FARMERS & MERCHANTS BANCORP 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q ☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2023 or ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission File Number: 000-26099 FARMERS & MERCHANTS BANCORP (Exact name of registrant as specified in its charter) Delaware 94-3327828 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 111 W. Pine Street , Lodi , California 95240 (Address of principal executive offices) (Zip Code) Registrant’s telephone number, including area code ( 209 ) 367-2300 Securities registered pursuant to Section 12(b) of the Act: Title of each class Trading Symbol(s) Name of each exchange on which registered None Not Applicable Not Applicable Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 Par Value Per Share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes ☒ No ☐ Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. Large accelerated filer ☐ Accelerated filer ☒ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ As of July 31, 2023, the registrant had 754,436 shares of common stock $0.01 par value per share, outstanding. FARMERS & MERCHANTS BANCORP FORM 10-Q TABLE OF CONTENTS PART I. - FINANCIAL INFORMATION Page Item 1 - Financial Statements Unaudited Consolidated Balance Sheets 3 Unaudited Consolidated Statements of Income 4 Unaudited Consolidated Statements of Comprehensive Income 5 Unaudited Consolidated Statements of Changes in Shareholders’ Equity 6 Unaudited Consolidated Statements of Cash Flows 7 Notes to Unaudited Consolidated Financial Statements 8 Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations 27 Item 3 - Quantitative and Qualitative Disclosures about Market Risk 49 Item 4 - Controls and Procedures 51 PART II. - OTHER INFORMATION Item 1 – Legal Proceedings 52 Item 1A – Risk Factors 52 Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds 52 Item 3 – Defaults upon Senior Securities 53 Item 4 – Mine Safety Disclosures 53 Item 5 – Other Information 53 Item 6 – Exhibits 53 Signatures 54 2 Table of Contents PART 1. FINANCIAL INFORMATION Item 1. Financial Statements FARMERS & MERCHANTS BANCORP UNAUDITED CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share amounts) June 30, 2023 December 31, 2022 ASSETS Cash and due from banks $ 80,280 $ 73,358 Interest bearing deposits with banks 506,692 514,899 Total cash and cash equivalents 586,972 588,257 Securities available-for-sale, at fair value 114,643 152,864 Securities held-to-maturity, fair value $ 684,503 and $ 688,393 respectively 838,446 845,346 Allowance for credit losses - securities held-to-maturity ( 450 ) ( 393 ) Total investment securities 952,639 997,817 Non-marketable securities 15,549 15,549 Loans and leases held-for-investment 3,491,723 3,512,361 Allowance for credit losses - loans and leases ( 71,112 ) ( 66,885 ) Loans held-for-investment, net 3,420,611 3,445,476 Bank-owned life insurance 66,582 73,038 Premises and equipment, net 51,519 49,476 Deferred income tax assets 30,612 31,507 Accrued interest receivable 22,116 21,602 Goodwill 11,183 11,183 Other intangibles 2,523 2,809 Other real estate owned 873 873 Other assets 89,199 89,812 TOTAL ASSETS $ 5,250,378 $ 5,327,399 LIABILITIES AND SHAREHOLDERS’ EQUITY Deposits: Non-interest bearing $ 1,495,279 $ 1,758,793 Interest bearing: Demand 920,920 1,125,014 Savings and money market 1,669,334 1,544,062 Certificates of deposit 552,780 331,400 Total interest bearing 3,143,034 3,000,476 Total deposits 4,638,313 4,759,269 Subordinated debentures 10,310 10,310 Interest payable and other liabilities 87,046 72,512 TOTAL LIABILITIES 4,735,669 4,842,091 SHAREHOLDERS’ EQUITY Preferred shares, no par value, 1,000,000 shares authorized and, none issued or outstanding - - Common shares, $ 0.01 par value, 7,500,000 authorized 754,523 and 768,337 outstanding at June 30, 2023 and December 31, 2022 , respectively 8 8 Additional paid in capital 43,263 57,206 Retained earnings 488,501 449,932 Accumulated other comprehensive (loss), net of taxes ( 17,063 ) ( 21,838 ) TOTAL SHAREHOLDERS’ EQUITY 514,709 485,308 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 5,250,378 $ 5,327,399 See accompanying notes to the unaudited consolidated financial statements. 3 Table of Contents FARMERS & MERCHANTS BANCORP UNAUDITED CONSOLIDATED STATEMENTS OF INCOME Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands, except share and per share amounts) 2023 2022 2023 2022 Interest income Interest and fees on loans and leases $ 49,690 $ 38,570 $ 97,698 $ 76,003 Interest and dividends on investment securities 5,445 5,716 11,108 11,011 Interest on deposits with others 5,882 1,409 11,843 1,775 Total interest income 61,017 45,695 120,649 88,789 Interest expense Deposits 8,391 873 12,105 1,676 Subordinated debentures 204 103 400 185 Total interest expense 8,595 976 12,505 1,861 Net interest income 52,422 44,719 108,144 86,928 Provision for credit losses 2,557 1,500 4,057 1,500 Net interest income after provision for credit losses 49,865 43,219 104,087 85,428 Non-interest income Card processing 1,712 1,847 3,303 3,584 Service charges on deposit accounts 690 830 1,324 1,680 Increase in cash surrender value of BOLI 506 560 950 1,102 Gain on BOLI death benefit - - 4,346 - Net gain/(loss) on sale of securities available-for-sale - 2 ( 5,686 ) 2 Net gain/(loss) on deferred compensation benefits 1,302 ( 991 ) 2,198 ( 579 ) Other 1,237 1,264 2,472 2,035 Total non-interest income 5,447 3,512 8,907 7,824 Non-interest expense Salaries and employee benefits 17,937 16,403 37,521 33,187 Net gain/(loss) on deferred compensation benefits 1,302 ( 991 ) 2,198 ( 579 ) Data processing 1,307 1,233 2,567 2,448 Occupancy 1,228 1,150 2,408 2,304 FDIC insurance 592 361 1,203 710 Marketing 425 340 895 656 Legal 264 405 524 684 Other 3,767 4,130 7,689 7,409 Total non-interest expense 26,822 23,031 55,005 46,819 INCOME BEFORE INCOME TAXES 28,490 23,700 57,989 46,433 Income tax expense 7,182 5,257 13,134 10,932 NET INCOME $ 21,308 $ 18,443 $ 44,855 $ 35,501 Earnings per common share: Basic $ 28.03 $ 23.58 $ 58.83 $ 45.28 Diluted $ 28.03 $ 23.58 $ 58.83 $ 45.28 Weighted average number of common shares Basic 760,308 781,880 762,443 783,976 Diluted 760,308 781,880 762,443 783,976 See accompanying notes to the unaudited consolidated financial statements. 4 Table of Contents FARMERS & MERCHANTS BANCORP UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2023 2022 2023 2022 Net income $ 21,308 $ 18,443 $ 44,855 $ 35,501 Other comprehensive income Unrealized (losses)/gains on available-for-sale securities ( 1,191 ) ( 11,434 ) 1,171 ( 27,299 ) Reclassification adjustment for (gains)/losses on available-for-sale securities - ( 2 ) 5,685 ( 2 ) Amortization of unrealized loss on securities transferred to held-to-maturity ( 47 ) ( 64 ) ( 77 ) ( 141 ) Net unrealized (losses)/gains on available-for-sale securities ( 1,238 ) ( 11,500 ) 6,779 ( 27,442 ) Income tax benefit/(expense) 375 3,400 ( 2,004 ) 8,113 Other comprehensive (loss)/income, net of tax ( 863 ) ( 8,100 ) 4,775 ( 19,329 ) Total comprehensive income $ 20,445 $ 10,343 $ 49,630 $ 16,172 See accompanying notes to the unaudited consolidated financial statements. 5 Table of Contents FARMERS & MERCHANTS BANCORP UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY For the three and six months ended June 30, 2023 and 2022 (Dollars in thousands, except share amounts) Common Shares Amount Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive (Loss)/Income Total Balance as of March 31, 2023 762,931 $ 8 $ 51,615 $ 473,479 $ ( 16,200 ) $ 508,902 Net income - - - 21,308 - 21,308 Other comprehensive loss, net of tax - - - - ( 863 ) ( 863 ) Cash dividends declared ($ 8.30 per share) - - - ( 6,286 ) - ( 6,286 ) Repurchase of common stock ( 8,408 ) - ( 8,352 ) - - ( 8,352 ) Balance as of June 30 , 2023 754,523 $ 8 $ 43,263 $ 488,501 $ ( 17,063 ) $ 514,709 Balance as of March 31, 2022 785,146 $ 8 $ 73,264 $ 404,389 $ ( 12,948 ) $ 464,713 Net income - - - 18,443 - 18,443 Other comprehensive loss, net of tax - - - - ( 8,100 ) ( 8,100 ) Cash dividends declared ($ 7.85 per share) - - - ( 6,110 ) - ( 6,110 ) Repurchase of common stock ( 7,956 ) - ( 7,593 ) - - ( 7,593 ) Balance as of June 30 , 2022 777,190 $ 8 $ 65,671 $ 416,722 $ ( 21,048 ) $ 461,353 (Dollars in thousands, except share amounts) Common Shares Amount Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive (Loss)/Income Total Balance as of December 31, 2022 768,337 $ 8 $ 57,206 $ 449,932 $ ( 21,838 ) $ 485,308 Net income - - - 44,855 - 44,855 Other comprehensive loss, net of tax - - - - 4,775 4,775 Cash dividends declared ($ 8.30 per share) - - - ( 6,286 ) - ( 6,286 ) Repurchase of common stock ( 13,814 ) - ( 13,943 ) - - ( 13,943 ) Balance as of June 30 , 2023 754,523 $ 8 $ 43,263 $ 488,501 $ ( 17,063 ) $ 514,709 Balance as of December 31, 2021 789,646 $ 8 $ 77,516 $ 387,331 $ ( 1,719 ) $ 463,136 Net income - - - 35,501 - 35,501 Other comprehensive loss, net of tax - - - - ( 19,329 ) ( 19,329 ) Cash dividends declared ($ 7.85 per share) - - - ( 6,110 ) - ( 6,110 ) Repurchase of common stock ( 12,456 ) - ( 11,845 ) - - ( 11,845 ) Balance as of June 30 , 2022 777,190 $ 8 $ 65,671 $ 416,722 $ ( 21,048 ) $ 461,353 See accompanying notes to the unaudited consolidated financial statements. 6 Table of Contents FARMERS & MERCHANTS BANCORP UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, (Dollars in thousands) 2023 2022 Cash flows from operating activities: Net income $ 44,855 $ 35,501 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 4,057 1,500 Depreciation and amortization 1,196 1,270 Net amortization of securities premiums and discounts 35 275 Increase in cash surrender value of BOLI ( 950 ) ( 1,102 ) Gain on BOLI death benefit ( 4,346 ) - Decrease /(increase) in deferred income taxes, net 1,773 ( 1,127 ) Loss/(gain) on sale of securities available-for-sale 5,686 ( 2 ) Net changes in: Other assets ( 2,636 ) ( 7,797 ) Other liabilities 16,671 22,823 Net cash provided by operating activities 66,341 51,341 Cash flows from investing activities: Net change in loans and leases held-for-investment 6,388 ( 12,568 ) Purchase of available-for-sale securities ( 4,515 ) ( 10,090 ) Purchase of held-to-maturity securities ( 2,071 ) ( 168,149 ) Proceeds from sales, maturities, calls and pay downs of available-for-sale securities 43,885 27,679 Proceeds from maturities, calls and pay downs of held-to-maturity securities 23,498 36,641 Purchase of premises and equipment ( 3,239 ) ( 526 ) Purchase of other investments ( 2,166 ) ( 3,440 ) Proceeds from bank-owned life insurance 11,752 - Proceeds from sale of assets 27 34 Net cash provided by (used in) investing activities 73,559 ( 130,419 ) Cash flows from financing activities: Net (decrease) increase in deposits ( 120,956 ) 129,361 Cash dividends paid ( 6,286 ) ( 6,110 ) Net cash used in share repurchase of common stock ( 13,943 ) ( 11,845 ) Net cash (used in) provided by financing activities ( 141,185 ) 111,406 Net change in cash and cash equivalents ( 1,285 ) 32,328 Cash and cash equivalents, beginning of period 588,257 715,460 Cash and cash equivalents, end of period $ 586,972 $ 747,788 Supplemental disclosures of cash flow information: Cash paid for interest $ 9,907 $ 2,580 Income taxes paid $ 16 $ 9,343 Supplemental disclosures of non-cash transactions: Net change in unrealized gain/(losses) on securities available-for-sale $ 6,857 $ ( 27,301 ) See accompanying notes to the unaudited consolidated financial statements. 7 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS Note 1—Basis of Presentation and Significant Accounting Policies The accompanying unaudited condensed consolidated financial statements include the accounts of Farmers & Merchants Bancorp (“FMCB” or “Bancorp”), a bank holding company incorporated in the State of Delaware and its wholly owned subsidiary, Farmers & Merchants Bank of Central Californi a (“F&M Bank” or the “Bank”) collectively (the “Company”). These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). In preparing these financial statements, the Company has evaluated events and transactions subsequent to June 30, 2023 for potential recognition or disclosure. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Certain information and note disclosures have been condensed or omitted pursuant to the rules and regulations of the SEC and the accounting standards for interim financial statements. All significant intercompany transactions and balances have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. Various elements of the Company’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are significant to an understanding of Bank’s financial statements. These policies relate to: (i) the methodology for the recognition of interest income; (ii) the determination of the provision and allowance for credit losses; (iii) the valuation of financial assets and liabilities recorded at fair value; (iv) the valuation of intangibles, such as goodwill and core deposit intangibles (“CDI”); (v) the valuation of other real estate owned (“OREO”); and (vi) the valuation or recognition of deferred tax assets and liabilities. These policies and judgments, estimates and assumptions are described in greater detail in subsequent notes to the Unaudited Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations, Summary of Critical Accounting Policies and Estimates, in our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the SEC on March 15, 2023 and Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations Summary of Critical Accounting Policies and Estimates included in this Quarterly Report on Form 10-Q. The information included in this Form 10-Q should be read in conjunction with our 2022 Form 10-K. Interim results are not necessarily indicative of results for a full year or any other interim period. Accounting Standards Adopted in 2023 On January 1, 2023, the Company adopted ASU 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures using the prospective transition method. This ASU eliminates the troubled debt restructuring recognition and measurement guidance and requires an entity to present gross write-offs by year of origination. The amendments also enhance disclosure requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty. With the exception of enhanced disclosures, there was no material impact to the consolidated financial statements from adoption of this ASU. The Company’s updated accounting policy, as a result of this new ASU, is outlined below. Modifications for Borrowers Experiencing Financial Difficulty. The Company may renegotiate the terms of existing loans for a variety of reasons. When refinancing or restructuring a loan, the Company evaluates where the borrower is experiencing financial difficulty. In making this determination, the Company considers whether the borrower is currently in default on any of its debt. In addition, the Company evaluates whether it is probable that the borrower would be in payment default on any of its debt in the foreseeable future without the modification and if the borrower (without the current modification) could obtain equivalent financing from another creditor at a market rate for similar debt. Modifications of loans to borrowers in these situations may indicated that the borrower is facing financial difficulty. Modifications of loans to borrowers experiencing financial difficulty that are in the form of principal forgiveness, interest rate reductions, other-than-insignificant payment delays, or a term extension (or a combination thereof) require disclosure. The Company’s disclosures are included in Note 3, Loans and Leases. 8 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 1—Basis of Presentation and Significant Accounting Policies—Continued 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 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 . In March 2023, the FASB issued ASU 2023-02, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method. ASU 2023-02 allows reporting entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related income tax credits. The Amendments in ASU 2023-02 apply to all reporting entities that hold (1) tax equity investments that meet the conditions for and elect to account for them using the proportional amortization method or (2) an investment in a LIHTC structure through a limited liability entity that is not accounted for using the proportional amortization method and to which certain LIHTC-specific guidance removed from FASB ASC 323-740, Investments – Equity Method and Joint Ventures: Income Taxes, has been applied. ASU 2023-02 is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for any interim period within those fiscal years. The amendments in ASU 2023-02 must be applied on either a modified retrospective or a retrospective basis (except as discussed in the ASU for LIHTC investments not accounted for using the proportional amortization method). The adoption of this ASU is not expected to have material impact on the Company’s Consolidated Financial Statements. 9 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) N ote 2— Investment Securities The amortized cost, fair values, and unrealized gains and losses of the securities available-for-sale are as follows: Available-for-Sale Securities Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value As of June 30, 2023 U.S. Government-sponsored securities $ 3,845 $ 17 $ 21 $ 3,841 Mortgage-backed securities (1) 123,302 4 23,238 100,068 Collateralized mortgage obligations (1) 599 - 13 586 Corporate securities 10,038 - 200 9,838 Other 310 - - 310 Total available-for-sale securities $ 138,094 $ 21 $ 23,472 $ 114,643 (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. Available-for-Sale Securities 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. The book values, estimated fair values and unrealized gains and losses of investments classified as held-to-maturity are as follows: Held-to-Maturity Securities Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value Allowance for Credit Losses As of June 30, 2023 Mortgage-backed securities (1) $ 685,028 $ 16 $ 138,764 $ 546,280 $ - Collateralized mortgage obligations (1) 77,290 - 15,022 62,268 - Municipal securities 76,128 72 245 75,955 450 Total held-to-maturity securities $ 838,446 $ 88 $ 154,031 $ 684,503 $ 450 (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. 10 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 2—Investment Securities—Continued Held-to-Maturity Securities Gross Unrealized (Dollars in thousands) Amortized Cost Gains Losses Fair Value Allowance for Credit Losses As of December 31, 2022 Mortgage-backed securities (1) $ 702,858 $ 29 $ 141,121 $ 561,766 $ - Collateralized mortgage obligations (1) 80,186 - 15,701 64,485 - Municipal securities 62,302 49 209 62,142 393 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 . 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: June 30, 2023 Less Than 12 Months 12 Months or More Total (Dollars in thousands) Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses Available-for-Sale Securities U.S. Government-sponsored securities $ 267 $ 1 $ 1,127 $ 20 $ 1,394 $ 21 Mortgage-backed securities (1) 15,374 480 83,944 22,758 99,318 23,238 Collateralized mortgage obligations (1) - - 586 13 586 13 Corporate securities - - 9,838 200 9,838 200 Total available-for-sale securities $ 15,641 $ 481 $ 95,495 $ 22,991 $ 111,136 $ 23,472 (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. 11 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 2—Investment Securities—Continued 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 Available-for-Sale Securities 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 . As of June 30, 2023, the Company held 182 available-for-sale securities of which 56 were in an unrealized loss position for less than twelve months and 102 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 be 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 securities by major type: June 30, 2023 (Dollars in thousands) Municipal securities Mortgage-backed securities Collateralized Mortgage obligations Total Allowance for credit losses - securities Beginning Balance $ 393 $ - $ - $ 393 Provision for credit losses 57 - - 57 Ending Balance $ 450 $ - $ - $ 450 December 31, 2022 (Dollars in thousands) Municipal securities Mortgage- backed securities Collateralized Mortgage obligations Total Allowance for credit losses - securities Beginning Balance $ 393 $ - $ - $ 393 Provision for credit losses - - - - Ending Balance $ 393 $ - $ - $ 393 12 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 2—Investment Securities—Continued The amortized cost and estimated fair values of investment securities at June 30, 2023 by contractual final maturity are shown in the following table: Available-for-Sale Held-to-Maturity ( Doll ars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Securities maturing in: One year or less $ 321 $ 321 $ 283 $ 283 After one year through five years 18,571 18,018 12,292 12,201 After five years through ten years 7,135 6,871 28,355 26,675 After ten years 112,067 89,433 797,516 645,344 Total $ 138,094 $ 114,643 $ 838,446 $ 684,503 Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. 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. The Company monitors the credit quality of those held-to-maturity 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 securities by credit rating at June 30, 2023: Held-to-Maturity Amortized Cost (Dollars in thousands) AAA/AA/A BBB/BB/B Not Rated Total June 30, 2023 Municipal securities $ 19,380 $ 391 $ 56,357 $ 76,128 Total $ 19,380 $ 391 $ 56,357 $ 76,128 As of June 30, 2023, 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 Six months ended June 30, 2023 $ 30,482 $ - $ 5,686 Six months ended June 30, 2022 $ 2,610 $ 2 $ - Pledged Securities As of June 30, 2023, securities carried at $ 582.2 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 $ 478.7 million at December 31, 2022. 13 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 3— Loans and Leases Loans and leases as of the dates indicated consisted of the following: (Dollars in thousands) June 30, 2023 December 31, 2022 Loans and leases held-for-investment, net Real estate: Commercial $ 1,302,460 $ 1,328,691 Agricultural 739,207 726,938 Residential and home equity 392,754 387,753 Construction 172,903 166,538 Total real estate 2,607,324 2,609,920 Commercial & industrial 479,908 478,758 Agricultural 282,725 314,525 Commercial leases 126,554 112,629 Consumer and other 5,553 5,886 Total gross loans and leases 3,502,064 3,521,718 Unearned income ( 10,341 ) ( 9,357 ) Total net loans and leases 3,491,723 3,512,361 Allowance for credit losses ( 71,112 ) ( 66,885 ) Total loans and leases held-for-investment, net $ 3,420,611 $ 3,445,476 At June 30, 2023, 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 $ 1.3 billion and $ 894.4 million, respectively. The borrowing capacity on these loans was $ 784.1 million from FHLB and $ 655.0 million from the FRB. The following tables show an aging analysi s of the loan and lease portfolio, including unearned income, by the time past due for the periods indicated: June 30, 2023 (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 $ 1,293,842 $ - $ - $ 375 $ 375 $ 1,294,217 Agricultural 739,207 - - - - 739,207 Residential and home equity 392,754 - - - - 392,754 Construction 172,903 - - - - 172,903 Total real estate 2,598,706 - - 375 375 2,599,081 Commercial & industrial 479,729 179 - - 179 479,908 Agricultural 282,725 - - - - 282,725 Commercial leases 124,456 - - - - 124,456 Consumer and other 5,549 4 - - 4 5,553 Total loans and leases, net $ 3,491,165 $ 183 $ - $ 375 $ 558 $ 3,491,723 14 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 3—Loans and Leases—Continued 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 Non-accrual loans are summarized as follows: (Dollars in thousands) June 30, 2023 December 31, 2022 Non-accrual loans and leases: Real estate: Commercial $ 375 $ 403 Agricultural - - Residential and home equity - - Construction - 168 Total real estate 375 571 Commercial & industrial - - Agricultural - - Commercial leases - - Consumer and other - - Total non-accrual loans and leases $ 375 $ 571 During the six months ended June 30, 2023, we had one residential real estate loan modified in the amount of $ 127 ,000. The contractual interest rate of the modified loan decreased from 3.18 % to 2.18 % and the contractual term was extended from 15 years to 25 years . There were no loans modified on or after January 1, 2023, when the company adopted ASU 2022-02, through June 30, 2023 that subsequently defaulted during the period presented. 15 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 3—Loans and Leases—Continued The following table presents the credit risk rating categories for loans and leases held-for-investment (accruing and non-accruing) net of deferred fees by loan portfolio segment and class as of the dates indicated. June 30, 2023 (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 $ 1,290,902 $ 2,940 $ 375 $ - $ 1,294,217 $ 24,787 Agricultural 728,490 - 10,717 - 739,207 9,908 Residential and home equity 392,462 - 292 - 392,754 7,179 Construction 172,903 - - - 172,903 3,195 Total real estate 2,584,757 2,940 11,384 - 2,599,081 45,069 Commercial & industrial 471,586 8,083 239 - 479,908 11,291 Agricultural 282,699 17 9 - 282,725 12,903 Commercial leases 124,412 44 - - 124,456 1,657 Consumer and other 5,391 - 162 - 5,553 192 Total loans and leases, net $ 3,468,845 $ 11,084 $ 11,794 $ - $ 3,491,723 $ 71,112 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 16 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 3—Loans and Leases—Continued The following table presents outstanding loan and lease balances held-for-investment by segment and class, credit quality indicators, vintage year by class of financing receivable, and current period gross charge-offs by year of origination as of June 30, 2023: June 30, 2023 Term Loans Amortized Cost Basis by Origination Year (Dollars in thousands) 2023 2022 2021 2020 2019 Prior Revolving Loans Amortized Cost Total Net loans and leases held-for-investment Real estate: Commercial Pass $ 72,459 $ 172,866 $ 226,209 $ 146,307 $ 69,072 $ 285,957 $ 318,032 $ 1,290,902 Special mention - - - - - 2,340 600 2,940 Substandard - - - - - 375 - 375 Doubtful - - - - - - - - Total Commercial $ 72,459 $ 172,866 $ 226,209 $ 146,307 $ 69,072 $ 288,672 $ 318,632 $ 1,294,217 Commercial Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Agricultural Pass $ 35,673 $ 74,658 $ 41,588 $ 51,985 $ 14,224 $ 174,620 $ 335,742 $ 728,490 Special mention - - - - - - - - Substandard - - - - - 6,128 4,589 10,717 Doubtful - - - - - - - - Total Agricultural $ 35,673 $ 74,658 $ 41,588 $ 51,985 $ 14,224 $ 180,748 $ 340,331 $ 739,207 Agricultural Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Residential and home equity Pass $ 19,331 $ 63,975 $ 92,602 $ 82,832 $ 13,730 $ 76,970 $ 43,022 $ 392,462 Special mention - - - - - - - - Substandard - - - - - 292 - 292 Doubtful - - - - - - - - Total Residential and home equity $ 19,331 $ 63,975 $ 92,602 $ 82,832 $ 13,730 $ 77,262 $ 43,022 $ 392,754 Residential and home equity Current-period gross charge-offs $ 14 $ - $ - $ - $ - $ - $ - $ 14 Construction Pass $ - $ 3,000 $ - $ - $ 1,575 $ - $ 168,328 $ 172,903 Special mention - - - - - - - - Substandard - - - - - - - - Doubtful - - - - - - - - Total construction $ - $ 3,000 $ - $ - $ 1,575 $ - $ 168,328 $ 172,903 Construction Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Total Real estate $ 127,463 $ 314,499 $ 360,399 $ 281,124 $ 98,601 $ 546,682 $ 870,313 $ 2,599,081 Commercial & industrial Pass $ 33,979 $ 29,326 $ 33,982 $ 10,053 $ 6,174 $ 8,715 $ 349,357 $ 471,586 Special mention - - 48 - - 517 7,518 8,083 Substandard - - - - - 5 234 239 Doubtful - - - - - - - - Total Commercial & industrial $ 33,979 $ 29,326 $ 34,030 $ 10,053 $ 6,174 $ 9,237 $ 357,109 $ 479,908 Commercial & industrial Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - 17 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 3—Loans and Leases—Continued June 30, 2023 Term Loans Amortized Cost Basis by Origination Year (Dollars in thousands) 2023 2022 2021 2020 2019 Prior Revolving Loans Amortized Cost Total Net loans and leases held-for-investment Agricultural Pass $ 395 $ 4,976 $ 2,491 $ 794 $ 1,109 $ 2,368 $ 270,566 $ 282,699 Special mention - - - - - - 17 17 Substandard - - - - 9 - - 9 Doubtful - - - - - - - - Total Agricultural $ 395 $ 4,976 $ 2,491 $ 794 $ 1,118 $ 2,368 $ 270,583 $ 282,725 Agricultural Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Commercial leases Pass $ 28,715 $ 34,385 $ 12,082 $ 10,626 $ 5,315 $ 33,289 $ - $ 124,412 Special mention - - - - 44 - - 44 Substandard - - - - - - - - Doubtful - - - - - - - - Total Commercial leases $ 28,715 $ 34,385 $ 12,082 $ 10,626 $ 5,359 $ 33,289 $ - $ 124,456 Commercial leases Current-period gross charge-offs $ - $ - $ - $ - $ - $ - $ - $ - Consumer and other Pass $ 793 $ 1,361 $ 516 $ 155 $ 93 $ 1,694 $ 779 $ 5,391 Special mention - - - - - - - - Substandard 127 - - - - 35 - 162 Doubtful - - - - - - - - Total Consumer and other $ 920 $ 1,361 $ 516 $ 155 $ 93 $ 1,729 $ 779 $ 5,553 Consumer and other Current-period gross charge-offs $ 18 $ - $ - $ - $ - $ - $ - $ 18 Total net loans and leases Pass $ 191,345 $ 384,547 $ 409,470 $ 302,752 $ 111,292 $ 583,613 $ 1,485,826 $ 3,468,845 Special mention - - 48 - 44 2,857 8,135 11,084 Substandard 127 - - - 9 6,835 4,823 11,794 Doubtful - - - - - - - - Total net loans and leases $ 191,472 $ 384,547 $ 409,518 $ 302,752 $ 111,345 $ 593,305 $ 1,498,784 $ 3,491,723 Total current-period gross charge-offs $ 32 $ - $ - $ - $ - $ - $ - $ 32 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 six months ended June 30, 2023 and year ended December 31, 2022. 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: June 30, December 31, (Dollars in thousands) 2023 2022 Balance at beginning of the period $ 17,521 $ 18,128 New loans or advances during year 1,681 523 Repayments ( 579 ) ( 1,130 ) Balance at end of period $ 18,623 $ 17,521 18 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 3—Loans and Leases—Continued A loan or lease 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 or leases are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. The collateral on the loans and leases is a significant portion of what secures the collateral dependent loans or leases and significant changes to the fair value of the collateral can impact the ACL. During the six months ended June 30, 2023, 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 tables present the amortized cost basis for collateral dependent loans and leases by type as of June 30, 2023 and December 31, 2022, respectively: June 30, 2023 (Dollars in thousands) Real Estate Vehicles and Equipment Total Collateral dependent loans and leases Real estate: Commercial $ 1,471 $ - $ 1,471 Agricultural 10,717 - 10,717 Residential and home equity 1,649 - 1,649 Construction - - - Total real estate 13,837 - 13,837 Commercial & industrial - - - Agricultural - 9 9 Commercial leases - - - Consumer and other - 184 184 Total gross loans and leases $ 13,837 $ 193 $ 14,030 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 19 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 3—Loans and Leases—Continued Changes in the allowance for credit losses are as follows: For the Three Months Ended June 30, 2023 (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 period $ 32,694 $ 2,785 $ 7,334 $ 23,888 $ 1,720 $ 152 $ 68,573 Provision / (recapture) for credit losses 2,001 410 ( 176 ) 285 ( 63 ) 43 2,500 Charge-offs - - - - - ( 9 ) ( 9 ) Recoveries - - 21 21 - 6 48 Net (charge-offs) / recoveries - - 21 21 - ( 3 ) 39 Balance at end of period $ 34,695 $ 3,195 $ 7,179 $ 24,194 $ 1,657 $ 192 $ 71,112 For the Three Months Ended June 30, 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 $ 32,511 $ 3,777 $ 6,759 $ 16,098 $ 1,466 $ 421 $ 61,032 Provision / (recapture) for credit losses 2,205 ( 901 ) 10 ( 131 ) 179 ( 255 ) 1,107 Charge-offs - - - ( 276 ) - ( 9 ) ( 285 ) Recoveries - - 105 117 - 4 226 Net (charge-offs) / recoveries - - 105 ( 159 ) - ( 5 ) ( 59 ) Balance at end of period $ 34,716 $ 2,876 $ 6,874 $ 15,808 $ 1,645 $ 161 $ 62,080 For the Six Months Ended June 30, 2023 (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 period $ 32,551 $ 3,026 $ 7,508 $ 21,705 $ 1,924 $ 171 $ 66,885 Provision / (recapture) for credit losses 1,974 169 ( 346 ) 2,448 ( 267 ) 22 4,000 Charge-offs - - ( 14 ) - - ( 18 ) ( 32 ) Recoveries 170 - 31 41 - 17 259 Net (charge-offs) / recoveries 170 - 17 41 - ( 1 ) 227 Balance at end of period $ 34,695 $ 3,195 $ 7,179 $ 24,194 $ 1,657 $ 192 $ 71,112 For the Six Months Ended June 30, 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 period $ 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 2,757 ( 435 ) 876 ( 1,831 ) 78 ( 338 ) 1,107 Charge-offs - - - ( 276 ) - ( 18 ) ( 294 ) Recoveries - - 119 135 - 6 260 Net (charge-offs) / recoveries - - 119 ( 141 ) - ( 12 ) ( 34 ) Balance at end of period $ 34,716 $ 2,876 $ 6,874 $ 15,808 $ 1,645 $ 161 $ 62,080 20 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 4—Deposits Certificates of deposit greater than and less than or equal to the FDIC insurance limit of $250,000 are summarized as follows: (Dollars in thousands) June 30, 2023 December 31, 2022 Certificates of deposit: Certificates of deposit less than or equal to $250,000 $ 286,881 $ 202,554 Certificates of deposit greater than $250,000 265,899 128,846 Total certificates of deposit $ 552,780 $ 331,400 Scheduled maturities for certificates of deposit are as follows: (Dollars in thousands) Amount 2023 $ 205,571 2024 327,243 2025 15,007 2026 3,894 2027 and beyond 1,065 Total certificates of deposit $ 552,780 Note 5—Short-term borrowings As of June 30, 2023 and December 31, 2022, committed lines of credit arrangements totaling $ 1.6 billion and $ 1.5 billion were available to the Company from unaffiliated banks, respectively. The average Federal Funds interest rate as of June 30, 2023 was 5.25 %. The Company is a member of the FHLB of San Francisco and has a committed credit line of $ 784.1 million, which is secured by $ 1.3 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 5.35 % as of June 30, 2023. The Company has $ 894.4 million in pledged loans with the Federal Reserve Bank (the “Fed”). As of June 30, 2023, the Company’s overnight borrowing capacity using the primary credit facilities from the Fed account was $ 655.0 million. The borrowing rate was 5.25 % as of June 30, 2023. There were no outstanding advances on the above borrowing facilities as of June 30, 2023 and December 31, 2022. 21 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 6—Employee Benefit Plans Executive Retirement Plan 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 comprised of two contributions, one based upon profitability and a second based upon long-term cumulative profitability in the form of the increase in market value in excess of the increase in the book 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 expensed $ 4.5 million to the ERP during the six months ended June 30, 2023 and $ 3.3 million during the six months ended June 30, 2022. The Company’s carrying value of the liability under the ERP was $ 58.3 million as of June 30, 2023 and $ 57.0 million as of December 31, 2022. The Company’s shares of common stock held as investments in the Rabbi Trust of the ERP as of June 30, 2023 and December 31, 2022 totaled 49,156 and 50,196 with an historical cost basis of $ 31.6 million and $ 31.4 million, respectively. All amounts have been fully funded into the Rabbi Trust as of June 30, 2023 and December 31, 2022. 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 $ 1.8 million compared to net loss of $ 0.7 million at June 30, 2023 and 2022, respectively. 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. 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 expensed $ 2.1 million to the SMRP during the six months ended June 30, 2023 and $ 1.4 million for six months ended June 30, 2022. The Company’s carrying value of the liability under the SMRP was $ 16.9 million as of June 30, 2023 and $ 13.6 million as of December 31, 2022. The Company’s shares of stock held as investments in the Rabbi Trust of the SMRP as of June 30, 2023 and December 31, 2022 totaled 17,941 and 15,998 shares with an historical cost basis of $ 12.7 million and $ 10.8 million, respectively. All amounts have been fully funded into the Rabbi Trust as of June 30, 2023 and December 31, 2022. 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 compared to net gains of $ 0.1 million at June 30, 2023 and 2022, respectively. 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. 22 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 7—Fair Value Measurements The Company uses fair value measurements to record fair value adjustments to certain financial and non-financial assets and liabilities and to determine fair value disclosures. Various financial instruments such as available-for-sale securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets and liabilities on a non-recurring basis, such as collateral dependent loans and other real estate owned. These non-recurring fair value adjustments typically involve lower of cost or fair value accounting or write-down of individual assets. Fair Value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value. For accounting disclosure purposes, a three-level valuation hierarchy of fair value measurements has been established. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows: • Level 1 – inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets. • Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs that are observable for the assets or liabilities, either directly or indirectly (such as interest rates, yield curves, and prepayment speeds). • Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value. These may be internally developed, using the Company’s best information and assumptions that a market participant would consider. The carrying amounts and estimated fair values of financial instruments held by the Company are set forth below. Fair value estimates are made at a specific point in time based on relevant market information. They do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for many of the Company’s financial instruments, fair value estimates are based on judgements regarding future expected loss experience, risk characteristics and economic conditions. These estimates are subjective, involve uncertainties, and cannot be determined with precision. Changes in assumptions could significantly affect the estimates. The valuation methodologies for assets and liabilities measured at fair value on a recurring and non-recurring basis are described in the Fair Value note in the Company’s 2022 Annual Report on Form 10-K. There have been no significant changes in these methodologies since then. 23 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 7—Fair Value Measurements—Continued The following tables summarize the carrying amount and estimated fair values of the Company’s financial assets and liabilities not carried at fair value, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value for the periods indicated. June 30 , 2023 Fair Value Measurements (Dollars in thousands) Carrying Amount Level 1 Level 2 Level 3 Total Fair Value Financial Assets: Cash and cash equivalents $ 586,972 $ 586,972 $ - $ - $ 586,972 Held-to-maturity securities 837,996 - 628,149 56,356 684,505 Non-marketable securities 15,549 - - 15,549 15,549 Loans and leases, net 3,420,611 - - 3,224,473 3,224,473 Bank-owned life insurance 66,582 66,582 - - 66,582 Financial Liabilities: Total deposits $ 4,638,313 $ - $ 4,085,533 $ 543,784 $ 4,629,317 Subordinated debentures 10,310 - 12,717 - 12,717 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 Held-to-maturity securities 844,953 - 645,859 42,534 688,393 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 24 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 7—Fair Value Measurements—Continued 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. June 30 , 2023 Fair Value Measurements (Dollars in thousands) Carrying Amount Level 1 Level 2 Level 3 Total Fair Value Fair valued on a recurring basis: Available-for-sale securities U.S. Government-sponsored securities $ 3,841 $ - $ 3,841 $ - $ 3,841 Mortgage-backed securities 100,068 - 100,068 - 100,068 Collateralized mortgage obligations 586 - 586 - 586 Corporate securities 9,838 - 9,838 - 9,838 Other 310 - 310 - 310 Fair valued on a non-recurring basis: Collateral Dependent loans $ 14,030 $ - $ - $ 14,030 $ 14,030 Other real estate owned 873 - - 873 873 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: Available-for-sale securities 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 25 Table of Contents FARMERS & MERCHANTS BANCORP NOTES TO UNAUDITED CONSOLIDATED STATEMENTS (Continued) Note 8—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. (Dollars in thousands) June 30, 2023 December 31, 2022 Commitments to extend credit, including unsecured commitments of $ 19,961 and $ 20,401 as of June 30, 2023 and December 31, 2022, respectively $ 1,123,756 $ 1,141,036 Stand-by letters of credit, including unsecured commitments of $ 8,065 and $ 7,954 as of June 30, 2023 and December 31, 2022, respectively 16,863 17,138 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. The estimated exposure to loss from these commitments is included in the reserve for unfunded loan commitments which amounted to $ 2.1 million at June 30, 2023 and December 31, 2022. 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 78 months with final expiration in January 2027. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company has commitments to fund investments in LIHTC partnerships and limited liability companies. At June 30, 2023, the remaining commitments to the LIHTC partnerships and limited liability companies were approximately $ 20.5 million. At December 31, 2022, the remaining commitments to the LIHTC partnerships and the limited liability companies were $ 19.7 million. 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. 26 Table of Contents Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion is intended to provide a more comprehensive review of the Company’s operating results and financial condition. The information contained in this section should be read in conjunction with the Unaudited Consolidated Financial Statements and the accompanying Notes to Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q included in “Part I. Item 1. Financial Statements.” FORWARD-LOOKING INFORMATION This Quarterly Report on Form 10–Q may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act. These forward-looking statements reflect our current views and are not historical facts. These statements may include statements regarding projected performance for periods following the date of this report. These statements can generally be identified by use of phrases such as “believe,” “expect,” “will,” “seek,” “should,” “anticipate,” “estimate,” “intend,” “plan,” “target,” “project,” “commit” or other words of similar import. Similarly, statements that describe our future financial condition, results of operations, objectives, strategies, plans, goals or future performance and business are also forward-looking statements. Statements that project future financial conditions, results of operations, and shareholder value are not guarantees of performance and many of the factors that will determine these results and values are beyond our ability to control or predict. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors, including, but not limited to, those described in the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections and other parts of this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 (“Form 10-K”), could cause actual results to differ materially from those anticipated in these forward-looking statements. The following is a non-exclusive list of factors which could cause actual results to differ materially from forward-looking statements in this Quarterly Report on Form 10-Q: ■ changes in general economic conditions, either nationally, in California, or in our local markets; ■ inflation, changes in interest rates, securities market volatility and monetary fluctuations; ■ increases in competitive pressures among financial institutions and businesses offering similar products and services; ■ risks associated with recent negative events in the banking industry, and any legislative and/or bank regulatory actions, that could potentially impact earnings, liquidity and/or the availability of capital; ■ higher defaults in our loan and lease portfolio than we expect; ■ changes in management’s estimate of the adequacy of the allowance for credit losses; ■ risks associated with our growth and expansion strategy and related costs; ■ increased lending risks associated with our high concentration of real estate loans; ■ legislative or regulatory changes or changes in accounting principles, policies or guidelines; ■ technological changes; ■ regulatory or judicial proceedings; and ■ other factors and risks including those described under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2022. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. Please take into account that forward-looking statements speak only as of the date of this Form 10-Q (or documents incorporated by reference, if applicable). 27 Table of Contents The Company does not undertake any obligation to publicly correct or update any forward-looking statements if it later becomes aware that actual results are likely to differ materially from those expressed in such forward-looking statements, except as required by law. Overview Farmers & Merchants Bancorp (the “Company” or “FMCB”) is a Delaware registered bank holding company organized in 1999. As a registered bank holding company, FMCB is subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (“FRB”) and by the California Department of Financial Protection and Innovation (“DFPI”). The Company’s principal business is to serve as a holding company for Farmers & Merchants Bank of Central California (the “Bank” or “F&M Bank”) the Bank and for other banking or banking related subsidiaries, which the Company may establish or acquire. As a legal entity separate and distinct from its subsidiary, the Company’s principal source of funds is, and will continue to be, dividends paid by and other funds received from the Bank. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company. 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. Since 2002, the Company has converted all of its daily operating and image advertising to the “F & M Bank” name and the Company’s logo, slogan and signage were redesigned to incorporate the trade name, “F & M Bank”. The Company’s outstanding common stock as of June 30, 2023, consisted of 754,523 shares of common stock, $0.01 par value and no shares of preferred stock were issued or outstanding. The common stock of the Company is not widely held or listed on any exchange. However, trades are reported on the OTCQX under the symbol “FMCB.” The primary source of funding for the Company’s growth has been the generation of core deposits, which the Company raises through its existing branch locations, newly opened branch locations, or through acquisitions. Loan growth over the years is the result of organic growth generated by the Company’s seasoned relationship managers and supporting associates who provide outstanding service and responsiveness to the Company’s clients. The Company’s results of operations are largely dependent on net interest income. Net interest income is the difference between interest income earned on interest earning assets, which are comprised of loans and leases, investment securities and short-term investments, and the interest the Company pays on interest bearing liabilities, which are primarily deposits, and, to a lesser extent, other borrowings. Management strives to match the re-pricing characteristics of the interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. The Company measures its performance by calculating the net interest margin, return on average assets, and return on average equity. Net interest margin is calculated by dividing net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities, by average interest earning assets. Net interest income is the Company’s largest source of revenue. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income. The Company also measures its performance by the efficiency ratio, which is calculated by dividing non-interest expense by the sum of net interest income and non-interest income. 28 Table of Contents Critical Accounting Policies and Estimates Our accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. We identify critical policies and estimates as those that require management to make particularly difficult, subjective, and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies and estimates relate to the allowance for credit losses on loans and leases held for investment, investment securities, the carrying value of goodwill and other intangible assets, fair value measurements and the realization of deferred income tax assets and liabilities. Our critical accounting policies and estimates are described in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Form 10-K. Impact of Recently Issued Accounting Standards See Note 1. “Basis of Presentation and Significant Accounting Policies” to the Unaudited Consolidated Financial Statements in “Item 1. Financial Information” in this Quarterly Report on Form 10-Q. Non-GAAP Measurements We use certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company’s operational performance and to enhance investors’ overall understanding of such financial performance. The methodology for determining these non-GAAP measures may differ among companies. We used the following non-GAAP measures in this Form 10-Q: • Tangible common equity ratio and tangible book value per common share: Given that the use of these measures is prevalent among banking regulators, investors, and analysts, we disclose them in addition the related GAAP measures of return on average equity and book value per common share. The reconciliations of these non-GAAP measurements to the GAAP measurements are presented in the following tables for and as of the periods presented. Tangible Common Equity Ratio and June 30, June 30, Tangible Book Value Per Common Share 2023 2022 (Dollars in thousands, except per share data) Shareholders' equity $ 514,709 $ 461,353 Less: Intangible assets 13,705 14,289 Tangible common equity $ 501,004 $ 447,064 Total Assets $ 5,250,378 $ 5,326,681 Less: Intangible assets 13,705 14,289 Tangible assets $ 5,236,673 $ 5,312,392 Tangible comon equity ratio (1) 9.57 % 8.42 % Book Value per common share (2) $ 682.16 $ 593.62 Tangible book value per common share (3) $ 664.00 $ 575.23 Common shares oustanding 754,523 777,190 (1) Tangible common equity divided by tangible asssets (2) Total common equtiy divided by common shares outstanding. (3) Tangible common equity divided by common shares outstanding. 29 Table of Contents Results of Operations The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and its subsidiaries’ financial condition at June 30, 2023 and December 31, 2022 and results of operations during the three and six months ended June 30, 2023 and 2022, respectively. Information related to the comparison of the results of operations for the years ended December 31, 2022, and 2021 can be found in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2022 Annual Report on Form 10-K filed with the SEC on March 15, 2023. Factors that determine the level of net income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, fee income, non-interest expense, the level of non-performing loans and other non-earning assets, and the amount of non-interest bearing liabilities supporting earning assets. Non-interest income includes card processing fees, service charges on deposit accounts, bank-owned life insurance income, gains/losses on the sale of investment securities, and gains/losses on deferred compensation plan investments. Non-interest expense consists primarily of salaries and employee benefits, cost of deferred compensation benefits, occupancy, data processing, FDIC insurance, marketing, legal and other expenses. Earnings Performance The following table presents performance metrics for the periods indicated: Three Months ended June 30, Six Months Ended June 30, (dollars in thousands, except per share amounts) 2023 2022 2023 2022 Earnings Summary: Interest income $ 61,017 $ 45,695 $ 120,649 $ 88,789 Interest expense 8,595 976 12,505 1,861 Net interest income 52,422 44,719 108,144 86,928 Provision for credit losses 2,557 1,500 4,057 1,500 Noninterest income 5,447 3,512 8,907 7,824 Noninterest expense 26,822 23,031 55,005 46,819 Income before taxes 28,490 23,700 57,989 46,433 Income tax expense 7,182 5,257 13,134 10,932 Net Income $ 21,308 $ 18,443 $ 44,855 $ 35,501 Per Common Share Data: Diluted earnings per common share $ 28.03 $ 23.58 $ 58.83 $ 45.28 Book value per common share $ 682.16 $ 593.62 $ 682.16 $ 593.62 Tangible book value per common share (1) $ 664.00 $ 575.23 $ 664.00 $ 575.23 Performance Ratios: Return on average assets 1.65 % 1.38 % 1.73 % 1.33 % Return on average equity 16.60 % 15.94 % 17.75 % 15.30 % Net interest margin (tax equivalent) 4.27 % 3.52 % 4.38 % 3.44 % Yield on average loans and leases (tax equivalent) 5.75 % 4.76 % 5.72 % 4.76 % Cost of average total deposits 0.74 % 0.07 % 0.53 % 0.07 % Efficiency Ratio 46.35 % 47.75 % 46.99 % 49.41 % Loan-to-deposit ratio 75.50 % 68.32 % 75.50 % 68.32 % Percentage of checking deposits to total deposits 52.09 % 58.98 % 52.09 % 58.98 % Capital Ratios Bancorp: Common equity tier 1 capital to risk-weighted assets 12.22 % 11.55 % 12.22 % 11.55 % Tier 1 capital to risk-weighted assets 12.46 % 11.80 % 12.46 % 11.80 % Risk-based capital to risk-weighted assets 13.71 % 13.05 % 13.71 % 13.05 % Tier 1 leverage capital ratio 10.21 % 8.94 % 10.21 % 8.94 % Tangible Common Equity Ratio (1) 9.57 % 8.42 % 9.57 % 8.42 % (1) See "Non-GAAP Measurements" 30 Table of Contents Average Balance and Yields The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield, cost and net interest margin information for the periods presented. Average balances are derived from daily balances. Three Months Ended June 30, 2023 2022 (Dollars in thousands) Average Balance Interest Income / Expense Average Yield / Rate Average Balance Interest Income / Expense Average Yield / Rate ASSETS Interest earnings deposits in other banks and federal funds sold $ 458,927 $ 5,882 5.14 % $ 683,655 $ 1,409 0.83 % Investment Securities: (1) Taxable securities 923,063 4,626 2.00 % 1,090,507 5,107 1.87 % Non-taxable securities (2) 61,576 564 3.66 % 48,339 391 3.24 % Total investment securities 984,639 5,190 2.11 % 1,138,846 5,498 1.94 % Loans: (3) Real estate: Commercial 1,307,376 16,744 5.14 % 1,158,892 13,531 4.68 % Agricultural 718,094 9,762 5.45 % 701,905 8,509 4.86 % Residential and home equity 390,416 4,267 4.38 % 365,872 3,591 3.94 % Construction 161,992 2,928 7.25 % 205,491 2,535 4.95 % Total real estate 2,577,878 33,701 5.24 % 2,432,160 28,166 4.64 % Commercial & industrial 475,472 8,346 7.04 % 439,137 4,891 4.47 % Agricultural 281,321 5,613 8.00 % 264,791 2,988 4.53 % Commercial leases 126,158 1,947 6.19 % 90,855 1,377 6.08 % Consumer and other 5,531 83 6.02 % 21,457 1,148 21.46 % Total loans and leases 3,466,360 49,690 5.75 % 3,248,400 38,570 4.76 % Non-marketable securities 15,549 255 6.58 % 15,549 218 5.62 % Total interest earning assets 4,925,475 61,017 4.97 % 5,086,450 45,695 3.60 % Allowance for credit losses (69,800 ) (61,439 ) Non-interest earning assets 313,671 317,066 Total average assets $ 5,169,346 $ 5,342,077 LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing deposits: Demand $ 941,500 444 0.19 % $ 1,117,283 319 0.11 % Savings and money market accounts 1,624,285 5,153 1.27 % 1,544,753 361 0.09 % Certificates of deposit greater than $250,000 227,958 1,655 2.91 % 165,944 106 0.26 % Certificates of deposit less than $250,000 261,372 1,139 1.75 % 219,157 87 0.16 % Total interest bearing deposits 3,055,115 8,391 1.10 % 3,047,137 873 0.11 % Short-term borrowings - - 0.00 % - - 0.00 % Subordinated debentures 10,310 204 7.94 % 10,310 103 4.01 % Total interest bearing liabilities 3,065,425 8,595 1.12 % 3,057,447 976 0.13 % Non-interest bearing deposits 1,506,145 1,735,258 Total funding 4,571,570 8,595 0.75 % 4,792,705 976 0.08 % Other non-interest bearing liabilities 84,454 86,550 Shareholders' equity 513,322 462,822 Total average liabilities and shareholders' equity $ 5,169,346 $ 5,342,077 Net interest income $ 52,422 $ 44,719 Interest rate spread 3.84 % 3.48 % Net interest margin (4) 4.27 % 3.53 % (1) Excludes average unrealized (losses) of ($22.5) million and ($24.7) million for the three months ended June 30, 2023, and 2022, respectively, which are included in non-interest earning assets. (2) The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $149,000 and $103,000 for the three months ended June 30, 2023, and 2022, respectively. (3) Loan interest income includes loan fees of $ 1.3 million and $3.3 million for the three months ended June 30, 2023 and 2022, respectively. (4) Net interest margin is computed by dividing net interest income by average interest earning assets. 31 Table of Contents For the Six Months Ended June 30, 2023 2022 (Dollars in thousands) Average Balance Interest Income / Expense Average Yield / Rate Average Balance Interest Income / Expense Average Yield / Rate ASSETS Interest earnings deposits in other banks and federal funds sold $ 489,865 $ 11,843 4.88 % $ 721,656 $ 1,775 0.50 % Investment Securities: (1) Taxable securities 945,258 9,431 2.00 % 1,056,670 9,695 1.84 % Non-taxable securities (2) 59,556 1,121 3.76 % 49,164 793 3.23 % Total investment securities 1,004,814 10,552 2.10 % 1,105,834 10,488 1.90 % Loans: (3) Real estate: Commercial 1,293,712 33,393 5.21 % 1,155,271 26,807 4.68 % Agricultural 716,921 19,376 5.45 % 691,128 16,302 4.76 % Residential and home equity 388,901 8,362 4.34 % 359,656 6,892 3.86 % Construction 166,428 5,865 7.11 % 198,626 4,607 4.68 % Total real estate 2,565,962 66,996 5.27 % 2,404,681 54,608 4.58 % Commercial & industrial 470,498 15,970 6.84 % 431,907 9,690 4.52 % Agricultural 280,896 10,817 7.77 % 256,648 5,743 4.51 % Commercial leases 121,579 3,752 6.22 % 92,844 2,793 6.07 % Consumer and other 5,555 163 5.92 % 36,683 3,169 17.42 % Total loans and leases 3,444,490 97,698 5.72 % 3,222,763 76,003 4.76 % Non-marketable securities 15,549 556 7.21 % 15,549 523 6.78 % Total interest earning assets 4,954,718 120,649 4.91 % 5,065,802 88,789 3.53 % Allowance for credit losses (68,752 ) (61,232 ) Non-interest earning assets 311,891 315,037 Total average assets $ 5,197,857 $ 5,319,607 LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing deposits: Demand $ 1,004,651 888 0.18 % $ 1,116,436 578 0.10 % Savings and money market accounts 1,593,158 7,656 0.97 % 1,531,069 703 0.09 % Certificates of deposit greater than $250,000 188,053 2,142 2.30 % 166,725 203 0.25 % Certificates of deposit less than $250,000 233,945 1,419 1.22 % 221,487 192 0.17 % Total interest bearing deposits 3,019,807 12,105 0.81 % 3,035,717 1,676 0.11 % Short-term borrowings 1 - 0.00 % 1 - 0.00 % Subordinated debentures 10,310 400 7.82 % 10,310 185 3.62 % Total interest bearing liabilities 3,030,118 12,505 0.83 % 3,046,028 1,861 0.12 % Non-interest bearing deposits 1,584,215 1,728,962 Total funding 4,614,333 12,505 0.55 % 4,774,990 1,861 0.08 % Other non-interest bearing liabilities 78,150 80,413 Shareholders' equity 505,374 464,204 Total average liabilities and shareholders' equity $ 5,197,857 $ 5,319,607 Net interest income $ 108,144 $ 86,928 Interest rate spread 4.08 % 3.41 % Net interest margin (4) 4.40 % 3.46 % (1) Excludes average unrealized (losses) of ($25.3) million and ($15.9) million for the six months ended June 30, 2023, and 2022, respectively, which are included in non-interest earning assets. (2) The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $296,000 and $210,000 for the six months ended June 30, 2023, and 2022, respectively. (3) Loan interest income includes loan fees of $3.3 million and $7.2 million for the six months ended June 30, 2023 and 2022, respectively. (4) Net interest margin is computed by dividing net interest income by average interest earning assets. 32 Table of Contents Second Quarter 2023 vs. Second Quarter 2022 Interest-bearing deposits with banks and Federal Reserve balances are earning assets available to the Company. Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earned an average interest rate of 5.14% and 0.83% for the second quarter of 2023 and 2022, respectively. The increase was primarily the result of the FRB increasing rates by 350 basis points from the second quarter of 2022 and the first six months of 2023. Average interest-bearing deposits were $458.9 million and $683.7 million for the quarter ended June 30, 2023 and 2022, respectively. Interest income on interest-bearing deposits with banks was $5.9 million and $1.4 million for the quarter ended June 30, 2023 and 2022, respectively. The investment portfolio is also a component of the Company’s earning assets. Historically, the company invested primarily in: (1) mortgage-backed securities issued by government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans and leases, the yield earned on investments is generally less than that of loans and leases. Average total investment securities were $984.6 million and $1.1 billion for the quarter ended June 30, 2023 and 2022, respectively. The average yield on total investment securities was 2.11% and 1.94% for the quarter ended June 30, 2023 and 2022, respectively. Average loans and leases held for investment were $3.5 billion and $3.2 billion for the quarter ended June 30, 2023 and 2022, respectively. The average yield on the loan and lease portfolio was 5.75% and 4.76% for the quarter ended June 30, 2023 and 2022, respectively. The increase in the loan yield reflects the increase in market interest rates over the last year. Average interest-bearing deposits were $3.1 billion and $3.1 billion for the quarter ended June 30, 2023 and 2022, respectively. The average rate paid on interest-bearing deposits was 1.10% and 0.11% for the quarter ended June 30, 2023 and 2022, respectively. Total interest expense on interest-bearing deposits was $8.4 million and $0.9 million for the quarter ended June 30, 2023 and 2022, respectively, as a result of increases in short-term market interest rates during 2022 and the first half of 2023. The average rate paid on total funding costs was 0.75% and 0.08% for the quarter ended June 30, 2023 and 2022, respectively. Industry competition for deposits remains challenging which has the potential to increase future deposit costs in order to retain key customers, which could place negative pressure on the net interest margin looking forward. Six Months Ended June 30, 2023 vs. Six Months Ended June 30, 2022 Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earned an average interest rate of 4.88% and 0.50% for the first six months ended of 2023 and 2022, respectively. The increase was primarily the result of the FRB increasing rates by 500 basis points during 2022 and the first six months of 2023. Average interest-bearing deposits were $489.9 million and $721.7 million for the six months ended June 30, 2023 and 2022, respectively. Interest income on interest-bearing deposits with banks was $11.8 million and $1.8 million for the six months ended June 30, 2023 and 2022, respectively. Average total investment securities were $1.0 billion and $1.1 billion for the six months ended June 30, 2023 and 2022, respectively. The average yield on total investment securities was 2.10% and 1.90% for the six months ended June 30, 2023 and 2022, respectively. Average loans and leases held for investment were $3.4 billion and $3.2 billion for the six months ended June 30, 2023 and 2022, respectively. The average yield on the loan and lease portfolio was 5.72% and 4.76% for the six months ended June 30, 2023 and 2022, respectively. The increase in the loan yield reflects the increase in market interest rates over the last year. 33 Table of Contents Average interest-bearing deposits were $3.0 billion and $3.0 billion for the six months ended June 30, 2023 and 2022, respectively. The average rate paid on interest-bearing deposits was 0.81% and 0.11% for the six months ended June 30, 2023 and 2022, respectively. Total interest expense on interest-bearing deposits was $12.1 million and $1.7 million for the six months ended June 30, 2023 and 2022, respectively, as a result of increases in short-term market interest rates during 2022 and the first six months of 2023. The average rate paid on total funding costs was 0.55% and 0.08% for the six months ended June 30, 2023 and 2022, respectively. Rate/Volume Analysis The following table shows the change in interest income and interest expense and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes of volume and rates. For purposes of this table, the change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of change in each. Three Months Ended June 30, 2023 compared with 2022 Six Months Ended June 30, 2023 compared with 2022 Increase (Decrease) Due to: Increase (Decrease) Due to: (Dollars in thousands) Volume Rate Net Volume Rate Net Interest income: Interest earnings deposits in other banks and federal funds sold (609 ) 5,082 $ 4,473 (756 ) 10,824 $ 10,068 Investment securities: Taxable securities (822 ) 341 (481 ) (1,071 ) 807 (264 ) Non-taxable securities 117 56 173 183 145 328 Total investment securities (705 ) 397 (308 ) (888 ) 952 64 Loans: Real estate: Commercial 1,829 1,384 3,213 3,399 3,187 6,586 Agricultural 200 1,053 1,253 626 2,448 3,074 Residential and home equity 251 425 676 588 882 1,470 Construction (617 ) 1,010 393 (849 ) 2,107 1,258 Total real estate 1,664 3,871 5,535 3,764 8,624 12,388 Commercial & industrial 434 3,021 3,455 932 5,348 6,280 Agricultural 197 2,428 2,625 588 4,486 5,074 Commercial leases 544 26 570 885 74 959 Consumer and other (1) (541 ) (524 ) (1,065 ) (1,690 ) (1,316 ) (3,006 ) Total loans and leases 2,299 8,821 11,120 4,479 17,216 21,695 Non-marketable securities - 37 37 - 33 33 Total interest income 985 14,337 15,322 2,835 29,025 31,860 Interest expense: Interest bearing deposits: Demand (57 ) 182 125 (64 ) 374 310 Savings and money market accounts 20 4,772 4,792 30 6,923 6,953 Certificates of deposit greater than $250,000 54 1,495 1,549 29 1,910 1,939 Certificates of deposit less than $250,000 20 1,032 1,052 11 1,216 1,227 Total interest bearing deposits 37 7,481 7,518 7 10,422 10,429 Short-term borrowings - - - - - - Subordinated debentures - 101 101 - 215 215 Total interest expense 37 7,582 7,619 7 10,637 10,644 Net interest income $ 948 $ 6,755 $ 7,703 $ 2,828 $ 18,388 $ 21,216 (1) Consumer and other - These decreases represent the end of the PPP loans which were $0 and $6.8 million as of June 30, 2023 and 2022 respectively. 34 Table of Contents Comparison of Results of Operations for the Three and Six Months Ended June 30, 2023 and 2022 Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2023 2022 $ Better / (Worse) % Better / (Worse) 2023 2022 $ Better / (Worse) % Better / (Worse) Selected Income Statement Information: Interest income $ 61,017 $ 45,695 $ 15,322 33.53 % $ 120,649 $ 88,789 $ 31,860 35.88 % Interest expense 8,595 976 (7,619 ) (780.64 %) 12,505 1,861 (10,644 ) (571.95 %) Net interest income 52,422 44,719 7,703 17.23 % 108,144 86,928 21,216 24.41 % Provision for credit losses 2,557 1,500 (1,057 ) (70.47 %) 4,057 1,500 (2,557 ) (170.47 %) Net interest income after provision for credit losses 49,865 43,219 6,646 15.38 % 104,087 85,428 18,659 21.84 % Non-interest income 5,447 3,512 1,935 55.10 % 8,907 7,824 1,083 13.84 % Non-interest expense 26,822 23,031 (3,791 ) (16.46 %) 55,005 46,819 (8,186 ) (17.48 %) Income before income tax expense 28,490 23,700 4,790 20.21 % 57,989 46,433 11,556 24.89 % Income tax expense 7,182 5,257 (1,925 ) (36.62 %) 13,134 10,932 (2,202 ) (20.14 %) Net income $ 21,308 $ 18,443 $ 2,865 15.53 % $ 44,855 $ 35,501 $ 9,354 26.35 % For the three and six months ended June 30, 2023, net income was $21.3 million and $44.9 million, respectively compared to $18.4 million and $35.5 million for the same periods a year ago. For the three months ended June 30, 2023 the increase in net income was primarily the result of higher net interest income of $7.7 million and an increase in non-interest income of $1.9 million. These increases were offset by an increase in non-interest expense of $3.8 million, higher provision for credit losses of $1.1 million and higher income tax expense of $1.9 million. For the six months ended June 30, 2023, the increase in net income was primarily the result of higher net interest income of $21.2 million. The Company also recognized in non-interest income, a $4.3 million death benefit on bank-owned life insurance (“BOLI”) during the six months ended June 30, 2023 that was not present during the six months ended June 30, 2022. This increase was offset by an increase in non-interest expense of $8.2 million, higher provision for credit losses of $2.5 million and higher income tax expense of $2.2 million. Net Interest Income and Net Interest Margin. For the quarter ended June 30, 2023, net interest income increased $7.7 million, or 17.23%, to $52.4 million compared with $44.7 million for the same period a year earlier. The increase is primarily the result of the net interest margin increasing 74 basis points to 4.27% compared with 3.53% for the same period a year earlier. The increase in the net interest margin was primarily the result of the FRB increasing the federal funds rate by 350 basis points from the second quarter of 2022 and the first half of 2023. The yield on interest earning assets increased 137 basis points to 4.97% compared to 3.60% for the second quarter of 2022 as the yield on interest bearing liabilities increased 99 basis points to 1.12% compared to .13% for the second quarter of 2022. For the six months ended June 30, 2023, net interest income increased $21.2 million, or 24.41%, to $108.1 million compared with $86.9 million for the same period a year earlier. The increase is primarily the result of the net interest margin increasing 94 basis points to 4.40% compared with 3.46% for the same period a year earlier. The increase in the net interest margin was primarily the result of the FRB increasing the federal funds rate by 350 basis points from the second quarter of 2022 and the first six months of 2023. The loan yield increased 96 basis points compared to the first six months of 2022 and outpaced the increase in deposit yield of 71 basis points compared to the same period a year earlier. Provision for Credit Losses The Company made a $2.6 million provision for credit losses during the three months ended June 30, 2023 compared to $1.5 million for the same period a year ago. Net recoveries during the three months ended June 30, 2023 were $39,000 compared to net charge-offs of $59,000 for the same period a year ago. The Company made a $4.1 million provision for credit losses during the first half of 2023 compared to $1.5 million during the first half of 2022. Net recoveries during the first half of 2023 were $227,000 compared to net charge-offs of $34,000 in the first half of 2022. The increase in ACL during the first six months of 2023 was primarily related to higher expected probable losses inherent in the loan and lease portfolio that was directly related to quantitative and qualitative factors associated with the current economic environment. 35 Table of Contents Non-interest Income Non-interest income increased $1.9 million, or 55.1%, to $5.4 million for the quarter ended June 30, 2023 compared with $3.5 million for the same period a year earlier. The increase in non-interest income was primarily due to a $2.3 million increase in net gains on deferred compensation plan investments. The Company recorded net gains on deferred compensation plan investments of $1.3 million for the quarter ended June 30, 2023 compared with net losses of $1.0 million for the same respective period a year ago. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2022 Form 10-K filed on March 15, 2023 for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although GAAP requires these investment gains/losses to be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no net-effect on the Company’s net income. Non-interest income increased $1.1 million, or 13.8%, to $8.9 million for the six months ended June 30, 2023 compared with $7.8 million for the same period of 2022. The year-over-year increase in non-interest income was primarily due to a $4.3 million BOLI death benefit and a $2.8 million increase in net gains on deferred compensation plan investments. These increases were partially off-set by a $5.7 million net loss on the sale of investment securities in the first quarter of 2023 to reposition the investment portfolio. The Company recorded net gains on deferred compensation plan investments of $2.2 million for the six months ended June 30, 2023 compared with net losses of $0.6 million for the same respective period. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2022 Form 10-K filed on March 15, 2023 for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although GAAP requires these investment gains/losses to be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no net-effect on the Company’s net income. Non-interest Expense Non-interest expense increased $3.8 million, or 16.46%, to $26.8 million for the quarter ended June 30, 2023 compared with $23.0 million for the same period a year ago. This increase was primarily comprised of a $2.3 million increase in net gains on deferred compensation plan investments, a $1.1 million increase in salaries and a $0.4 million increase in employee benefits. Net gains on deferred compensation plan obligations were $1.3 million for the quarter ended June 30, 2023 compared with net losses of $1.0 million for the same respective period. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2022 Form 10-K filed on March 15, 2023 for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although GAAP requires these gains on obligations to be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no net-effect on the Company’s net income. Non-interest expense increased $8.2 million, or 17.48%, to $55.0 million for the six months ended June 30, 2023 compared with $46.8 million for the same period a year ago. This increase was primarily comprised of a $2.8 million increase in net gains on deferred compensation plan investments, a $2.2 million increase in salaries, a $2.1 million increase in employee benefits, a $0.6 million increase in other expenses and a $0.5 million increase in FDIC insurance. 36 Table of Contents The Company recorded net gains on deferred compensation plan investments of $2.2 million for the six months ended June 30, 2023 compared with net losses of $0.6 million for the same respective period. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2022 Form 10-K filed on March 15, 2023 for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although GAAP requires these gains on obligations to be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no net-effect on the Company’s net income. Income Tax Expense For the three and six months ended June 30, 2023, income tax expense was $7.2 million and $13.1 million, respectively compared to $5.3 million and $10.9 million for the same periods a year ago. The Company’s effective tax rate for the three and six months ended June 30, 2023 was 25.21% and 22.65%, respectively compared to 22.18% and 23.54% for the same period in 2022. The Company’s effective tax rate for the six months ended June 30, 2023 was lower than its historical effective tax rate primarily due to a non-taxable BOLI death benefit of $4.3 million recognized during the six months ended June 30, 2023. The Company’s effective tax rate can fluctuate from quarter to quarter due primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to BOLI death benefits, the cash surrender value of life insurance; credits associated with low income housing tax credit investments (LIHTC); and tax-exempt interest income on municipal securities and loans. Balance Sheet Analysis Total assets were $5.3 billion at June 30, 2023, a decrease of $77.0 million or 1.45% compared to December 31, 2022. Loans held for investment were $3.5 billion at June 30, 2023, a decrease of $20.6 million, or 0.59% compared to December 31, 2022. Total deposits were $4.6 billion at June 30, 2023 compared with $4.8 billion at December 31, 2022, a decrease of $121.0 million or 2.54%. Cash and Cash Equivalents The Company’s cash and cash equivalents consists of interest bearing deposits with banks and overnight investments in Federal Reserve balances. Interest bearing deposits with banks consisted primarily of FRB deposits. Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB. Interest bearing deposits with banks totaled $506.7 million at June 30, 2023 and $514.9 million at December 31, 2022. The Company’s total cash and cash equivalents as of June 30, 2023 represents 11.2% of the Company’s total assets as compared to 11.0% as of December 31, 2022. Investment Securities The Company’s net investment portfolio decreased by $45.2 million or 4.53% to $952.6 million at June 30, 2023 compared to December 31, 2022. This decrease is net of the impact of $36.2 million in available for sale securities sold for interest rate risk management purposes. The Company uses its investment portfolio to manage interest rate and liquidity risks. The Company's total investment portfolio as of June 30, 2023 represents 18.14% of the Company’s total assets as compared to 18.72% at December 31, 2022. The Company classifies its investment securities as either held-to-maturity (“HTM”) or available-for-sale (“AFS”). Securities are classified as HTM and are carried at amortized cost, net of an allowance for credit losses, when the Company has the intent and ability to hold the securities to maturity. See Note 2 “Investment Securities” to the Unaudited Consolidated Financial Statements in “Item 1. Financial Statements” in this Quarterly Report on Form 10-Q. Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, as accumulated other comprehensive income(loss), net of related income taxes. As of June 30, 2023, the Company held no investment securities from any issuer (other than the U.S. Treasury or an agency of the U.S. government or a government sponsored entity) that totaled over 10% of our shareholders’ equity. 37 Table of Contents The carrying value of our portfolio of investment securities was as follows: (Dollars in thousands) June 30, 2023 December 31, 2022 Available-for-Sale Securities U.S. Treasury notes $ - $ 4,964 U.S. Government-sponsored securities 3,841 4,427 Mortgage-backed securities (1) 100,068 132,528 Collateralized mortgage obligations (1) 586 1,054 Corporate securities 9,838 9,581 Other 310 310 Total available-for-sale securities $ 114,643 $ 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. (Dollars in thousands) June 30, 2023 December 31, 2022 Held-to-Maturity Securities Mortgage-backed securities (1) $ 685,028 $ 702,858 Collateralized mortgage obligations (1) 77,290 80,186 Municipal securities (2) 76,128 61,909 Total held-to-maturity securities $ 838,446 $ 844,953 (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. (2) Municipal securities are net of allowance for credit losses of $450 and $393, respectively. The following tables show the carrying value for contractual final maturities of investment securities and the weighted average yields of such securities, including the benefit of tax-exempt securities: As of June 30, 2023 Within One Year After One but Within Five Years After Five but Within Ten Years After Ten Years Total (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Securities available-for-sale U.S. Government-sponsored securities $ - 0.00 % $ 80 6.35 % $ 271 6.19 % $ 3,490 5.91 % $ 3,841 5.94 % Mortgage-backed securities (1) 10 2.56 % 8,100 2.52 % 6,600 3.58 % 85,358 1.95 % 100,068 2.11 % Collateralized mortgage obligations (1) - 0.00 % - 0.00 % - 0.00 % 586 2.28 % 586 2.28 % Corporate securities - 0.00 % 9,838 5.31 % - 0.00 % - 0.00 % 9,838 5.31 % Other 310 3.90 % - 0.00 % - 0.00 % - 0.00 % 310 3.90 % Total securities available-for-sale $ 320 3.86 % $ 18,018 4.06 % $ 6,871 3.68 % $ 89,434 2.11 % $ 114,643 2.52 % (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. As of June 30, 2023 Within One Year After One but Within Five Years After Five but Within Ten Years After Ten Years Total (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Securities held-to-maturity Mortgage-backed securities (1) $ - 0.00 % $ - 0.00 % $ 16,315 1.27 % $ 668,713 1.91 % $ 685,028 1.89 % Collateralized mortgage obligations (1) - 0.00 % - 0.00 % - 0.00 % 77,290 1.77 % 77,290 1.77 % Municipal securities 283 1.93 % 12,292 2.49 % 12,040 3.65 % 51,513 3.34 % 76,128 3.24 % Total securities held-to-maturity $ 283 1.93 % $ 12,292 2.49 % $ 28,355 2.28 % $ 797,516 1.99 % $ 838,446 2.00 % (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. 38 Table of Contents As of December 31, 2022 Within One Year After One but Within Five Years After Five but Within Ten Years After Ten Years Total (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Securities available-for-sale U.S. Treasury notes $ 4,964 2.37 % $ - 0.00 % $ - 0.00 % $ - 0.00 % $ 4,964 2.37 % U.S. Government-sponsored securities 3 2.17 % 53 2.29 % 380 4.52 % 3,991 4.52 % 4,427 4.29 % Mortgage-backed securities (1) 13 2.82 % 16,460 2.31 % 15,156 2.41 % 100,899 1.82 % 132,528 1.95 % Collateralized mortgage obligations (1) - 0.00 % - 0.00 % - 0.00 % 1,054 2.35 % 1,054 2.35 % Corporate securities - 0.00 % 9,581 3.13 % - 0.00 % - 0.00 % 9,581 3.13 % Other 310 4.60 % - 0.00 % - 0.00 % - 0.00 % 310 4.60 % Total securities available-for-sale $ 5,290 2.50 % $ 26,094 2.61 % $ 15,536 2.46 % $ 105,944 1.93 % $ 152,864 2.11 % (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. As of December 31, 2022 Within One Year After One but Within Five Years After Five but Within Ten Years After Ten Years Total (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Securities held-to-maturity Mortgage-backed securities (1) $ - 0.00 % $ - 0.00 % $ 18,197 1.22 % $ 684,661 1.90 % $ 702,858 1.88 % Collateralized mortgage obligations (1) - 0.00 % - 0.00 % - 0.00 % 80,186 1.80 % 80,186 1.80 % Municipal securities 883 5.92 % 8,058 3.98 % 15,670 3.70 % 37,691 4.83 % 62,302 4.45 % Total securities held-to-maturity $ 883 5.92 % $ 8,058 3.98 % $ 33,867 2.37 % $ 802,538 2.03 % $ 845,346 2.07 % (1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. 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 penalties. The Company evaluates securities for expected credit losses at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Loans and Leases Loans and leases can be categorized by borrowing purpose and use of funds. Common examples of loans and leases made by the Company include: Commercial and Agricultural Real Estate – These are loans secured by owner-occupied real estate, non-owner-occupied real estate, owner-occupied farmland, and multifamily residential properties. Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing, or the income will be the Bank's primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; maturities generally do not exceed 15 years (and may have pricing adjustments on a shorter timeframe) amortizations of up to 25 years (30 years for multifamily residential properties); have debt service coverage ratios of 1.00 or better with a target of 1.25 or greater; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan. Real Estate Construction – These are loans for acquisition, development and construction and are secured by commercial or residential real estate. These loans are generally made only to experienced local developers with a successful track record; for projects in our service area; with Loan to Value (LTV) below 75%; and where the property can be developed and sold within 2 years. Commercial construction loans are generally made only when there is an approved take-out commitment from the Bank or an acceptable financial institution or government agency. Most acquisition, development and construction loans are tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Single Family Residential Real Estate – These are loans primarily made on owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC. However, the Company will make loans on rural residential properties up to 41 acres. Most residential loans have terms from ten to thirty years and carry fixed or variable rates priced to treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income” loans. 39 Table of Contents Home Equity Lines and Loans – These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $500,000; but can be made for up to $1,000,000 in high cost counties. Combined Loan to Value (CLTV) does not exceed 75%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1 st lien position. Agricultural – These are non-real estate loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on livestock, crops, crop proceeds and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Commercial – These are non-real estate loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations. Lines of credit are extended to finance the seasonal working capital needs of customers during peak business periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on accounts receivable, inventory and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a plant or purchase of a business; have maturities from three to seven years; and fixed rates that are most often tied to treasury indices or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Consumer – These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit. The Company has a minimal consumer loan portfolio. Commercial Leases – These are leases primarily to businesses and farmers for financing the acquisition of equipment. They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases; or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains the tax benefits of ownership. Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed with qualified, independent appraisers that establish the residual values the Company uses in structuring a lease. The Company accounts for leases with Investment Tax Credits (“ITC”) under the deferred method as established in ASC 740-10. ITCs are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement. Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan or lease structure. See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan and lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan and lease type. The Company’s policies require that loans and leases be approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting procedures for all loan and lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease. 40 Table of Contents Most loans and leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan or lease is made. In order to be responsive to borrower needs, the Company prices loans and leases: (1) on both a fixed rate and adjustable rate basis; (2) over different terms; and (3) based upon different rate indices as long as these structures are consistent with the Company’s interest rate risk management policies and procedures. See “Item 3. Quantitative and Qualitative Disclosures about Market Risk” in this Report on Form 10-Q for further details. Overall, the Company's loan and lease portfolio at June 30, 2023 totaled $3.5 billion, a decrease of $20.6 million or 0.59% compared to December 31, 2022. The following table sets forth the distribution of the loan and lease portfolio by type and percent at the end of each period presented: June 30, 2023 December 31, 2022 (Dollars in thousands) Dollars Percent of Total Dollars Percent of Total Gross Loans and Leases Real estate: Commercial $ 1,302,460 37.19 % $ 1,328,691 37.73 % Agricultural 739,207 21.11 % 726,938 20.64 % Residential and home equity 392,754 11.21 % 387,753 11.01 % Construction 172,903 4.94 % 166,538 4.73 % Total real estate 2,607,324 74.45 % 2,609,920 74.11 % Commercial & industrial 479,908 13.71 % 478,758 13.59 % Agricultural 282,725 8.07 % 314,525 8.93 % Commercial leases 126,554 3.61 % 112,629 3.20 % Consumer and other 5,553 0.16 % 5,886 0.17 % Total gross loans and leases $ 3,502,064 100.00 % $ 3,521,718 100.00 % The following table shows the maturity distribution and interest rate sensitivity of the loan and lease portfolio of the Company as of June 30, 2023. Loan Contractual Maturity (Dollars in thousands) One Year or Less After One But Within Five Years After Five Years But Within Fifteen Years After Fifteen Years Total Gross loan and leases: Real estate: Commercial $ 36,189 $ 396,249 $ 835,140 $ 34,882 $ 1,302,460 Agricultural 21,047 188,361 452,673 77,126 739,207 Residential and home equity 33 4,310 118,004 270,407 392,754 Construction 100,220 72,683 - - 172,903 Total real estate 157,489 661,603 1,405,817 382,415 2,607,324 Commercial & industrial 164,160 217,555 92,166 6,027 479,908 Agricultural 139,259 117,908 23,858 1,700 282,725 Commercial leases 5,083 43,476 77,995 - 126,554 Consumer and other 858 3,589 1,106 - 5,553 Total gross loans and leases $ 466,849 $ 1,044,131 $ 1,600,942 $ 390,142 $ 3,502,064 Rate Structure for Loans Fixed Rate $ 97,118 $ 586,584 $ 1,166,360 $ 231,022 $ 2,081,084 Adjustable Rate 369,731 457,547 434,582 159,120 1,420,980 Total gross loans and leases $ 466,849 $ 1,044,131 $ 1,600,942 $ 390,142 $ 3,502,064 41 Table of Contents The following table summarizes the loans for which the accrual of interest has been discontinued and loans more than 90 days past due and still accruing interest, and OREO (as hereinafter defined): (Dollars in thousands) June 30, 2023 December 31, 2022 Non-performing assets: Non-accrual loans and leases Real estate: Commercial $ 375 $ 403 Agricultural - - Residential and home equity - - Construction - 168 Total real estate 375 571 Commercial & industrial - - Agricultural - - Commercial leases - - Consumer and other - - Total non-performing loans and leases $ 375 $ 571 Other real estate owned ("OREO") $ 873 $ 873 Total non-performing assets $ 1,248 $ 1,444 Selected ratios: Non-performing loans to total loans and leases 0.01 % 0.02 % Non-performing assets to total assets 0.02 % 0.03 % 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. Non-accrual loans and leases totaled $375,000 and $571,000 at June 30, 2023 and December 31, 2022, respectively. Other Real Estate Owned –OREO represents real property taken either through foreclosure or through a deed in lieu thereof from the borrower. The Company records all OREO properties at amounts equal to or less than the fair market value of the properties based on current independent appraisals reduced by estimated selling costs. The Company reported $873,000 of foreclosed OREO at June 30, 2023, and at December 31, 2022. Although management believes that non-performing loans and leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. See Note 3. “Loans and Leases”, located in “Item 1. Financial Statements” in this Quarterly Report on Form 10-Q for an allocation of the allowance classified to collateral dependent loans and leases. Except for non-performing loans and leases discussed above, the Company’s management is not aware of any loans and leases as of June 30, 2023, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date. However, the State of California has routinely experienced drought conditions such as from 2013 through 2016 and 2020-2022. Although the availability of water in our primary service area was not an issue for the 2022 growing season, the weather patterns over the past nine years further reinforce the fact that the long-term risks associated with the availability of water are significant. 42 Table of Contents Loan Modifications/Restructurings – A modification/restructuring of a loan or lease happens when the Company makes certain concessions to a borrower experiencing financial difficulty. These concessions either stem from an agreement between the Company and the borrower or is imposed by law or a court; some of these concessions include: term extension, principle forgiveness, rate reduction, or a combination of any of those. The Company has granted a concession when, as a result of the modification/restructuring, it does not expect to collect all amounts due, including interest accrued at the original contract rate. ASU 2022-02 requires certain disclosure of loans and leases that have been modified or restructured within the past 12 months and the effects that said modifications had on the loans or leases. Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses and because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification. Occasionally, the Company modifies loans by providing principal forgiveness that is deemed to be uncollectable; therefore, that portion of the loan is written off, resulting in a reduction of the amortized cost basis and a corresponding adjustment to the allowance for credit losses. The Company modified one residential real estate loan in the amount of $127,000, during the three months ended June 30, 2023. Allowance for Credit Losses—Loans and Leases The Company maintains an allowance for credit losses (“ACL”) under ASC Topic 326, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“CECL”). The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan and lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary components: specific reserves related to collateral dependent loans and leases; general reserves for current expected credit losses related to loans and leases that are not collateral dependent; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors. The Company uses the Weighted Average Remaining Maturity (“WARM”) method to calculate the ACL as this method is the most appropriate given the Company’s current size and complexity. See “Summary of Critical Accounting Policies and Estimates - Allowance for Credit Losses – Loans and Leases.” 43 Table of Contents The following table sets forth the activity in our ACL for loans and leases for the periods indicated: Six Months Ended June 30, (Dollars in thousands) 2023 2022 Allowance for credit losses: Balance at beginning of year $ 66,885 $ 61,007 Provision for credit losses 4,000 1,107 Charge-offs: Real estate: Commercial - - Agricultural - - Residential and home equity (14 ) - Construction - - Total real estate (14 ) (276 ) Commercial & industrial - - Agricultural - - Commercial leases - - Consumer and other (18 ) (18 ) Total charge-offs (32 ) (294 ) Recoveries: Real estate: Commercial 170 - Agricultural - - Residential and home equity 31 119 Construction - - Total real estate 201 119 Commercial & industrial 38 131 Agricultural 3 4 Commercial leases - - Consumer and other 17 6 Total recoveries 259 260 Net recoveries / (charge-offs) 227 (34 ) Balance at end of year $ 71,112 $ 62,080 Selected financial information: Net loans and leases held-for-investment $ 3,491,723 $ 3,249,886 Average loans and leases 3,444,490 3,222,763 Non-performing loans and leases 375 3,028 Allowance for credit losses to non-performing loans and leases 18963.20 % 2050.20 % Net (recoveries)/charge-offs to average loans and leases (0.01 %) 0.00 % Provision for credit losses to average loans and leases 0.12 % 0.03 % Allowance for credit losses to gross loans and leases held-for-investment 2.03 % 1.91 % The increase in ACL during the first six months of 2023 was primarily related to higher expected probable losses inherent in the loan and lease portfolio that was directly related to quantitative and qualitative factors associated with the current economic environment. The allowance for credit losses in total is $73.2 million which includes the allowance for loan and lease losses of $71.1 million and the reserve for unfunded loan commitments of $2.1 million. 44 Table of Contents The following table indicates management’s allocation of the ACL for loans and leases by loan type as of each of the following dates: June 30, 2023 December 31, 2022 (Dollars in thousands) Dollars Percent of Each Loan Type to Total Loans Dollars Percent of Each Loan Type to Total Loans Allowance for credit losses: Real estate: Commercial $ 24,787 37.19 % $ 18,055 37.73 % Agricultural 9,908 21.11 % 14,496 20.64 % Residential and home equity 7,179 11.21 % 7,508 11.01 % Construction 3,195 4.94 % 3,026 4.73 % Total real estate 45,069 74.45 % 43,085 74.11 % Commercial & industrial 11,291 13.71 % 11,503 13.59 % Agricultural 12,903 8.07 % 10,202 8.93 % Commercial leases 1,657 3.61 % 1,924 3.20 % Consumer and other 192 0.16 % 171 0.17 % Total allowance for credit losses $ 71,112 100.00 % $ 66,885 100.00 % Deposits Total deposits were $4.6 billion and $4.8 billion as of June 30, 2023 and December 31, 2022, respectively a decrease of $121.0 million or 2.5% due in part to seasonality within our agriculture client base. The Company experienced a decrease in deposits in the first quarter of 2023 of $220.1 million or 4.6% while during the second quarter of 2023, deposits increased $99.1 million or 2.2%. The increase in deposits during the second of 2023 reflects seasonality within our agricultural client base and the Company focus on business development activities for deposits. Non-interest bearing demand deposits were $1.50 billion as of June 30, 2023 and $1.76 billion at December 31, 2022. Non-interest bearing deposits were 32.24% of total deposits, as of June 30, 2023 and 36.96% as of December 31, 2022. Interest bearing deposits were $3.1 billion as of June 30, 2023 and $3.0 billion as of December 31, 2022. Interest bearing deposits are comprised of interest-bearing transaction accounts, money market accounts, regular savings accounts, and certificates of deposit. The decrease in non-interest bearing deposits and the increase in interest-bearing deposits reflects customer behavior in shifting from non-interest bearing accounts to higher interest earning accounts given the current interest rate environment. The following table shows the average amount and average rate paid on the categories of deposits for each of the periods presented: Six Months Ended June 30, 2023 2022 (Dollars in thousands) Average Balance Interest Expense Average Rate Average Balance Interest Expense Average Rate Total deposits: Interest bearing deposits: Demand $ 1,004,651 $ 888 0.18 % $ 1,116,436 $ 578 0.10 % Savings and money market 1,593,158 7,656 0.97 % 1,531,069 703 0.09 % Certificates of deposit greater than $250,000 188,053 2,142 2.30 % 166,725 203 0.25 % Certificates of deposit less than $250,000 233,945 1,419 1.22 % 221,487 192 0.17 % Total interest bearing deposits 3,019,807 12,105 0.81 % 3,035,717 1,676 0.11 % Non-interest bearing deposits 1,584,215 1,728,962 Total deposits $ 4,604,022 $ 12,105 0.53 % $ 4,764,679 $ 1,676 0.07 % 45 Table of Contents Deposits are gathered from individuals and businesses in our market areas. The interest rates paid are competitively priced for each particular deposit product and structured to meet our funding requirements. The significant increase in short-term interest rates during 2022 and into 2023 has placed pressure on deposit pricing, and we will continue to manage this ongoing impact through careful deposit pricing. The average cost of deposits, including non-interest bearing deposits, increased to 0.74% for the three months ended June 30, 2023, compared to 0.32% for the three months ended March 31, 2023 and 0.53% for the six months ended June 30, 2023 compared with 0.07% for the same period a year ago. The Bank participates in a program wherein the State of California places time deposits with the Bank at the Bank’s option. At June 30, 2023 and December 31, 2022, the Bank had $3.0 million, of these deposits. Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings Lines of Credit with the Federal Reserve Bank and Federal Home Loan Bank are other key sources of funds to support earning assets and liquidity. These sources of funds are also used to manage the Company’s interest rate risk exposure; and, as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB advances at June 30, 2023 or December 31, 2022. There were no Federal Funds purchased or advances from the FRB at June 30, 2023 or December 31, 2022. Long-Term Subordinated Debentures On December 17, 2003, the Company raised $10.0 million through the sale of subordinated debentures to an off-balance-sheet trust and its sale of trust-preferred securities. See Note 9. “Long-Term Subordinated Debentures” located in “Item 8. Financial Statements and Supplementary Data” in our Annual Report on Form 10-K filed with the SEC on March 15, 2023. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our Trust Preferred Securities will continue to qualify as regulatory capital. These securities accrue interest at a variable rate based upon 3-month LIBOR plus 2.85%. Interest rates reset quarterly (the next reset is September 18, 2023) and the rate was 8.36% as of June 30, 2023 and 7.59% at December 31, 2022. The average rate paid for these securities was 7.82% for the first half of 2023 and 3.62% for the first half of 2022. Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock. Capital Resources The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders’ Equity totaled $514.7 million at June 30, 2023, and $485.3 million at December 31, 2022. 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. 46 Table of Contents The Company’s and Bank’s actual and required capital amounts and ratios are as follows: June 30, 2023 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 $ 518,285 12.22 % $ 190,829 4.50 % N/A N/A Tier 1 capital to risk-weighted assets 528,285 12.46 % 254,439 6.00 % N/A N/A Risk-based capital to risk-weighted assets 581,548 13.71 % 339,252 8.00 % N/A N/A Tier 1 leverage capital ratio 528,285 10.21 % 206,998 4.00 % N/A N/A Farmers & Merchants Bank CET1 capital to risk-weighted assets $ 528,826 12.47 % $ 190,821 4.50 % $ 275,630 6.50 % Tier 1 capital to risk-weighted assets 528,826 12.47 % 254,428 6.00 % 339,238 8.00 % Risk-based capital to risk-weighted assets 582,087 13.73 % 339,238 8.00 % 424,047 10.00 % Tier 1 leverage capital ratio 528,826 10.23 % 206,821 4.00 % 258,527 5.00 % 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 % On November 8, 2022, the Board of Directors authorized an extension to its share repurchase program through December 31, 2024 for an additional $20.0 million of the Company’s common stock (“Repurchase Plan”), which represents approximately 4% of outstanding shareholders’ equity. Repurchases by the Company under the Repurchase Plan may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means. The Inflation Reduction Act of 2022 signed into law in August 2022 includes a provision for an excise tax equal to 1% of the fair market value of any stock repurchased by covered corporations during a taxable year, subject to certain limits and provisions. The excise tax became effective on January 1, 2023. During the six months of 2023 the Company repurchased 13,814 shares under the Repurchase Plan, for a total of $13.9 million. The Company has repurchased a total of 14,616 shares or $14.6 million under the current Repurchase Plan. 47 Table of Contents Off-Balance-Sheet Arrangements Off-balance-sheet arrangements are any contractual arrangement to which an unconsolidated entity is a party, under which the Company has: (1) any obligation under a guarantee contract; (2) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to that entity for such assets; (3) any obligation under certain derivative instruments; or (4) any obligation under a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services with the Company. The Company had the following off balance sheet commitments as of the dates indicated. The following table sets forth our off-balance-sheet lending commitments as of June 30, 2023: Amount of Commitment Expiration per Period (Dollars in thousands) Total Committed Amount Less than One Year One to Three Years Three to Five Years After Five Years Off-balance sheet commitments Commitments to extend credit $ 1,123,756 $ 422,126 $ 465,434 $ 41,354 $ 194,842 Standby letters of credit 16,863 10,800 4,593 1,470 - Total off-balance sheet commitments $ 1,140,619 $ 432,926 $ 470,027 $ 42,824 $ 194,842 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. Additionally, the Company maintains an allowance for credit losses – unfunded loan commitments, for off-balance-sheet commitments, which totaled $2.1 million at June 30, 2023 and December 31, 2022. Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third-party. Most standby letters of credit have maturity dates ranging from 1 to 78 months with final expiration in January 2027. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Liquidity The ability to have readily available funds sufficient to repay maturing liabilities is of primary importance to depositors, creditors and regulators. In an effort to satisfy our liquidity needs, we actively manage our assets and liabilities. We have access to immediate liquid resources in the form of cash which is primarily on deposit with the FRB and amounted to $506.7 million as of June 30, 2023. Potential sources of liquidity also include investment securities in our available-for-sale securities portfolio, our ability to sell loans in the secondary market, and to secure borrowings from the FRB and FHLB. Our diversified deposit portfolio has historically provided us with a long-term source of stable low cost funding. Maturities and payments on outstanding loans and investment securities also provide a steady flow of funds. Our liquidity, represented by cash borrowing lines, federal funds and available for sale securities, is a result of our operating, investing and financing activities and related cash flows. In order to ensure funds are available at all times, we devote resources to projecting the amount of funds that will be required and we maintain relationships with a diversified client base so funds are accessible. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets. 48 Table of Contents We had the following borrowing lines available at June 30, 2023: June 30, 2023 (Dollars in thousands) Total Credit Line Limit Current Credit Line Available Outstanding Amount Remaining Credit Line Available Value of Collateral Pledged Additional liquidity sources: Federal Home Loan Bank $ 784,138 $ 784,138 $ - $ 784,138 $ 1,267,719 Federal Reserve BIC 655,017 655,017 - 655,017 894,400 FHLB Fed Funds 18,000 18,000 - 18,000 - US Bank Fed Funds 50,000 50,000 - 50,000 - PCBB Fed Funds 50,000 50,000 - 50,000 - Total additional liquidity sources $ 1,557,155 $ 1,557,155 $ - $ 1,557,155 $ 2,162,119 We continued our focus on maintaining a strong liquidity position throughout the first six months of 2023 and we believe our liquid assets and short-term borrowing credit lines are adequate to meet our cash flow needs for loan and lease funding and deposit cash withdrawal for the foreseeable future. As of June 30, 2023, we had $835.6 million in cash and unencumbered investment securities, which is 15.91% of total assets. We also had $2.0 million in investment securities and $2.2 billion in loans pledged as collateral on short-term borrowing credit lines. We have the option of either borrowing on our credit lines or selling these investment securities for cash flow needs. We also have additional loans which are available to pledge which would further increase our borrowing capacity. On a long-term basis, our liquidity will be met by changing the relative distribution of our asset portfolios by reducing our investment or loan and lease volumes, or selling or encumbering assets. Further, we will increase liquidity by soliciting higher levels of deposit accounts through promotional activities and/or borrowing from our correspondent banks as well as the FHLB. At the current time, our long-term liquidity needs primarily relate to funds required to support loan and lease originations and commitments and deposit withdrawals. We believe we can meet all of these needs from existing liquidity sources. Our liquidity is comprised of three primary classifications: cash flows from or used in operating activities; cash flows from or used in investing activities; and cash flows from or used in financing activities. Net cash provided by or used in operating activities has consisted primarily of net income adjusted for certain non-cash income and expense items such as the credit loss provision, investment and other amortization and depreciation. Our primary investing activities are the origination of loans and lease and purchases and sales of investment securities. As of June 30, 2023, we had unfunded loan commitments of $1.1 billion and unfunded letters of credit of $16.9 million. We anticipate that we will have sufficient funds available to meet current loan commitments. Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company’s assessment of market risk at June 30, 2023 indicates there have been no material changes in the quantitative and qualitative disclosures from those made in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2023. 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. In monitoring interest rate risk we continually analyze and manage our earning assets and funding liabilities based on their payment streams and interest rates, the timing of their maturities and/or prepayments, and their sensitivity to actual or potential changes in market interest rates. 49 Table of Contents Since our earnings are primarily dependent on our ability to generate net interest income, we focus on actively monitoring and managing the effects of adverse changes in interest rates on our net interest income. 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 use 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 size remains static throughout the simulation horizon by replacing existing cashflows/amortization into similar products at current rates to try and capture the ongoing activity of the balance sheet without forecasting any level of growth. 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 100, 200 and 300 basis points. We then evaluate the simulation results using two approaches: Net Interest Income at Risk (“NII at Risk”) and Economic Value of Equity (“EVE”). Under NII at Risk, the impact on net interest income from the changes in interest rates on interest-earning assets and interest-bearing liabilities is modeled using various assumptions of assets and liabilities. EVE measures the period end present value of assets minus the present value of liabilities. Management uses this value to measure the changes in the economic value of the Company under various interest rate scenarios. In some ways, the economic value approach provides a broader scope than net income volatility approach since it captures all anticipated cash flows. Based on our quarterly simulations, 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 as rates earned on our interest-bearing assets reprice higher at a faster pace than rates paid on our interest-bearing liabilities. 50 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 specific term of the Treasury Curve 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. The following table present the projected change in the Company’s net interest income over the next twelve months and the economic value of equity at June 30, 2023, that would occur upon an immediate change in interest rates, but without giving effect to any steps that management might take to counteract that change: Estimated Change in Net Interest Income (NII) (as a % of NII) Estimated Change in Market Value of Equity (MVE) (as a % of MVE) June 30, 2023 +300 bps 3.44% (10.50%) +200 bps 2.09% (7.31%) +100 bps 1.19% (2.99%) 0 bps - - -100 bps (3.43%) (0.65%) -200 bps (7.18%) (3.90%) -300 bps (11.21%) (9.50%) Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the disclosure controls and procedures (as required by Exchange Act Rules 240.13a-15(b) and 15d-14(a)). Based on that evaluation, the CEO and CFO have concluded that as of the end of the period covered by this Report, the disclosure controls and procedures are effective to provide reasonable assurance that the information required to be disclosed by the Company in reports that are filed or submitted under the Exchange Act are recorded, processed, summarized and timely reported as provided in the SEC’s rules and forms. Changes in Internal Controls There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the six months ended June 30, 2023, to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. 51 Table of Contents PART II – OTHER INFORMATION Item 1. Legal Proceedings Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. Based upon information available to the Company, its review of such lawsuits and claims and consultation with its counsel, the Company believes the liability relating to these actions, if any, would not have a material adverse effect on its consolidated financial statements. There are no material proceedings adverse to the Company to which any director, officer or affiliate of the Company is a party. Item 1A. Risk Factors There have been no material changes in the risk factors previously disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2022. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The following table reports information regarding repurchases of our common stock during the six months ended June 30, 2023: Period Total number of shares purchased Average price paid per share (2) Total number of shares purchased as part of publicly announced plans or programs Maximum number (or approximate dollar value) of shares that may yet purchased under the plans or programs ( In thousands ) (1) Total 1st Quarter 2023 5,406 $ 1,024.02 5,406 $ 13,682 April 1, 2023 to April 30, 2023 538 $ 997.40 538 $ 13,145 May 1, 2023 to May 31, 2023 20 982.49 20 12,830 June 1, 2023 to June 30, 2023 7,850 982.54 7,850 5,413 Total 2nd Quarter 2023 8,408 $ 983.49 8,408 $ 5,413 Total 2023 13,814 $ 999.35 13,814 $ 5,413 (1) As of November 8, 2022 the Board approved an extension to the repurchase program through December 31, 2024 and for an additional $20 million of the Company's common stock. (2) The aggregate purchase price and weighted average price per share does not include the effect of excise tax expense incurred on net stock repurchases. For the six months ended June 30, 2023, excise tax expense totaled $138,000. On November 8, 2022, the Board of Directors authorized an extension to its share repurchase program through December 31, 2024 for an additional $20.0 million of the Company’s common stock (“Repurchase Plan”), which represents approximately 4% of outstanding shareholders’ equity. Repurchases by the Company under the Repurchase Plan may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means. The Inflation Reduction Act of 2022 signed into law in August 2022 includes a provision for an excise tax equal to 1% of the fair market value of any stock repurchased by covered corporations during a taxable year, subject to certain limits and provisions. The excise tax became effective on January 1, 2023. During the first half of 2023 the Company repurchased 13,814 shares under the Repurchase Plan, for a total of $13.9 million. All of these shares were purchased at prices ranging from $967.00 to $1,082.00 per share, based upon the then current price on the OTCQX. The Company has repurchased a total of 14,616 shares or $14.6 million under the current Repurchase Plan. 52 Table of Contents Item 3. Defaults upon Senior Securities Not Applicable Item 4. Mine Safety Disclosures Not Applicable Item 5. Other Information During the three months ended June 30, 2023, no director or officer of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” or “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408(a) of Regulation S-K. Item 6. Exhibits List of Financial Statements and Financial Statement Schedules (a) The following documents are filed as a part of this Quarterly Report on Form 10-Q: (1) Financial Statements and (2) Financial Statement schedules required to be filed by Item 1 of this Quarterly Report on Form 10-Q. (3) The following exhibits are required by Item 601 of Regulation S-K and are included as part of this Quarterly Report on Form 10-Q: Exhibit Number Description 31(a) Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* 31(b) Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* 32 Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* 101.INS Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document). 101.SCH Inline XBRL Taxonomy Extension Schema Document. 101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document. 101.DEF Inline XBRL Taxonomy Extension Definition Linkbase Document. 101.LAB Inline XBRL Taxonomy Extension Label Linkbase Document. 101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document. 104 Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101) *Filed herewith 53 Table of Contents SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FARMERS & MERCHANTS BANCORP Date: August 8, 2023 /s/ Kent A. Steinwert Kent A. Steinwert Director, Chairman, President and Chief Executive Officer (Principal Executive Officer) Date: August 8, 2023 /s/ Bart R. Olson Bart R. Olson Executive Vice President and Chief Financial Officer (Principal Financial Officer) 54