FARMERS & MERCHANTS BANCORP INC

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Inflation Risk

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Periods of inflation may impact our profitability by negatively impacting our fixed costs and expenses, including increasing funding costs and expense related to talent acquisition and retention. Additionally, inflation may lead to a decrease in our customers’ purchasing power and negatively affect the need or demand for our products and services. If significant inflation continues, our business could also be negatively affected by, among other things, increased default rates leading to credit losses which could decrease our appetite for new credit extensions.

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Quantitative Modeling Risk

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We rely on quantitative modeling to measure risks and to estimate certain financial values. Quantitative models may be used to help manage certain aspects of our business and to assist with certain business decisions, including estimating expected lifetime credit losses, measuring the fair value of financial instruments when reliable market prices are unavailable, estimating the effects of changing interest rates and other market measures on our financial condition and results of operations, managing risk, and for capital planning purposes. All models have certain limitations. For instance, these methodologies inherently rely on assumptions, historical analyses, and correlations which may not capture or fully incorporate all relevant conditions and circumstances. As a consequence, such limitations may result in losses, particularly in times of market distress. Additionally, as businesses and markets continue to rapidly evolve, our measurements may not accurately reflect this evolution. Even if the underlying assumptions and historical correlations used in our models are adequate, our models may be deficient due to errors in computer code, inaccurate data, misuse of data, or the use of a model for a purpose outside the scope of the model’s design.

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Reliance on such models presents the risk that our resulting business decisions will be adversely affected due to incorrect, missing, or misleading information. If our models fail to produce reliable results on an ongoing basis, we may not make appropriate risk management, capital planning, or other business or financial decisions. Strategies that we employ to manage and govern the risks associated with our use of models may not be effective or fully reliable. Also, information that we provide to the public or regulators based on poorly designed models could be inaccurate or misleading.

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Trade Policy Risk

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The ongoing trade policies and tariff initiatives being pursued by the U.S. government under the administration of President Trump could present potential risks unique to the markets within which we operate. Many of our commercial borrowers operate in agriculture, food processing, and manufacturing; industries that are particularly sensitive to changes in trade policy. The imposition of tariffs on imported goods, the added potential for retaliatory tariffs by foreign governments, or other similar restrictions on international trade could increase costs for domestic manufacturers and consumers alike, as well as reduce demand abroad for U.S. exports, and disrupt supply chains. Any prolonged trade tensions could negatively impact the broader economic environment in the Midwest where the Bank operates, potentially leading to reduced consumer spending, lower economic growth, and decreased demand for other banking products and services. If these factors lead to financial strain on our borrowers, we may experience increased credit risk, higher loan delinquencies, and a potential decline in loan demand.

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As a result, our financial performance, including credit quality and loan growth, could be adversely affected by these policy changes. While we actively monitor these developments and work closely with our agricultural customers, there is no assurance that we can fully mitigate the risks posed by tariff initiatives or other trade-related disruptions. These factors could materially affect our business, financial condition, and results of operations.

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Emerging financial technologies such as digital assets, stablecoins, and distributed ledger systems may reduce the demand for traditional banking services and create new competitive pressures that adversely affect our business.

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The rapid development and increasing regulatory acceptance of financial technologies such as digital assets (including cryptocurrencies and tokenized money), stablecoins, and distributed ledger technologies (DLT) could materially alter the landscape of financial services in the coming years. These technologies enable near-instantaneous value transfer, programmable money, and peer-to-peer settlement mechanisms, many of which may operate outside the traditional banking system.

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Large technology companies, fintech platforms, and digital asset service providers—some of which are not subject to the same regulatory or capital constraints as depository institutions—are increasingly offering products that compete with core banking functions, such as payments, custody, lending, and liquidity management. The adoption of digital financial infrastructure by governments or central banks, such as central bank digital currencies (CBDCs), or by major corporate platforms could accelerate these shifts.

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As a relatively small financial institution, we may be disproportionately impacted by these developments. Our ability to compete with larger institutions or well-capitalized technology entrants in developing or integrating such technologies is limited by our size, risk appetite, and regulatory obligations. A failure to adapt to or participate in these emerging ecosystems—either directly or through strategic partnerships—could erode our relevance in key banking functions, reduce our share of customer deposits and fee income, and adversely affect our long-term growth prospects and financial condition.

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Compliance Obligations of Bank Holding Companies and Insured Depositories

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We and our bank subsidiary operate within an extensive and evolving framework of federal and state laws, regulations, and supervisory expectations that govern nearly all aspects of our operations. As a bank holding company, we are subject to the Bank Holding Company Act and related regulations, while our bank is overseen by federal and state regulators through examination and enforcement authority. We are also subject to numerous requirements under consumer protection, privacy, anti-money laundering, sanctions, community reinvestment, and securities laws, as well as payment system and third-party risk management standards.

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These obligations restrict permissible activities, affect capital, liquidity, and growth strategies, and impose significant compliance and operational costs. Examinations may result in Matters Requiring Attention or enforcement actions, and deficiencies in our risk, compliance, or governance programs could lead to penalties, remediation orders, restrictions on dividends or expansion, and reputational harm.

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The regulatory landscape continues to evolve through new legislation, rulemaking, and supervisory guidance in areas such as consumer protection, AML and sanctions, fintech partnerships, model risk, payments modernization, data privacy, and fair access. Future changes—or differing federal and state requirements—could increase compliance costs, limit product or service offerings, or otherwise adversely affect our business, financial condition, and results of operations.

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“Debanking,” Fair Access, and Supervisory Expectations

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Evolving federal and state scrutiny of account onboarding, offboarding, and access to banking services—often referred to as “debanking” or “fair access”—could increase our compliance, legal, and reputational risks. Policymakers and regulators are reconsidering the role of “reputation risk” in supervision and adopting laws that limit account decisions based on perceived political or non-risk factors. These measures may conflict with each other or with our obligations under existing law.

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Supervisory expectations emphasizing individualized, risk-based decisions and enhanced documentation may require policy and system changes and greater resources. We could face criticism or penalties if regulators find our account actions insufficiently supported or discriminatory, or if we must maintain accounts beyond our risk appetite. Conflicting standards and rising public attention to alleged “debanking” may increase complaint volume, compliance costs, and reputational exposure. Any of these developments could materially affect our business, financial condition, or results of operations.

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Data Privacy, Cybersecurity, and Information Security Compliance

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We are subject to extensive federal and state data privacy, cybersecurity, and information security requirements. Expanding state privacy regimes, incident-notification rules, and vendor-oversight standards have increased the complexity and cost of compliance, particularly across multiple jurisdictions and third-party relationships. Failure to comply with applicable laws or to safeguard customer or confidential information could result in regulatory inquiries, penalties, litigation, remediation costs, and reputational harm. Ongoing changes in privacy and cybersecurity laws may require additional investment in systems, controls, and personnel, and could adversely affect our operations and financial results.

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Consumer Compliance, CRA Modernization, and Fair Lending

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We are subject to extensive consumer protection, fair lending, and Community Reinvestment Act (CRA) obligations. CRA modernization and evolving fair-lending expectations may require changes to our assessment areas, data collection, monitoring, product offerings, and governance. The use of models or analytics in pricing, marketing, or underwriting increases fair-lending and conduct risk if not properly controlled. Failure to meet supervisory expectations could result in criticism, penalties, remediation obligations, restrictions on growth or activities, or reputational harm.

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Payments, Fee Practices, and Operational Risk

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Regulatory and supervisory scrutiny of consumer fees—including overdraft and other service charges—continues to evolve. Changes to fee practices, disclosure requirements, or remediation obligations could reduce noninterest income and increase compliance costs. Adoption of faster payment systems and real-time networks heightens operational, fraud, and funds-availability risks, requiring ongoing enhancements to risk controls, vendor oversight, and reconciliation processes. Network rule changes or settlement obligations could further increase costs or operational complexity and adversely affect our results.

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Consumer Credit Normalization and Portfolio Risk

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Consumer credit performance is normalizing from historically strong conditions, reflecting higher interest rates, elevated prices, and reduced savings. Deterioration in borrower cash flows, labor-market weakness, or persistent inflation could increase delinquencies and charge-offs in our retail portfolios, including unsecured consumer loans. Higher loss emergence would increase our allowance for credit losses under CECL, potentially leading to earnings volatility, elevated provision levels, and slower loan growth.