FARMERS & MERCHANTS BANCORP 10-K

Item 7A. Quantitative and Qualitative Disclosures about Market Risk Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Our market risk arises primarily from interest rate risk inherent in our lending and deposit taking activities. Management actively monitors and manages our interest rate risk exposure. We do not have any market-risk sensitive instruments entered into for trading purposes. We manage our interest-rate sensitivity by matching the re-pricing opportunities on our earning assets to those on our funding liabilities. 66 Table of Contents Management uses various asset/liability strategies to manage the re-pricing characteristics of our assets and liabilities designed to ensure that exposure to interest rate fluctuations is limited within our guidelines of acceptable levels of risk-taking. Hedging strategies, including the terms and pricing of loans and deposits, and managing the deployment of our securities, are used to reduce mismatches in interest rate re-pricing opportunities of portfolio assets and their funding sources. Our Asset Liability Management Committee (“ALCO”), which is comprised of members of the Board of Directors and executive officers, manages market risk. ALCO monitors interest rate risk by analyzing the potential impact on net interest income from potential changes in interest rates, and considers the impact of alternative strategies or changes in balance sheet structure. ALCO manages our balance sheet in part to maintain the potential impact of changes in interest rates on net interest income within acceptable ranges despite changes in interest rates. Our exposure to interest rate risk is reviewed on at least a quarterly basis by ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine our change in net interest income in the event of hypothetical changes in interest rates. If potential changes to net interest income resulting from hypothetical interest rate changes are not within risk tolerances determined by ALCO, and approved by the full Board of Directors, Management may make adjustments to the Company’s asset and liability mix to bring interest rate risk levels within the Board approved limits. Net Interest Income Simulation. In order to measure interest rate risk, we used a simulation model to project changes in net interest income that result from forecasted changes in interest rates. This analysis calculates the difference between net interest income forecasted using a rising and a falling interest rate scenario and a net interest income forecast using a base market interest rate derived from the current treasury yield curve. The income simulation model includes various assumptions regarding the re-pricing relationships for each of our products. Many of our assets are floating rate loans, which are assumed to re-price immediately, and to the same extent as the change in market rates according to their contracted index. Some loans and investment vehicles include the opportunity of prepayment (embedded options), and accordingly the simulation model uses national indexes to estimate these prepayments and assumes the reinvestment of the proceeds at current yields. Our non-term deposit products re-price more slowly, usually changing less than the change in market rates and at our discretion. This analysis indicates the impact of changes in net interest income for the given set of rate changes and assumptions. It assumes the balance sheet grows modestly, but that its structure will remain similar to the structure as of the period presented. It does not account for all factors that affect this analysis, including changes by management to mitigate the effect of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates change. Furthermore, loan prepayment-rate estimates and spread relationships change regularly. Interest rate changes create changes in actual loan prepayment rates that will differ from the market estimates incorporated in this analysis. Changes that vary significantly from the assumptions may have significant effects on our net interest income. For the rising and falling interest rate scenarios, the base market interest rate forecast was increased or decreased, on an instantaneous and sustained basis, by 200 basis points. As of the periods presented, our net interest margin exposure related to these hypothetical changes in market interest rates was within the current guidelines established by us. Our simulation model highlights the fact that our balance sheet is asset sensitive, which means that our net interest income rises in a rising interest rate environment. 67 Table of Contents The ratio of variable to fixed-rate loans in our loan portfolio, the ratio of short-term (maturing at a given time within 12 months) to long-term loans, and the ratio of our demand, money market and savings deposits to CDs (and their time periods), are the primary factors affecting the sensitivity of our net interest income to changes in market interest rates. Our short-term loans are typically priced at prime plus a margin, and our long-term loans are typically priced based on a FHLB index for comparable maturities, plus a margin. The composition of our rate-sensitive assets or liabilities is subject to change and could result in a more unbalanced position that would cause market rate changes to have a greater impact on our net interest margin. Gap Analysis. Another way to measure the impact that future changes in interest rates will have on net interest income is through a cumulative gap measure. The gap represents the net position of assets and liabilities subject to re-pricing in specified periods. A gap analysis highlights the distribution of re-pricing opportunities of our interest earning assets and interest-bearing liabilities, the interest rate sensitivity gap (that is, interest rate sensitive assets less interest rate sensitive liabilities), cumulative interest earning assets and interest bearing liabilities, the cumulative interest rate sensitivity gap, the ratio of cumulative interest earning assets to cumulative interest-bearing liabilities and the cumulative gap as a percentage of total assets and total interest earning assets as of the periods presented. The analysis also sets forth the time periods during which interest earning assets and interest bearing liabilities will mature or may re-price in accordance with their contractual terms. The interest rate relationships between the re-priceable assets and re-priceable liabilities are not necessarily constant and may be affected by many factors, including the behavior of clients in response to changes in interest rates. Gap analysis has certain limitations. Measuring the volume of re-pricing or maturing assets and liabilities does not always measure the full impact on the portfolio value of equity or net interest income. Gap analysis does not account for rate caps on products, dynamic changes such as increasing prepayment speeds as interest rates decrease, basis risk, embedded options or the benefit of no-rate funding sources. The relation between product rate re-pricing and market rate changes (basis risk) is not the same for all products. The majority of interest earning assets generally re-price along with a movement in market rates, while non-term deposit rates in general move more slowly and usually incorporate only a fraction of the change in market rates. Products categorized as non-rate sensitive, such as our non-interest bearing demand deposits, in the gap analysis behave like long-term fixed rate funding sources. Management uses income simulation, net interest income rate shocks and market value of portfolio equity as its primary interest rate risk management tools. 68 Table of Contents Item 8. Financial Statements and Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm ( Eide Bailly LLP , San Ramon, California , PCAOB ID: 286 ) Report of Independent Registered Public Accounting Firm ( Moss Adams LLP , San Francisco, California , PCAOB ID: 659 ) 70 Consolidated Financial Statements Consolidated Statements of Financial Condition as of December 31, 2022, and 2021 74 Consolidated Statements of Income for the three years ended December 31, 2022, 2021 and 2020 75 Consolidated Statements of Comprehensive Income for the three years ended December 31, 2022, 2021 and 2020 76 Consolidated Statements of Changes in Shareholders’ Equity for the three years ended December 31, 2022, 2021 and 2020 77 Consolidated Statements of Cash Flows for the three years ended December 31, 2022, 2021 and 2020 78 Notes to the Consolidated Financial Statements 79 69 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders Farmers & Merchants Bancorp Lodi, California Opinions on the Consolidated 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, 2022, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended, 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, 2022, based on criteria established in 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2022, and the consolidated results of its operations and its cash flows for the year then ended, 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, 2022, based on criteria established in 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Change in Accounting Principle As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for the recognition and measurement of credit losses as of January 1, 2022 due to the adoption of the Financial Accounting Standards Board Accounting Standards Update 2016-13, Financial Instruments - Credit Losses, Measurement of Credit Losses on Financial Instruments. 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 Management’s Report on Internal Control Over Financial Reporting. 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 audit 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 that responds to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit 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. 70 Table of Contents Definition and Limitations of Internal Control Over Financial Reporting An entity’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 accounting principles generally accepted in the United States of America. An entity’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 entity; (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 entity are being made only in accordance with authorizations of management and directors of the entity; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity’s assets that could have a material effect on the financial statements. 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 Matter The critical audit matter communicated below is a matter arising from the current-period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved 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 matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Allowance for Credit Losses – Loans and Leases The Company has a gross loan portfolio of $3.5 billion and related allowance for credit losses (ACL) of $66.9 million as of December 31, 2022. As discussed in Notes 1 & 5 of the Company’s consolidated financial statements, the ACL represents management’s estimate of expected credit losses over the contractual life of the loan portfolio. The ACL is estimated using relevant available information relating to past events, current economic conditions, and reasonable and supportable forecasts, as well as qualitative adjustments applied on a portfolio segment basis. The qualitative adjustments are used to bring the ACL to the level management believes is appropriate based on factors that are otherwise unaccounted for in the quantitative process. Auditing these complex judgments and assumptions involves especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed. Our considerations and procedures performed to address this critical audit matter included: • Obtaining an understanding of the Company’s process for establishing the ACL, including the models selected by management to estimate quantitative components of the ACL and qualitative adjustments made to the ACL. This includes the process utilized by management to challenge the model results and determine the best estimate of the ACL as of the balance sheet date. • Evaluating the design and testing the operating effectiveness of controls relating to the development and approval of the ACL methodology, management’s identification, determination and controls related to the significant assumptions used in the models, controls around the reliability and accuracy of the data used in the models, analysis of the ACL results and management’s review and approval of the ACL. 71 Table of Contents • Determining whether the loan portfolio is segmented by similar risk characteristics by comparing to the Company’s business environment and relevant industry practices. • Evaluating the identification and measurement of the qualitative adjustments, including the basis for concluding an adjustment was warranted and compared the adjustments utilized by management to both internal portfolio metrics and external macroeconomic data to support the adjustments and evaluated the trends in such adjustments. We searched for and evaluated information that corroborates or contradicts management’s identification and measurement of qualitative factors. • Testing the completeness and accuracy of internal loan level data used as the basis for the calculation, including management’s controls. • Testing the mathematical accuracy and computation of the ACL. /s/ Eide Bailly LLP We have served as the Company’s auditor since 2022. San Ramon, California March 15, 2023 72 Table of Contents Report of Independent Registered Public Accounting Firm To the Shareholders and the Board of Directors of Farmers & Merchants Bancorp Opinion on the Financial Statements We have audited the accompanying consolidated statement of financial condition of Farmers & Merchants Bancorp and subsidiaries (the “Company”) as of December 31, 2021 , the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the year s in the two-year period ended December 31, 2021, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2021, and the consolidated results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit s . 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 audit s in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits 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. We believe that our audit s provide a reasonable basis for our opinion. /s/ Moss Adams LLP Sacramento, California March 16, 2022 We have served as the Company’s auditor from 2013 through 2022. 73 Table of Contents Farmers & Merchants Bancorp CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, (Dollars in thousands, except share and per share amounts) 2022 2021 ASSETS Cash and due from banks $ 73,358 $ 52,499 Interest bearing deposits with banks 514,899 662,961 Total cash and cash equivalents 588,257 715,460 Securities available-for-sale, at fair value 152,864 270,454 Securities held-to-maturity, fair value $ 688,393 and $ 725,841 , respectively 845,346 737,052 Allowance for credit losses - securities ( 393 ) - Total investment securities 997,817 1,007,506 Non-marketable securities 15,549 15,549 Loans and leases held for investment 3,512,361 3,237,177 Allowance for credit losses - loans and leases ( 66,885 ) ( 61,007 ) Loans held for investment, net 3,445,476 3,176,170 Bank-owned life insurance 73,038 71,411 Premises and equipment, net 49,476 47,730 Deferred income tax assets 31,507 25,542 Accrued interest receivable 21,602 18,098 Goodwill 11,183 11,183 Other intangibles 2,809 3,402 Other real estate owned 873 873 Other assets 89,812 84,796 TOTAL ASSETS $ 5,327,399 $ 5,177,720 LIABILITIES AND SHAREHOLDERS’ EQUITY Deposits: Non-interest bearing $ 1,758,793 $ 1,750,330 Interest bearing: Demand 1,125,014 1,097,337 Savings and money market 1,544,062 1,400,000 Certificates of deposit 331,400 392,485 Total interest bearing 3,000,476 2,889,822 Total deposits 4,759,269 4,640,152 Subordinated debentures 10,310 10,310 Interest payable and other liabilities 72,512 64,122 Total Liabilities 4,842,091 4,714,584 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, 768,337 and 789,646 issued and outstanding at December 31, 2022 and 2021, respectively 8 8 Additional paid-in capital 57,206 77,516 Retained earnings 449,932 387,331 Accumulated other comprehensive (loss), net of taxes ( 21,838 ) ( 1,719 ) TOTAL SHAREHOLDERS’ EQUITY 485,308 463,136 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 5,327,399 $ 5,177,720 See accompanying notes to the consolidated financial statements. 74 Table of Contents Farmers & Merchants Bancorp Consolidated Statements of Income Year Ended December 31, (Dollars in thousands, except share and per share amounts) 2022 2021 2020 Interest income Interest and fees on loans and leases $ 164,022 $ 147,208 $ 143,383 Interest and dividends on securities 22,289 17,158 14,704 Interest on deposits with others 12,102 902 1,207 Total interest income 198,413 165,268 159,294 Interest expense Deposits 4,349 4,017 9,113 Subordinated debentures 491 315 378 Total 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 Card processing 7,123 6,959 5,536 Service charges on deposit accounts 2,794 2,972 2,637 Increase in cash surrender value of BOLI 2,233 2,175 2,088 Net (loss)/gain on sale of investment securities available-for-sale ( 10,689 ) 2,554 40 Net gain on deferred compensation benefits 451 2,614 1,777 Other 4,266 3,782 2,976 Total non-interest income 6,178 21,056 15,054 Non-interest expense Salaries and employee benefits 64,250 63,860 56,950 Net gain on deferred compensation benefits 451 2,614 1,777 Occupancy 4,717 4,675 4,640 Data Processing 4,968 4,967 4,994 FDIC insurance 1,444 1,237 517 Marketing 1,324 1,097 922 Legal 737 140 128 Other 15,669 13,171 12,478 Total non-interest expense 93,560 91,761 82,406 INCOME BEFORE INCOME TAXES 99,741 88,321 77,951 Income tax expense 24,651 21,985 19,217 NET INCOME $ 75,090 $ 66,336 $ 58,734 Earnings per common share: Basic $ 96.55 $ 84.01 $ 74.03 Diluted $ 96.55 $ 84.01 $ 74.03 Weighted average number of common shares Basic 777,726 789,646 793,337 Diluted 777,726 789,646 793,337 See accompanying notes to the consolidated financial statements. 75 Table of Contents FARMERS & MERCHANTS BANCORP Consolidated Statements of Comprehensive Income Year Ended December 31, (Dollars in thousands) 2022 2021 2020 Net income $ 75,090 $ 66,336 $ 58,734 Other comprehensive income Unrealized holding (losses)/gains on available-for-sale debt securities ( 39,015 ) ( 17,986 ) 13,905 Reclassification adjustment for losses/(gains) on available-for-sale debt securities 10,689 ( 2,554 ) ( 40 ) Amortization of unrealized loss on debt securities transferred to held-to-maturity ( 238 ) ( 457 ) - Net unrealized holding (losses)/gains on available-for-sale debt securities ( 28,564 ) ( 20,997 ) 13,865 Income tax benefit/(expense) 8,445 6,207 ( 4,099 ) Other comprehensive (loss)/income, net of tax ( 20,119 ) ( 14,790 ) 9,766 Total comprehensive income $ 54,971 $ 51,546 $ 68,500 See accompanying notes to the consolidated financial statements. 76 Table of Contents Farmers & Merchants Bancorp Consolidated Statements of Changes in Shareholders’ Equity (Dollars in thousands, except share and per share amounts) Common Shares Amount Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive (Loss)/Income Total Balance as of January 1, 2020 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 Net income - - - 75,090 - 75,090 Other comprehensive loss, net of tax - - - - ( 20,119 ) ( 20,119 ) Cash dividends declared ($ 16.15 per share) - - - ( 12,489 ) - ( 12,489 ) Repurchase of common stock ( 21,309 ) - ( 20,310 ) - - ( 20,310 ) Balance as of December 31, 2022 768,337 $ 8 $ 57,206 $ 449,932 $ ( 21,838 ) $ 485,308 See accompanying notes to the consolidated financial statements. 77 Table of Contents Farmers & Merchants Bancorp Consolidated Statements of Cash Flows Year Ended December 31, (Dollars in thousands) 2022 2021 2020 Cash flows from operating activities: Net income $ 75,090 $ 66,336 $ 58,734 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 6,450 1,910 4,500 Depreciation and amortization 2,428 2,632 2,769 Net amortization of securities premiums and discounts 376 1,446 1,159 Increase in cash surrender value of BOLI ( 2,233 ) ( 2,175 ) ( 2,088 ) Decrease/(increase) in deferred income taxes, net 4,330 ( 880 ) ( 1,962 ) Loss/(gains) on sale of securities available-for-sale 10,689 ( 2,554 ) ( 40 ) Net changes in: Other assets ( 8,262 ) ( 12,432 ) ( 818 ) Other liabilities 12,910 5,680 ( 4,135 ) Net cash provided by operating activities 101,778 59,963 58,119 Cash flows from investing activities: Net change in loans held for investment ( 275,061 ) ( 137,216 ) ( 427,049 ) Purchase of available-for-sale securities ( 10,217 ) ( 257,231 ) ( 670,550 ) Purchase of held-to-maturity securities ( 173,907 ) ( 395,176 ) ( 22,020 ) Purchase of non-marketable securities - ( 2,856 ) - Proceeds from sales, maturities, calls and pay downs of available-for-sale securities 88,504 458,855 383,257 Proceeds from maturities, calls and pay downs of held-to-maturity securities 65,493 43,287 13,299 Purchase of premises and equipment ( 4,190 ) ( 2,069 ) ( 7,709 ) Purchase of other investments ( 6,600 ) ( 8,192 ) ( 6,063 ) Redemption of other investments - 2,752 - Proceeds from bank-owned life insurance 606 - - Proceeds from sale of assets 73 1,696 81 Net cash used in investing activities ( 315,299 ) ( 296,150 ) ( 736,754 ) Cash flows from financing activities: Net increase in deposits 119,117 579,885 782,248 Cash dividends paid ( 12,489 ) ( 12,075 ) ( 11,700 ) Net cash used in share repurchase of common stock ( 20,310 ) - ( 2,834 ) Net provided by financing activities 86,318 567,810 767,714 Net change in cash and cash equivalents ( 127,203 ) 331,623 89,079 Cash and cash equivalents, beginning of year 715,460 383,837 294,758 Cash and cash equivalents, end of year $ 588,257 $ 715,460 $ 383,837 Supplemental disclosures of cash flow information: Cash paid for interest $ 5,785 $ 4,369 $ 10,903 Income taxes paid $ 12,469 $ 29,941 $ 9,581 Issuance of common stock $ - $ - $ 403 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 $ 28,326 $ 20,540 $ ( 13,865 ) Lease liabilities arising from obtaining right-of-use assets $ - $ 295 $ - See accompanying notes to the consolidated financial statements. 78 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 free-standing 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, Alameda 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 products. 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. 79 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, 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 (or loss) (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. Allowance for Credit Losses – Securities — 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. Further information regarding our policies and methodology used to estimate the allowance for credit losses on held-to-maturity securities is presented in Note 2 – Investment securities. 80 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued 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 cost, 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. 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. 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 non-accrual. 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. 81 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Restructured loan 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. 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. As of 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. 82 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Allowance for Credit Losses — Loans — The methodology for determining the allowance for credit losses (“ACL”) on loans is considered a critical accounting policy by Management because of the high degree of judgment involved. The subjectivity of the assumptions used and the potential for changes in the economic environment could result in changes to the amount of the recorded ACL. Among the material estimates required to establish the ACL are: (i) a reasonable and supportable forecast; (ii) a reasonable and supportable forecast period and the reversion period; (iii) value of collateral; strength of guarantors; (iv) the amount and timing of future cash flows for loans individually evaluated; and (v) the determination of the qualitative loss factors. All of these estimates are susceptible to significant change. The Company has established systematic methodologies for the determination of the adequacy of the ACL. The methodologies are set forth in a formal policy and take into consideration the need for a valuation allowance for loans evaluated on a collective (pool) basis, which have similar risk characteristics as well as allowances to individual loans that do not share risk characteristics. The ACL is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. The provision for credit losses reflects the amount required to maintain the ACL at an appropriate level based upon management’s evaluation of the adequacy of loss reserves. The Company increases its ACL by charging provisions for credit losses on its consolidated statement of income. Losses related to specific assets are applied as a reduction of the carrying value of the assets and charged against the ACL when management believes a loan balance is uncollectable. Recoveries on previously charged off loans are credited to the ACL. Management estimates the ACL using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience, either internal or peer information, provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made, using qualitative factors, when management expects current conditions and reasonable and supportable forecasts to differ from the conditions that existed for the period over which historical information was evaluated. The ACL is maintained at a level sufficient to provide for expected credit losses over the life of the loan based on evaluating historical credit loss experience and making adjustments to historical loss information for differences in the specific risk characteristics in the current loan portfolio. These factors include, among others, changes in the size and composition of the loan portfolio, differences in underwriting standards, delinquency rates, actual loss experience and current economic conditions. On January 1, 2022, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology that delays recognition until it is probable a loss has been incurred with an expected loss methodology that is referred to as CECL. Both the Financial Accounting Standards Board (“FASB Staff Q&A Topic 326, No. 1”) and the federal financial institution regulatory agencies (“Financial Institution Letter FIL-17-2019”), along with the Securities and Exchange Commission, have confirmed that smaller, less complex organizations are not required to implement complex models, developed by outside vendors to calculate current expected credit losses. Accordingly, in adopting ASU 2016-13 (Topic 326) Management determined that the Weighted Average Remaining Maturity (“WARM”) method was most appropriate given the Company’s current size and complexity. Management will incorporate reasonable and supportable information in order to calculate CECL reserves. This includes the ability to reliably forecast and document exogenous events that may affect the credit performance of the Company’s loan portfolio. Management is confident with its ability to effectively identify 83 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued historical loss information by the appropriate portfolio segmentation. In addition, Management believes that it can reasonably obtain historical loss information by its respective peers to further improve historical loss information. Additionally, the Company believes that it can effectively evaluate the potential impact that both macro and micro-economic conditions can have on its loan portfolio. Management is also comfortable that it can rely on weighted average maturity calculations, including estimated prepayments with its existing third party Asset/Liability Management (“ALM”) applications. Management determined that the most effective approach to segment its portfolio and to extract the relevant information it needed to calculate its CECL reserves was to utilize the seventeen loan segments used in preparing regulatory Call Reports. This allows Management the ability to obtain historical loss information for itself as well as its peer group. Additionally, Management’s ALM application also utilizes a similar loan segmentation in calculating weighted average remaining terms. The foundation of CECL modeling is the ability to estimate expected credit losses over the lifetime of a loan. Management must use relevant available information about past events (e.g. historical losses) current conditions, and reasonable and supportable forecasts about future conditions. Historical losses serve as the starting point to estimate expected credit losses. When available, historical losses should include cumulative actual losses incurred over the lifetime of the various loan segments of the loans being evaluated. In cases where such information is not available, companies may need to rely on external data, such as peer data of historical losses for similar loan segments. Management has determined to use a “through-the-cycle” historical credit loss experience as its baseline for historical credit losses. Management has determined a representative period for a full credit cycle would be from 2008 to 2022 ( fifteen-year credit cycle). Management has collected historical loss information on its own loan portfolio as well as peer group information by the seventeen loan segments over this time horizon using information available from the Federal regulators on the Uniform Bank Performance Report (“UBPR”). Federal Regulators have placed the Company into a peer group of banks with assets between $ 3 billion to $ 10 billion. This peer group segmentation includes 181 banks across the nation. The model calculates the mean historical loss rate over the 15 -year economic cycle for both the Bank and its peer group. The model calculates the stressed historical loss rate over the 15-year economic cycle for both the Bank and its peer group. Management evaluates macro and micro economic information as well as internal trends in credit performance on the Company’s loan portfolio to determine where they believe it is in an economic credit cycle. Depending upon estimations of what point in the credit cycle the current economy may exist, management adjusts, on a quantitative basis, historical loss rates either upwards or downwards from the mean. If Management believes we are nearing the end on a credit cycle, the Company may adjust historical losses in increments higher from the mean (e.g. one standard deviation from the mean). If the Company believes that we are in the recovery stage of a credit cycle, it may adjust historical losses downwards from the mean. Management understands that historical credit losses may not exactly follow a normal bell-shaped curve, but that the approach provides consistency across all loan segments as well as a measured probability of credit loss coverage. Management evaluated current economic metrics as its basis to determine that it believes that the U.S. economy is at the beginning of an economic recession. Based on this determination, management has used a one-standard deviation from the mean to capture 68.2 % of all credit losses over the 15-year economic cycle. 84 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Management used the duration of each loan segment to estimate the remaining life of loans to ensure that the model covers credit losses over the expected life of such loans. Management will continue to employ the use of qualitative factors as defined by the Interagency Policy Statement on the Allowance for Loan and Lease Losses (“SR 2006-17”). Management will consider qualitative or environmental factors that are likely to cause estimated credit losses associated with our existing portfolio to differ from historical loss experience, as defined in the Interagency Guidance, including but not 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 international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments. ◾ Changes in the nature and volume of the portfolio and in the terms of loans. ◾ Changes in the experience, ability, and depth of lending management and other relevant staff. ◾ Changes in the volume and severity of past due loans, 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. ◾ The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio. These qualitative factors are applied primarily to our agriculture and agricultural real estate loan exposure. 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. 85 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued 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 certain employee benefit 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. 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 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. 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 statements of financial condition. 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 86 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued 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. 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 statements of financial condition. 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. 87 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued 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. 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 operates as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as customer 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 are any such loss contingencies that will have a material and adverse effect on the consolidated financial statements. 88 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued Advertising costs — Advertising costs are expensed when incurred and totaled $ 1.3 million in 2022, $ 1.1 million in 2021, and $ 0.9 million in 2020. Accounting Standards Pending Adoption — The following paragraphs provide descriptions of newly issued but not yet effective accounting standards that could have a material effect on the Company’s financial position or results of operations. In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. ASU 2020-04 was effective upon issuance and, based upon the amendments provided in ASU 2022-06 discussed below, can generally be applied through December 31, 2024. We have not elected to apply these amendments. However, we will assess the applicability of the ASU to us and continue to monitor guidance for reference rate reform from the FASB and its impact on our financial condition and results of operations. In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848). The main amendments in this ASU are intended to clarify certain optional expedients and scope of derivative instruments. The amendments are elective and effective immediately upon issuance of this ASU. ASU 2021-01 was effective upon issuance and, based upon the amendments provided in ASU 2022-06 discussed below, can generally be applied through December 31, 2024. We have not elected to apply these amendments; however, we will assess the applicability of this ASU to us as we continue to monitor guidance for reference rate reform from the FASB and its impact on our financial condition and results of operations. In March 2022, the FASB issued guidance within ASU 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures . The amendments in this ASU eliminate the current troubled debt restructuring (TDR) recognition and measurement guidance and, instead, require that a creditor evaluate (consistent with the accounting for other loan modifications) whether the modification represents a new loan or a continuation of an existing loan. The amendments also introduce new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty. These amendments require vintage disclosures including current-period gross write-offs by year of origination for financing receivables. Gross write-off information must be included in the vintage disclosures in accordance with ASC 326-20-50-6, which requires disclosure of the amortized cost basis of financing receivables by credit quality indicator and class of financing receivable by year of origination. The Company has elected to adopt this portion of the amendments in the current year. The amendments in this ASU are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. These amendments should be applied prospectively, though for the transition method related to the recognition and measurement of TDRs, an entity has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. Early adoption is permitted, including adoption in an interim period. If an entity elects to early adopt in an interim period, the guidance should be applied as of the beginning of the fiscal year that includes the interim 89 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued period. An entity may elect to early adopt the amendments about TDRs and related disclosure enhancements separately from the amendments related to the vintage disclosures. ASU 2022-02 will be effective for the Company on January 1, 2023. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements. In June 2022, the FASB issued guidance within ASU 2022-03, Fair Value Measurement of Equity Securities Subject to contractual Sale Restrictions. The amendments in this ASU affect all entities that have investments in equity securities measured at fair value that are subject to a contractual sale restriction. These amendments clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. The amendments in this ASU are effective for fiscal years, beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance. The adoption of this ASU is not expected to have material impact on the Company’s consolidated financial statements. ASU No. 2022-06, “Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848.” ASU 2022-06 extends the period of time preparers can utilize the reference rate reform relief guidance provided by ASU 2020-04 and ASU 2021-01, which are discussed above. ASU 2022-06, which was effective upon issuance, defers the sunset date of this prior guidance from December 31, 2022 to December 31, 2024, after which entities will no longer be permitted to apply the relief guidance in Topic 848. We have not elected to apply amendments at this time, however, will assess the applicability of this ASU to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations. Adoption of New Accounting Standard — 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. On January 1, 2022, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology that delays recognition until it is probable a loss has been incurred with an expected loss methodology that is referred to as CECL. The Company adopted ASC 326 using the modified retrospective method for all financials assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. In adopting ASU 2016-13 (Topic 326) Management determined that the Weighted Average Remaining Maturity (“WARM”) method was most appropriate given the Company’s current size and complexity. The implementation of CECL did not result in any material change in the amount of the Company’s December 31, 2021 Allowance for Credit Losses, therefore, no adjustment to Shareholders’ Equity was made as of January 1, 2022. 90 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 1—Summary of Significant Accounting Policies—Continued 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 replaces the incurred loss impairment methodology in previous GAAP with CECL, a methodology that reflects current 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 is 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 entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit loss, which will be more decision useful to users of the financial statements. The following table illustrates the pre-tax impact of the adoption of this ASU: January-2022 (Dollars in thousands) Reported under ASC 326 Reported Pre- Adoption Impact of ASC 326 Adoption Allowance for credit losses: Real estate: Commercial $ ( 17,379 ) $ ( 28,536 ) $ 11,157 Agricultural ( 14,580 ) ( 9,613 ) ( 4,967 ) Residential and home equity ( 5,879 ) ( 2,847 ) ( 3,032 ) Construction ( 3,311 ) ( 1,456 ) ( 1,855 ) Total real estate ( 41,149 ) ( 42,452 ) 1,303 Commercial & industrial ( 11,417 ) ( 11,489 ) 72 Agricultural ( 6,363 ) ( 5,465 ) ( 898 ) Commercial leases ( 1,567 ) ( 938 ) ( 629 ) Consumer and other ( 511 ) ( 663 ) 152 Total allowance for credit losses on loans $ ( 61,007 ) $ ( 61,007 ) $ - 91 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 2 — Investment Securities The amortized cost, fair values, and unrealized gains and losses of the securities available-for-sale are as follows: Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value As of December 31, 2022 U.S. Treasury notes $ 4,989 $ - $ 25 $ 4,964 U.S. Government-sponsored securities 4,430 21 24 4,427 Mortgage-backed securities (1) 162,314 9 29,795 132,528 Collateralized mortgage obligations (1) 1,085 - 31 1,054 Corporate securities 10,043 - 462 9,581 Other 310 - - 310 Total available-for-sale securities $ 183,171 $ 30 $ 30,337 $ 152,864 (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. 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 (1) 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 and collateralized mortgage obligations 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: Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value Allowance for Credit Losses As of December 31, 2022 Municipal securities $ 62,302 $ 49 $ 209 $ 62,142 $ 393 Mortgage-backed securities (1) 702,858 29 141,121 561,766 - Collateralized mortgage obligations (1) 80,186 - 15,701 64,485 - Total held-to-maturity securities $ 845,346 $ 78 $ 157,031 $ 688,393 $ 393 ( 1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. 92 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 2—Investment Securities—Continued 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 (1) 73,781 36 229 73,588 Total held-to-maturity securities $ 737,052 $ 782 $ 11,993 $ 725,841 (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account that is deducted from the amortized cost basis of held-to-maturity securities to present the net amount expected to be collected. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to residential mortgage-backed securities issued by the U.S. government, or agencies thereof, it is expected that the securities will not be settled at prices less than the amortized cost bases of the securities as such securities are backed by the full faith and credit of and/or guaranteed by the U.S. government. Accordingly, no allowance for credit losses has been recorded for these securities. With regard to securities issued by States and political subdivisions and other held-to-maturity securities, management considers (i) issuer bond ratings, (ii) historical loss rates for given bond ratings, (iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, (iv) internal forecasts and (v) whether or not such securities are guaranteed or pre-refunded by the issuers. 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. The following tables show the gross unrealized losses for available-for-sale securities, for which an allowance for credit losses has not been recorded, that are less than 12 months and 12 months or more: December 31, 2022 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, 2022 U.S.Treasury notes $ 4,964 $ 25 $ - $ - $ 4,964 $ 25 U.S. Government-sponsored securities 378 1 1,326 23 1,704 24 Mortgage-backed securities (1) 35,117 1,639 96,589 28,156 131,706 29,795 Collateralized mortgage obligations (1) 1,054 31 - - 1,054 31 Corporate securities - - 9,581 462 9,581 462 Total available-for-sale securities $ 41,513 $ 1,696 $ 107,496 $ 28,641 $ 149,009 $ 30,337 (1) All mortgage-backed securities and collateralized mortgage obligations 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 2—Investment Securities—Continued 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. As of December 31, 2022, the Company held 195 available-for-sale securities of which 94 were in an unrealized loss position for less than twelve months and 75 securities were in an unrealized loss position for twelve months or more without an allowance for credit losses. Because the decline in fair value is attributable to changes in interest rates and not credit quality and because the Company does not have the intent to sell these securities and it is more likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to impaired. Management evaluates the available-for-sale securities in an unrealized loss position, relying primarily on industry analyst reports and observations of market conditions and interest rate fluctuations. The following table presents the activity in the allowance for credit losses for held-to-maturity debt securities by major type: December 31, 2022 (Dollars in thousands) Municipal securities Mortgage-backed securities Collateralized mortgage obligations Total Allowance for credit losses - securities Beginning Balance $ - $ - $ - $ - Provision for credit losses 393 - - 393 Ending Balance $ 393 $ - $ - $ 393 The amortized cost and estimated fair values of investment securities at December 31, 2022 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 $ 5,316 $ 5,290 $ 883 $ 883 After one year through five years 27,290 26,094 8,058 8,004 After five years through ten years 17,241 15,536 33,867 32,030 After ten years 133,324 105,944 802,538 647,476 Total $ 183,171 $ 152,864 $ 845,346 $ 688,393 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. 94 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 2—Investment Securities—Continued The Company monitors the credit quality of those held-to-maturity debt securities not issued by the U.S. government or one of its agencies or government sponsored entities, through the use of credit ratings. Credit ratings are reviewed and updated quarterly. The following table summarizes the amortized cost of held-to-maturity municipal debt securities by credit rating at December 31, 2022: Held-to-Maturity Amortized Cost (Dollars in thousands) AAA/AA/A BBB/BB/B Not Rated Total December 31, 2022 Municipal securities $ 19,380 $ 388 $ 42,534 $ 62,302 Total $ 19,380 $ 388 $ 42,534 $ 62,302 As of December 21, 2022, there were no past due principal or interest payments associated with these securities. Proceeds from sales and calls of these securities were as follows: (Dollars in thousands) Gross Proceeds Gross Gains Gross Losses 2022 $ 51,359 $ 2 $ 10,691 2021 301,320 5,570 3,016 2020 5,080 40 - Pledged Securities As of December 31, 2022, securities carried at $ 479 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 $ 426 million at December 31, 2021. Note 3—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 statements of financial condition and totaled $ 15.5 million at both December 31, 2022 and 2021. 95 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—Loans and Leases Loans and leases as of the dates indicated consisted of the following: December 31, (Dollars in thousands) 2022 2021 Loans and leases held-for-investment, net Real estate: Commercial $ 1,328,691 $ 1,167,516 Agricultural 726,938 672,830 Residential and home equity 387,753 350,581 Construction 166,538 177,163 Total real estate 2,609,920 2,368,090 Commercial & industrial 478,758 427,799 Agricultural 314,525 276,684 Commercial leases 112,629 96,971 Consumer and other (1) 5,886 78,367 Total gross loans and leases 3,521,718 3,247,911 Unearned income ( 9,357 ) ( 10,734 ) Total net loans and leases 3,512,361 3,237,177 Allowance for credit losses ( 66,885 ) ( 61,007 ) Total loans and leases held-for-investment, net $ 3,445,476 $ 3,176,170 (1) Includes SBA PPP loans of $ 0 and $ 70,765 as of December 31, 2022 and December 31, 2021, respectively. Paycheck Protection Program (“PPP”)—Under the CARES Act and H.R. 133, the U.S. 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 were 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 2022 and 2021, PPP loans outstanding were $ 0 and $ 70.8 million, respectively. At December 31, 2022, 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 $ 1.2 billion and $ 884 million, respectively. The borrowing capacity on these loans was $ 758.0 million from FHLB and $ 651.0 million from the FRB. 96 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—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, 2022 and 2021: December 31, 2022 (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 $ 1,319,911 $ - $ - $ 403 $ 403 $ 1,320,314 Agricultural 726,938 - - - - 726,938 Residential and home equity 387,753 - - - - 387,753 Construction 166,370 - - 168 168 166,538 Total real estate 2,600,972 - - 571 571 2,601,543 Commercial & industrial 478,758 - - - - 478,758 Agricultural 314,525 - - - - 314,525 Commercial leases 111,649 - - - - 111,649 Consumer and other 5,789 97 - - 97 5,886 Total loans and leases, net $ 3,511,693 $ 97 $ - $ 571 $ 668 $ 3,512,361 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 $ 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 97 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—Loans and Leases —Continued Non-accrual loans are summarized as follows: December 31, (Dollars in thousands) 2022 2021 Non-accrual loans and leases: 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-accrual loans and leases $ 571 $ 516 98 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—Loans and Leases —Continued 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) 2022 2021 Troubled debt restructured loans and leases: Accruing TDR loans and leases Real estate: Commercial $ - $ 41 Agricultural - - Residential and home equity 1,305 1,522 Construction - - Total real estate 1,305 1,563 Commercial & industrial 6 260 Agricultural - - Commercial leases - - Consumer and other - 1 Subtotal 1,311 1,824 Non-accruing TDR loans and leases Real estate: Commercial $ - $ - Agricultural - - Residential and home equity - - Construction - - Total real estate - - Commercial & industrial - - Agricultural - 498 Commercial leases - - Consumer and other - - Subtotal - 498 Total TDR loans and leases $ 1,311 $ 2,322 99 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—Loans and Leases —Continued The following table summarizes TDRs outstanding by year of occurrence: Year Ended December 31, 2022 (Dollars in thousands) # of Accruing TDR $ of Accruing TDR # of Non- accruing TDR $ of Non- accruing TDR # of Total TDR $ of Total TDR Loan and lease TDRs 2022 - $ - - $ - - $ - 2021 - - - - - - 2020 4 257 - - 4 257 2019 - - - - - - Prior 8 1,054 - - 8 1,054 Total 12 $ 1,311 - $ - 12 $ 1,311 Year Ended December 31, 2021 (Dollars in thousands) # of Accruing TDR $ of Accruing TDR # of Non- accruing TDR $ of Non- accruing TDR # of Total TDR $ of Total TDR Loan and lease TDRs 2021 1 $ 49 - $ - 1 $ 49 2020 5 476 2 498 7 974 2019 - - - - - - 2018 1 84 - - 1 84 Prior 10 1,215 - - 10 1,215 Total 17 $ 1,824 2 $ 498 19 $ 2,322 100 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—Loans and Leases —Continued Outstanding loan balances (accruing and non-accruing) categorized by these credit quality indicators are summarized as follows: December 31, 2022 (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 $ 1,314,377 $ 5,535 $ 402 $ - $ 1,320,314 $ 18,055 Agricultural 709,927 10,891 6,120 - 726,938 14,496 Residential and home equity 387,371 - 382 - 387,753 7,508 Construction 166,370 - 168 - 166,538 3,026 Total real estate 2,578,045 16,426 7,072 - 2,601,543 43,085 Commercial & industrial 478,437 63 258 - 478,758 11,503 Agricultural 308,830 5,682 13 - 314,525 10,202 Commercial leases 111,568 81 - - 111,649 1,924 Consumer and other 5,650 - 236 - 5,886 171 Total loans and leases, net $ 3,482,530 $ 22,252 $ 7,579 $ - $ 3,512,361 $ 66,885 December 31, 2021 (Dollars in thousands) Pass Special Mention Sub- standard Doubtful Total Loans & Leases Total Allowance for Loan Losses Loans and leases held for investment, net Real estate: Commercial $ 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 - 78,367 663 Total loans and leases, net $ 3,200,251 $ 20,474 $ 16,452 $ - $ 3,237,177 $ 61,007 101 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—Loans and Leases —Continued The following table represents outstanding loan balances by credit quality indicators and vintage year by class of financing receivable and current period gross charge-offs by year of origination as follows: December 31, 2022 Term Loans Amortized Cost Basis by Origination Year (Dollars in thousands) 2022 2021 2020 2019 2018 Prior Revolving Loans Amortized Cost Total Net loans and leases held for investment Real estate: Commercial Pass $ 194,698 $ 234,478 $ 150,203 $ 71,333 $ 85,132 $ 218,261 $ 360,272 $ 1,314,377 Special mention - - - - 3,820 1,115 600 5,535 Substandard - - - - - 402 - 402 Doubtful - - - - - - - - Total Commercial $ 194,698 $ 234,478 $ 150,203 $ 71,333 $ 88,952 $ 219,778 $ 360,872 $ 1,320,314 Commercial Current-period gross charge-offs $ - $ - $ 170 $ - $ - $ - $ - $ 170 Agricultural Pass $ 67,044 $ 42,546 $ 54,893 $ 15,074 $ 50,186 $ 144,052 $ 336,132 $ 709,927 Special mention - - - 2,636 - - 8,255 10,891 Substandard - - - - 111 6,009 - 6,120 Doubtful - - - - - - - - Total Agricultural $ 67,044 $ 42,546 $ 54,893 $ 17,710 $ 50,297 $ 150,061 $ 344,387 $ 726,938 Agricultural Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Residential and home equity Pass $ 66,847 $ 96,354 $ 86,545 $ 14,530 $ 6,632 $ 76,155 $ 40,308 $ 387,371 Special mention - - - - - - - - Substandard - - - - - 300 82 382 Doubtful - - - - - - - - Total Residential and home equity $ 66,847 $ 96,354 $ 86,545 $ 14,530 $ 6,632 $ 76,455 $ 40,390 $ 387,753 Residential and home equity Current-period gross charge-offs $ - $ - $ - $ - $ - $ 25 $ - $ 25 Construction Pass $ 2,000 $ 1 $ - $ 1,575 $ - $ 31 $ 162,763 $ 166,370 Special mention - - - - - - - - Substandard - - - - - - 168 168 Doubtful - - - - - - - - Total construction $ 2,000 $ 1 $ - $ 1,575 $ - $ 31 $ 162,931 $ 166,538 Construction Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Total Real estate $ 330,589 $ 373,379 $ 291,641 $ 105,148 $ 145,881 $ 446,325 $ 908,580 $ 2,601,543 Commercial & industrial Pass $ 34,410 $ 36,846 $ 12,325 $ 8,245 $ 7,167 $ 5,679 $ 373,765 $ 478,437 Special mention - 63 - - - - - 63 Substandard - - - - 1 5 252 258 Doubtful - - - - - - - - Total Commercial & industrial $ 34,410 $ 36,909 $ 12,325 $ 8,245 $ 7,168 $ 5,684 $ 374,017 $ 478,758 Commercial & industrial Current-period gross charge-offs $ - $ - $ - $ 246 $ 78 $ - $ - $ 324 Agricultural Pass $ 5,378 $ 3,083 $ 989 $ 1,515 $ 636 $ 2,071 $ 295,158 $ 308,830 Special mention - - - - - - 5,682 5,682 Substandard - - - 11 2 - - 13 Doubtful - - - - - - - - Total Agricultural $ 5,378 $ 3,083 $ 989 $ 1,526 $ 638 $ 2,071 $ 300,840 $ 314,525 Agricultural Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Commercial leases Pass $ 35,689 $ 15,874 $ 13,050 $ 5,904 $ 20,560 $ 20,491 $ - $ 111,568 Special mention - - - 81 - - - 81 Substandard - - - - - - - - Doubtful - - - - - - - - Total Commercial leases $ 35,689 $ 15,874 $ 13,050 $ 5,985 $ 20,560 $ 20,491 $ - $ 111,649 Commercial leases Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Consumer and other Pass $ 1,476 $ 634 $ 275 $ 176 $ 315 $ 1,769 $ 1,005 $ 5,650 Special mention - - - - - - - - Substandard 236 - - - - - - 236 Doubtful - - - - - - - - Total Consumer and other $ 1,712 $ 634 $ 275 $ 176 $ 315 $ 1,769 $ 1,005 $ 5,886 Consumer and other Current-period gross charge-offs $ 40 $ 6 $ 7 $ 1 $ 4 $ 4 $ - $ 62 Total net loans and leases $ 407,778 $ 429,879 $ 318,280 $ 121,080 $ 174,562 $ 476,340 $ 1,584,442 $ 3,512,361 Certain directors and executive officers of the Company are defined as related parties. These related parties, including their immediate families and companies in which they are principal owners, were loan customers of the Bank during the twelve months ended December 31, 2022 and December 31, 2021. Such loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with borrowers not related to the Company. These loans did not involve more than the normal risk of collection or have other unfavorable features. A summary of the changes in those loans is as follows: December 31, (Dollars in thousands) 2022 2021 Balance at beginning of the period $ 18,128 $ 11,682 New loans or advances during year 523 7,254 Repayments ( 1,130 ) ( 808 ) Balance at end of period $ 17,521 $ 18,128 102 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—Loans and Leases —Continued Changes in the allowance for credit losses are as follows: Year Ended December 31, 2022 (Dollars in thousands) Commercial & Agricultural R/E Construction Residential & Home Equity Commercial & Agricultural Commercial Leases Consumer & Other Total Allowance for credit losses: Balance at beginning of year $ 38,149 $ 1,456 $ 2,847 $ 16,954 $ 938 $ 663 $ 61,007 Impact of Adopting ASC 326 ( 6,190 ) 1,855 3,032 826 629 ( 152 ) - Provision / (recapture) for credit losses 762 ( 285 ) 1,523 4,001 357 ( 301 ) 6,057 Charge-offs ( 170 ) - ( 25 ) ( 324 ) - ( 62 ) ( 581 ) Recoveries - - 131 248 - 23 402 Net (charge-offs) / recoveries ( 170 ) - 106 ( 76 ) - ( 39 ) ( 179 ) Balance at end of year $ 32,551 $ 3,026 $ 7,508 $ 21,705 $ 1,924 $ 171 $ 66,885 Year Ended December 31, 2021 (Dollars in thousands) Commercial & Agricultural R/E Construction Residential & Home Equity Commercial & Agricultural Commercial Leases Consumer & Other Total Allowance for credit losses: Balance at beginning of year $ 36,312 $ 1,643 $ 2,984 $ 14,775 $ 1,731 $ 1,417 $ 58,862 Provision / (recapture) for credit losses 1,837 ( 187 ) ( 235 ) 2,025 ( 793 ) ( 737 ) 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 $ 663 $ 61,007 Year Ended December 31, 2020 (Dollars in thousands) Commercial & Agricultural R/E Construction Residential & Home Equity Commercial & Agricultural Commercial Leases Consumer & Other Total Allowance for credit losses: Balance at beginning of year $ 26,181 $ 1,949 $ 3,530 $ 19,542 $ 3,162 $ 648 $ 55,012 Provision / (recapture) for credit losses 10,050 ( 306 ) ( 669 ) ( 3,946 ) ( 1,431 ) 802 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 $ 1,417 $ 58,862 103 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 4—Loans and Leases —Continued A loan is considered collateral dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. When management determines that foreclosure is probable, expected credit losses for collateral dependent loans are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. The collateral on the loans is a significant portion of what secures the collateral dependent loans and significant changes to the fair value of the collateral can impact the ACL. During 2022, there were no significant changes to the collateral that secures the collateral dependent loans, whether due to general deterioration or with credit quality indicators like appraisal value. The following table presents the amortized cost basis of collateral dependent loans by collateral type as of December 31, 2022: December 31, 2022 (Dollars in thousands) Real Estate Vehicles and Equipment Total Collateral dependent loans and leases Real estate: Commercial $ 1,114 $ - $ 1,114 Agricultural 11,035 - 11,035 Residential and home equity 2,153 - 2,153 Construction - - - Total Real estate 14,302 - 14,302 Commercial & industrial - - - Agricultural - 13 13 Commercial leases - - - Consumer and other - 158 158 Total gross loans and leases $ 14,302 $ 171 $ 14,473 104 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 5—Premises and Equipment Premises and equipment consisted of the following: December 31, (Dollars in thousands) 2022 2021 Premises and equipment: Buildings and land $ 61,274 $ 59,325 Furniture, fixtures, and equipment 23,203 22,302 Leasehold improvements 3,982 3,658 Subtotal 88,459 85,285 Accumulated depreciation and amortization ( 38,983 ) ( 37,555 ) Total premises and equipment $ 49,476 $ 47,730 Depreciation and amortization on premises and equipment included in occupancy and equipment expense amounted to $ 2.4 , $ 2.6 , and $ 2.8 million for the years ended December 31, 2022, 2021 and 2020, respectively. Rental income was $ 640,000 , $ 491,000 , and $ 434,000 for the years ended December 31, 2022, 2021, and 2020, respectively and is recorded in other income. Note 6—Other Real Estate Owned The Bank reported $ 873,000 in other real estate owned at December 31, 2022 and 2021, 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 7—Deposits Certificates of deposit greater than and less than or equal to the FDIC insurance limit of $250,000 are summarized as follows: December 31, (Dollars in thousands) 2022 2021 Certificates of deposit: Certificates of deposit less than or equal to $250,000 $ 202,554 $ 223,620 Certificates of deposit greater than $250,000 128,846 168,865 Total certificates of deposit $ 331,400 $ 392,485 Scheduled maturities for certificates of deposit are as follows for the years ending December 31: (Dollars in thousands) Amount 2023 $ 299,575 2024 26,097 2025 3,070 2026 1,310 2027 and beyond 1,348 Total certificates of deposit $ 331,400 Note 8—Short-term borrowings As of December 31, 2022 and 2021, committed lines of credit arrangements totaling $ 1.5 billion and $ 1.4 billion were available to the Company from unaffiliated banks, respectively. The average Federal Funds interest rate as of December 31, 2022 was 4.50 %. The Company is a member of the FHLB of San Francisco and has a committed credit line of $ 757.9 million, which is secured by $ 1.2 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 4.63 % as of December 31, 2022. The Company has $ 883.8 million in pledged loans with the Federal Reserve Bank (the “Fed”). As of December 31, 2022, the Company’s overnight borrowing capacity using the primary credit facilities from the Fed account was $ 651.0 million. The borrowing rate is 425 basis points. There were no outstanding advances on the above borrowing facilities as of December 31, 2022 and 2021. 106 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 9—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 therefor 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 10—Shareholders’ Equity 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. The Company’s and Bank’s actual and required capital amounts and ratios are as follows: December 31, 2022 Actual Required for Capital Adequacy Purposes Minimum to be Categorized as “Well Capitalized” Under Prompt Corrective Action Regulation (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Farmers & Merchants Bancorp CET1 capital to risk-weighted assets $ 493,438 11.57 % $ 191,984 4.50 % N/A N/A Tier 1 capital to risk-weighted assets 503,438 11.80 % 255,978 6.00 % N/A N/A Risk-based capital to risk-weighted assets 556,964 13.06 % 341,305 8.00 % N/A N/A Tier 1 leverage capital ratio 503,438 9.36 % 215,201 4.00 % N/A N/A Farmers & Merchants Bank CET1 capital to risk-weighted assets $ 502,838 11.79 % $ 191,970 4.50 % $ 277,290 6.50 % Tier 1 capital to risk-weighted assets 502,838 11.79 % 255,960 6.00 % 341,280 8.00 % Risk-based capital to risk-weighted assets 556,361 13.04 % 341,280 8.00 % 426,600 10.00 % Tier 1 leverage capital ratio 502,838 9.35 % 215,018 4.00 % 268,772 5.00 % 108 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 10—Shareholders’ Equity—Continued December 31, 2021 Actual Required for Capital Adequacy Purposes Minimum to be Categorized as “Well Capitalized” Under Prompt Corrective Action Regulation (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 % 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 capital adequacy standards per the regulations. Basic and diluted 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) 2022 2021 2020 Numerator Net income $ 75,090 $ 66,336 $ 58,734 Denominator Weighted average number of common shares outstanding 777,726 789,646 793,337 Weighted average number of dilutive shares outstanding 777,726 789,646 793,337 Basic earnings per common share $ 96.55 $ 84.01 $ 74.03 Diluted earning per commons share $ 96.55 $ 84.01 $ 74.03 109 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 11—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 $ 1.8 million, $ 1.6 million, and $ 1.5 million for the years ended December 31, 2022, 2021, and 2020, respectively. The mandatory contributions to the Profit Sharing Plan are made according to a predetermined set of criteria. Mandatory contributions totaled $ 1.6 million, $ 1.7 million, and $ 1.7 million for the years ended December 31, 2022, 2021, and 2020, 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 Internal Revenue Service regulations. 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 $ 7.4 million to the ERP during the year ended December 31, 2022, $ 9.0 million during the year ended December 31, 2021 and $ 6.8 million during the year ended December 31, 2020. The Company’s carrying value of the liability under the ERP was $ 57.0 million as of December 31, 2022 and $ 63.9 million as of December 31, 2021. The Company’s shares of common stock held as investments in the Rabbi Trust of the ERP as of December 31, 2022 and 2021 totaled 50,196 and 55,436 with an historical cost basis of $ 31.4 million and $ 33.2 million, respectively. All amounts have been fully funded into the Rabbi Trust as of December 31, 2022 and 2021. 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 $ 0.1 million in 2022 compared to net gains of $ 2.5 million in 2021 and $ 1.8 million in 2020. 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 11—Employee Benefit Plans —Continued The Company has purchased single premium life insurance policies on the lives of certain key employees of the Company. These policies provide: (1) financial protection to the Company in the event of the death of a key employee; and (2) significant income to the Company to offset the expense associated with the Executive Retirement Plan and other employee benefit plans, since the interest earned on the cash surrender value of the policies is tax exempt as long as the policies are used to finance employee benefits. As compensation to each employee for agreeing to allow the Company to purchase an insurance policy on his or her life, split dollar agreements have been entered into with those employees. These agreements provide for a division of the life insurance death proceeds between the Company and each employee’s designated beneficiary or beneficiaries. The Company earned tax-exempt interest on the life insurance policies of $ 2.2 million for the year ended December 31, 2022, $ 2.2 million for the year ended December 31, 2021, and $ 2.1 million for the year ended December 31, 2020. As of December 31, 2022 and 2021, the total cash surrender value of the insurance policies was $ 73.0 million and $ 71.4 million, respectively. 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 Internal Revenue Service regulations. 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 non-qualified 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 $ 3.0 million to the SMRP during the year ended December 31, 2022, $ 2.7 million during the year ended December 31, 2021 and $ 2.3 million during the year ended December 31, 2020. The Company’s carrying value of the liability under the SMRP was $ 13.6 million as of December 31, 2022 and $ 11.1 million as of December 31, 2021. The Company’s shares of stock held as investments in the Rabbi Trust of the SMRP as of December 31, 2022 and December 31, 2021 totaled 15,998 and 14,192 shares with an historical cost basis of $ 10.8 million and $ 9.5 million, respectively. All amounts have been fully funded into the Rabbi Trust as of December 31, 2022 and 2021. 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 $ 0.4 million in 2022, $ 0.1 million in 2021 and $ 0.1 in 2020. 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 12—Fair Value 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 collateral dependent and an allowance for credit losses is established. Once a loan or lease is identified as collaterally dependent, management measures impairment in accordance with the “Receivable” topic of the FASB ASC. The fair value of collateral dependent 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. Collateral dependent 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. Collateral dependent 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 loans is generally based on recent real estate appraisals. 112 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 12—Fair Value—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 non-recurring collateral dependent loans is primarily the sales comparison approach less estimated selling costs. Other Real Estate Owned (“OREO”) 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 non-recurring OREO is primarily the sales comparison approach less estimated selling costs. The following tables summarize the carrying value and estimated fair values of the Company’s financial assets and liabilities 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, 2022 Fair Value Measurements (Dollars in thousands) Carrying Amount Level 1 Level 2 Level 3 Total Fair Value Financial Assets: Cash and cash equivalents $ 588,257 $ 588,257 $ - $ - $ 588,257 Available-for-sale debt securities 152,864 4,964 147,900 - 152,864 Held-to-maturity debt securities 844,953 - 661,167 42,534 703,701 Non-marketable securities 15,549 - - 15,549 15,549 Loans and leases, net 3,445,476 - - 3,335,042 3,335,042 Bank-owned life insurance 73,038 73,038 - - 73,038 Financial Liabilities: Total deposits $ 4,759,269 $ - $ 4,427,869 $ 323,572 $ 4,751,441 Subordinated debentures 10,310 - 12,211 - 12,211 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 Available-for-sale debt securities 270,454 10,214 260,240 - 270,454 Held-to-maturity debt securities 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 - 6,890 113 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 12—Fair Value—Continued Non-recurring Measurements: collateral dependent loans and OREO are classified with Level 3 of the fair value hierarchy. The estimated fair value of collateral dependent 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 collateral dependent loan. The key inputs used to determine the fair value of collateral dependent 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 collateral dependent 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, 2022 Fair Value Measurements (Dollars in thousands) Carrying Amount Level 1 Level 2 Level 3 Total Fair Value Fair valued on a recurring basis: Debt securities available-for-sale U.S. Treasury notes $ 4,964 $ 4,964 $ - $ - $ 4,964 U.S. Government-sponsored securities 4,427 - 4,427 - 4,427 Mortgage-backed securities 132,528 - 132,528 - 132,528 Collateralized mortgage obligations 1,054 - 1,054 - 1,054 Corporate securities 9,581 - 9,581 - 9,581 Other 310 - 310 - 310 Fair valued on a non-recurring basis: Collateral dependent loans $ 14,473 $ - $ - $ 14,473 $ 14,473 Other real estate owned 873 - - 873 873 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: Debt 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 owned 873 - - 873 873 114 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 13—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) 2022 2021 Commitments to extend credit, including unsecured commitments of $ 20,401 and $ 21,036 as of December 31, 2022 and 2021, respectively $ 1,141,036 $ 937,009 Stand-by letters of credit, including unsecured commitments of $ 7,954 and $ 9,091 as of December 31, 2022 and 2021, respectively 17,138 17,880 Performance guarantees under interest rate swap contracts entered into with our clients and third-parties - 1,433 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 14 — 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 statements of financial condition. 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 nine months to 8 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, 2022, operating lease ROU assets and liabilities were $ 3.4 million and $ 3.5 million, respectively. Operating lease expenses totaled $ 730 ,000 for the year ended December 31, 2022. 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 and $ 833 ,000 for the years ended December 31, 2021 and 2020, respectively. The table below summarizes the information related to our operating leases: Year Ended December 31, (in thousands except for percent and period data) 2022 2021 Cash Paid for Amounts Included in the Measurement of Lease Liabilities Operating Cash Flow from Operating Leases $ 704 $ 709 Weighted-Average Remaining Lease Term - Operating Leases, in Years 5.48 6.55 Weighted-Average Discount Rate - Operating Leases 2.6 % 2.6 % 116 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 14—Leases — Continued The table below summarizes the maturity of remaining lease liability: (Dollars in thousands) Amount 2023 $ 720 2024 716 2025 714 2026 679 2027 367 2028 and beyond 520 Total lease payments 3,716 Discount ( 243 ) Net present value of lease liabilities $ 3,473 As of December 31, 2022, we had no additional operating leases for office space that have not yet commenced or that are anticipated to commence during the first quarter of 2023. 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 $ 111.6 million at December 31, 2022 and $ 96.4 million at December 31, 2021. 117 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 15—Income Taxes The components of income tax expense (benefit) are as follows: Year Ended December 31, (Dollars in thousands) 2022 2021 2020 Income tax expense / (benefit) Current: Federal $ 10,638 $ 12,595 $ 12,174 State 9,683 10,270 9,005 Total current expense 20,321 22,865 21,179 Deferred: Federal 3,744 59 ( 1,115 ) State 586 ( 939 ) ( 847 ) Total current deferred benefit 4,330 ( 880 ) ( 1,962 ) Provision for income tax expense $ 24,651 $ 21,985 $ 19,217 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, 2022 2021 2020 (Dollars in thousands) Amount Rate Amount Rate Amount Rate Effective income tax rate Federal statutory rate $ 20,946 21.00 % $ 18,548 21.00 % $ 16,370 21.00 % State taxes, net of Federal income tax benefit 8,112 8.13 % 7,370 8.34 % 6,445 8.27 % Low-income housing tax credits ( 3,031 ) ( 3.04 %) ( 3,116 ) ( 3.53 %) ( 2,655 ) ( 3.41 %) Compensation expense ( 578 ) ( 0.58 %) - - - - Bank owned life insurance ( 494 ) ( 0.49 %) ( 471 ) ( 0.53 %) ( 444 ) ( 0.57 %) Tax-exempt interest income ( 326 ) ( 0.32 %) ( 347 ) ( 0.39 %) ( 350 ) ( 0.45 %) Other, net 22 0.02 % 1 0.00 % ( 149 ) ( 0.19 %) Total provision for income tax expense and effective tax rate $ 24,651 24.72 % $ 21,985 24.89 % $ 19,217 24.65 % 118 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 15—Income Taxes—Continued The nature and components of the Company’s net deferred income tax assets are as follows: December 31, (Dollars in thousands) 2022 2021 Deferred income tax assets: Allowance for credit losses $ 20,508 $ 18,129 Deferred compensation 20,564 15,339 Unrealized losses on debt securities 9,341 945 Accrued liabilities 3,832 9,415 State income taxes 2,034 2,157 Lease liabilities 1,027 1,222 SBA PPP loan fee income - 764 Acquired net operating losses 584 614 Low-income housing tax investments 565 503 Acquired loans fair valuation 108 197 Acquired OREO fair valuation 108 108 Other 2 19 Total deferred income tax assets 58,673 49,412 Deferred income tax liabilities: Commercial leasing $ ( 21,204 ) $ ( 17,892 ) Premises and equipment ( 1,940 ) ( 1,860 ) Deferred loan and lease costs ( 1,105 ) ( 869 ) Right of use leasing asset ( 996 ) ( 1,197 ) Core deposit intangible asset ( 830 ) ( 1,006 ) Accretion on investment securities ( 547 ) ( 523 ) FHLB dividends ( 348 ) ( 348 ) Prepaid assets ( 40 ) ( 43 ) Other ( 156 ) ( 132 ) Total deferred income tax liabilities ( 27,166 ) ( 23,870 ) Net deferred income tax assets $ 31,507 $ 25,542 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, 2022 and 2021. 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, 2022 and 2021, 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 2018 through 2022 tax years remain subject to selection for examination as of December 31, 2022. As of December 31, 2022 and 2021, the Company has net operating loss of $ 1.9 million and $ 2.0 million carry-forwards and no tax credit carry-forwards. 119 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 16—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) 2022 2021 Balance Sheets Assets Cash and cash equivalents $ 1,582 $ 1,535 Investment in subsidiaries 495,019 472,573 Other assets 304 241 Total assets $ 496,905 $ 474,349 Liabilities and shareholders’ equity Subordinated debentures $ 10,310 $ 10,310 Other liabilities 1,287 903 Shareholders’ equity 485,308 463,136 Total liabilities and shareholders’ equity $ 496,905 $ 474,349 Year Ended December 31, (Dollars in thousands) 2022 2021 2020 Statements of Income Dividend and other income from subsidiaries $ 34,700 $ 9,900 $ 19,874 Interest and dividends 14 9 11 Total income 34,714 9,909 19,885 Reimbursement of expenses from subsidiaries 714 780 821 Other expenses 2,388 1,469 1,656 Total expense 3,102 2,249 2,477 Income before income taxes 31,612 7,660 17,408 Income tax benefit 913 660 729 32,525 8,320 18,137 Equity in undistributed net income of subsidiaries 42,565 58,016 40,597 Net income $ 75,090 $ 66,336 $ 58,734 120 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO CONSOLIDATED STATEMENTS (CONTINUED) Note 16—Condensed Financial Statements of Parent Company —Continued (Dollars in thousands) Year Ended December 31, Statements of Cash Flows 2022 2021 2020 Cash flows from operating activities: Net income $ 75,090 $ 66,336 $ 58,734 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of the Bank ( 42,565 ) ( 58,016 ) ( 40,597 ) Change in other assets and liabilities 197 739 ( 393 ) Net cash provided by operating activities 32,722 9,059 17,744 Cash flows from investing activities: Payments for investments in non-qualified retirement plans - - ( 403 ) Securities sold or matured 124 - - Net cash used in investing activities 124 - ( 403 ) Cash flows from financing activities: Common stock repurchases ( 20,310 ) - ( 2,834 ) Issuance of common stock - - 403 Cash dividends paid ( 12,489 ) ( 12,075 ) ( 11,700 ) Net used in financing activities ( 32,799 ) ( 12,075 ) ( 14,131 ) Net change in cash and cash equivalents 47 ( 3,016 ) 3,210 Cash and cash equivalents, beginning of year 1,535 4,551 1,341 Cash and cash equivalents, end of year $ 1,582 $ 1,535 $ 4,551 121 Table of Contents Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None