.