ITEM 1. BUSINESS
The Company
Landmark Bancorp, Inc.
(the “Company”) is a bank holding company which was incorporated under the laws of the State of Delaware in 2001. Currently,
the Company’s business consists solely of the ownership of Landmark National Bank (the “Bank”), which is a wholly-owned
subsidiary of the Company. As of December 31, 2012, the Company had $614.1 million in consolidated total assets.
The Company is headquartered
in Manhattan, Kansas and has expanded its geographic presence through past acquisitions. Effective April 1, 2012, the Company completed
the acquisition of The Wellsville Bank (the “2012 Acquisition”). In May 2009, the Company acquired an additional branch
in Lawrence, Kansas. Effective January 1, 2006, the Company completed the acquisition of First Manhattan Bancorporation, Inc. (“FMB”),
the holding company for First Savings Bank F.S.B. In conjunction with the transaction, FMB was merged into the Bank (the “2006
Acquisition”). In August 2005, the Company acquired 2 branches in Great Bend, Kansas. Effective April 1, 2004, the Company
acquired First Kansas Financial Corporation (“First Kansas”), the holding company for First Kansas Federal Savings
Association (“First Kansas Federal”). In conjunction with the transaction, First Kansas was merged into the Bank (the
“2004 Acquisition”). In October 2001, Landmark Bancshares, Inc., the holding company for Landmark Federal Savings Bank,
and MNB Bancshares, Inc., the holding company for Security National Bank, completed their merger into Landmark Merger Company,
which immediately changed its name to Landmark Bancorp, Inc. (the “2001 Merger”). In addition, Landmark Federal Savings
Bank merged with Security National Bank and the resulting bank changed its name to Landmark National Bank.
Pursuant to the 2012
Acquisition, the 2006 Acquisition, the 2004 Acquisition and the 2001 Merger, the Bank succeeded to all of the assets and liabilities
of the Wellsville Bank, FMB, First Savings Bank F.S.B., First Kansas, First Kansas Federal, Landmark Federal Savings Bank and Security
National Bank. The Bank is principally engaged in the business of attracting deposits from the general public and using such deposits,
together with borrowings and other funds, to originate one-to-four family residential real estate, construction and land, commercial
real estate, commercial, agriculture, municipal and consumer loans in the Bank’s principal market areas, as described below.
The Bank has continued to focus on originating greater numbers and amounts of commercial, commercial real estate and agricultural
loans; however, generally weak loan demand over the past few years has made it difficult to grow these loan portfolios significantly.
Additionally, greater emphasis has been placed on diversification of the deposit mix through expansion of core deposit accounts
such as checking, savings, and money market accounts. The Bank has also diversified its geographical markets as a result of its
prior acquisitions. The Company’s main office is in Manhattan, Kansas with branch offices across the state of Kansas. The
Company continues to explore opportunities to expand its banking markets through mergers and acquisitions, as well as branching
opportunities.
The results of operations
of the Bank and the Company are dependent primarily upon net interest income and, to a lesser extent, upon other income derived
from loan servicing fees and customer deposit services. Additional expenses of the Bank include general and administrative expenses
such as salaries, employee benefits, federal deposit insurance premiums, data processing, occupancy and related expenses.
Deposits of the Bank
are insured by the Deposit Insurance Fund (the “DIF”) of the Federal Deposit Insurance Corporation (the “FDIC”)
up to the maximum amount allowable under applicable federal law and regulation. The Bank is regulated by the Office of the Comptroller
of the Currency (the “OCC”), as the chartering authority for national banks, and the FDIC, as the administrator of
the DIF. The Bank is also subject to regulation by the Board of Governors of the Federal Reserve System with respect to reserves
required to be maintained against deposits and certain other matters. The Bank is a member of the Federal Reserve Bank of Kansas
City and the Federal Home Loan Bank (the “FHLB”) of Topeka.
The Company’s
executive office and the Bank’s main office are located at 701 Poyntz Avenue, Manhattan, Kansas 66502. The telephone number
is (785) 565-2000.
Market Areas
The Bank’s primary
deposit gathering and lending markets are geographically diversified with locations in eastern, central, and western Kansas. The
primary industries within these respective markets are also diverse and dependent upon a wide array of industry and governmental
activity for their economic base. The Bank’s markets have not been immune to the effects of the challenging economic conditions
of recent years. To varying degrees, the Bank’s markets generally have experienced either flat or declining commercial and
residential real estate values, as well as depressed consumer confidence, heightened unemployment levels and muted consumer spending.
Even though the geographic markets in which the Bank operates have been impacted by the economic conditions in recent years, the
effect has not been as severe as those experienced in some areas of the United States. A brief description of the three geographic
areas and the communities which the Bank serves is set forth below.
Shawnee, Douglas, Miami,
Osage, Bourbon and Franklin counties are located in eastern Kansas and encompass the Bank’s locations in Topeka, Auburn,
Lawrence, Paola, Louisburg, Osawatomie, Osage City, Fort Scott and Wellsville. Shawnee County’s market, which encompasses
the Bank’s locations in Topeka and Auburn, is strongly influenced by the State of Kansas, City of Topeka, two regional hospitals
and several major private firms and public institutions which are the main employers in this area. The Bank’s Lawrence locations
are located in Douglas County and are significantly impacted by the University of Kansas, the largest university in Kansas, in
addition to several private industries and businesses in the community. The communities of Paola, Louisburg, Osawatomie and Wellsville,
located within Miami and Franklin Counties, are influenced by the Kansas City market, resulting in housing growth and small private
industries and business. Additionally, the Osawatomie State Hospital is a major government employer within Miami County. Bourbon
and Osage Counties are primarily agricultural with small private industries and business firms while Bourbon County is also influenced
by a regional hospital and Fort Scott Community College.
Bank locations within
central Kansas include the communities of Manhattan within Riley County, Wamego within Pottawatomie County and Junction City within
Geary County. The Riley, Pottawatomie and Geary County economies are significantly impacted by employment at Fort Riley Military
Base and Kansas State University, the second largest university in Kansas, which is located in Manhattan. Manhattan was also selected
as the site of the new National Bio and Agro-Defense Facility, which is expected to have a significant impact on the regional economy
as the facility is constructed and begins operations. Several private industries and businesses are also located within these counties.
Additionally, manufacturing and service industries also play a key role within this central Kansas market.
The Bank’s western
Kansas branches are located in the communities of Dodge City in Ford County, Garden City in Finney County, Great Bend and Hoisington
in Barton County and LaCrosse in Rush County. Agriculture, oil, and gas are the predominant industries in the western Kansas region.
Predominant activities involve crop production, feed lot operations, and food processing. Dodge City is known as the “Cowboy
Capital of the World” and maintains a significant tourism industry. Both Dodge City and Garden City are recognized as regional
commercial centers within the state with small businesses, manufacturing, retail, and service industries having a significant influence
upon the local economies. Additionally, both communities have a community college, which attracts a number of individuals from
the surrounding area to live within the community to participate in educational programs and pursue a degree.
Competition
The Company faces strong
competition both in attracting deposits and making real estate, commercial and other loans. Its most direct competition for deposits
comes from commercial banks and other savings institutions located in its principal market areas, including many larger financial
institutions which have greater financial and marketing resources available to them. The ability of the Company to attract and
retain deposits generally depends on its ability to provide a rate of return, liquidity and risk comparable to that offered by
competing investment opportunities. The Company competes for loans principally through the interest rates and loan fees it charges
and the efficiency and quality of services it provides borrowers.
Employees
At December 31, 2012,
the Bank had a total of 215 employees (199 full time equivalent employees). The Company has no employees, although the Company
is a party to several employment agreements with executives of the Bank. Employees are provided with a comprehensive benefits program,
including basic and major medical insurance, life and disability insurance, sick leave, and a 401(k) profit sharing plan. Employees
are not represented by any union or collective bargaining group and the Bank considers its employee relations to be good.
Lending Activities
General
.
The Bank strives to provide a full range of financial products and services to small- and medium-sized businesses and to consumers
to each market area it serves. The Bank targets owner-operated businesses and utilizes Small Business Administration lending as
a part of its product mix. The Bank has a loan committee for each of its markets, which has authority to approve credits, within
established guidelines. Concentrations in excess of those guidelines must be approved by either a corporate loan committee comprised
of the Bank’s Chief Executive Officer, the Credit Risk Manager, and other senior commercial lenders or the Bank’s board
of directors. When lending to an entity, the Bank generally obtains a guaranty from the principals of the entity. The loan mix
is subject to the discretion of the Bank’s board of directors and the demands of the local marketplace.
The following is a
brief description of each major category of the Bank’s lending activity.
One-to-Four Family
Residential Real Estate Lending
. The Bank originates one-to-four family residential real estate loans with both fixed and
variable rates. One-to-four family residential real estate loans are priced and originated following global underwriting standards
that are consistent with guidelines established by the major buyers in the secondary market. Generally, residential real estate
loans retained in the Bank’s loan portfolio have fixed or variable rates with adjustment periods of five years or less and
amortization periods of typically either 15 or 30 years. A significant portion of these loans prepay prior to maturity. The Bank
has no potential negative amortization loans. While the origination of fixed-rate, one-to-four family residential loans continues
to be a key component of our business, the majority of these loans are sold in the secondary market. One-to-four family residential
real estate loans that exceed 80% of the appraised value of the real estate generally are required, by policy, to be supported
by private mortgage insurance, although on occasion the Bank will retain non-conforming residential loans to known customers at
premium pricing. The Bank’s one-to-four family residential real estate loan portfolio increased primarily as a result of
the acquisition of The Wellsville Bank during 2012; however the Bank also retained some newly originated one-to-four family residential
real estate loans that met internal criteria in addition to secondary market qualifications. These are typically loans with maturities
of 15 years or less. While the Bank does not intend to increase its one-to-four family residential real estate loan portfolio,
the Bank slowed the runoff of the portfolio by retaining some of the new loan originations to offset weak commercial loan demand;
however, most of the new loan originations continue to be sold.
Construction
and Land Lending.
Loans in this category include loans to facilitate the development of both residential and commercial
real estate. Construction and land loans generally have terms of less than 18 months and the Bank will retain a security interest
in the borrower’s real estate. Construction loans are generally limited, by policy, to 80% of the appraised value of the
property. Land loans are generally limited, by policy, to 65% of the appraised value of the property. The Bank has generally been
reducing its exposure to construction and land loans over the past few years. However, recently loan demand has began to increase
for these type of loans.
Commercial Real
Estate Lending
. Commercial real estate loans, including multi-family loans, represent the largest class of loans of the
Bank. Commercial and multi-family real estate loans generally have amortization periods of 15 or 20 years. Commercial real estate
and multi-family loans are generally limited, by policy, to 80% of the appraised value of the property. Commercial real estate
loans are also supported by an analysis demonstrating the borrower’s ability to repay. The Bank continues to focus on generating
additional commercial real estate loan relationships; However, this has been difficult over the past few years as a result of flat
or declining commercial real estate values.
Commercial Lending
.
Loans in this category include loans to service, retail, wholesale and light manufacturing businesses. Commercial loans are made
based on the financial strength and repayment ability of the borrower, as well as the collateral securing the loans. The Bank targets
owner-operated businesses as its customers and makes lending decisions based upon a cash flow analysis of the borrower as well
as a collateral analysis. Accounts receivable loans and loans for inventory purchases are generally on a one-year renewable term
and loans for equipment generally have a term of seven years or less. The Bank generally takes a blanket security interest in all
assets of the borrower. Equipment loans are generally limited to 75% of the cost or appraised value of the equipment. Inventory
loans are generally limited to 50% of the value of the inventory, and accounts receivable loans are generally limited to 75% of
a predetermined eligible base. The Bank continues to focus on generating additional commercial loan relationships.
Municipal Lending.
Loans to municipalities are generally related to equipment leasing or general fund loans. Terms are generally limited to 5 years.
Equipment leases are generally made for the purchase of municipal assets and are secured by the leased asset. The Bank is no longer
active in the origination of municipal leases; however, the Bank may still originate loans or leases for municipalities in its
market area.
Agriculture Lending.
Agricultural real estate loans generally have amortization periods of 20 years or less, during which time the Bank generally retains
a security interest in the borrower’s real estate. The Bank also provides short-term credit for operating loans and intermediate-term
loans for farm product, livestock and machinery purchases and other agricultural improvements. Farm product loans generally have
a one-year term, and machinery, equipment and breeding livestock loans generally have five to seven year terms. Extension of credit
is based upon the borrower’s ability to repay, as well as the existence of federal guarantees and crop insurance coverage.
These loans are generally secured by a blanket lien on livestock, equipment, feed, hay, grain and growing crops. Equipment and
breeding livestock loans are generally limited to 75% of appraised value. Although the Bank’s agriculture loan portfolio
declined during 2012, the Bank continues to focus on generating additional agriculture operating loan relationships. The Bank does
not focus on generating agriculture real estate loans.
Consumer and
Other Lending
. Loans classified as consumer and other loans include automobile, boat, home improvement and home equity
loans. With the exception of home improvement loans and home equity loans, the Bank generally takes a purchase money security interest
in collateral for which it provides the original financing. Home improvement loans and home equity loans are principally secured
through second mortgages. The terms of the loans typically range from one to five years, depending upon the use of the proceeds,
and generally range from 75% to 90% of the value of the collateral. The majority of these loans are installment loans with fixed
interest rates. Home improvement and home equity loans are generally secured by a second mortgage on the borrower’s personal
residence and, when combined with the first mortgage, limited to 80% of the value of the property unless further protected by private
mortgage insurance. Home improvement loans are generally made for terms of five to seven years with fixed interest rates. Home
equity loans are generally made for terms of ten years on a revolving basis with adjustable monthly interest rates tied to the
national prime interest rate. The Bank has experienced weak consumer loan demand and does not expect consumer loan demand to increase
until economic conditions improve further and the unemployment rate declines.
Loan Origination and Processing
Loan originations are
derived from a number of sources. Residential loan originations result from real estate broker referrals, direct solicitation by
the Bank’s loan officers, present depositors and borrowers, referrals from builders and attorneys, walk-in customers and,
in some instances, other lenders. Consumer and commercial real estate loan originations generally emanate from many of the same
sources. Residential loan applications are underwritten and closed based upon standards which generally meet secondary market guidelines.
The loan underwriting
procedures followed by the Bank conform to regulatory specifications and are designed to assess both the borrower’s ability
to make principal and interest payments and the value of any assets or property serving as collateral for the loan. Generally,
as part of the process, a loan officer meets with each applicant to obtain the appropriate employment and financial information
as well as any other required loan information. The Bank then obtains reports with respect to the borrower’s credit record,
and orders, on real estate loans, and reviews an appraisal of any collateral for the loan (prepared for the Bank through an independent
appraiser).
Loan applicants are
notified promptly of the decision of the Bank. Prior to closing any long-term loan, the borrower must provide proof of fire and
casualty insurance on the property serving as collateral, and such insurance must be maintained during the full term of the loan.
Title insurance is required on loans collateralized by real property.
The Bank is focusing
on the generation of commercial and commercial real estate loans to grow and diversify the loan portfolio. However, the difficult
economic environment has materially impacted commercial and commercial real estate loan origination as a result of decreased demand
for loans that meet the Bank’s credit standards. In several of the Bank’s markets there is an oversupply of newly constructed,
speculative residential real estate properties and developed vacant lots. As a result of these issues, the Bank has curtailed land
development and construction lending and does not expect this type of lending to increase significantly until the economic outlook
improves and the supply and demand of residential housing and vacant developed lots is in balance. Economic conditions in recent
years have also caused the Bank to increase underwriting requirements on other types of loans to insure borrowers can meet repayment
requirements.
SUPERVISION AND REGULATION
General
Financial institutions,
their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and
earnings performance of the Company may be affected not only by management decisions and general economic conditions, but also
by requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including
the OCC, the Federal Reserve, the FDIC, and the newly-created Bureau of Consumer Financial Protection (the “CFPB”).
Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities, accounting rules developed
by the Financial Accounting Standards Board (the “FASB”) and securities laws administered by the SEC and state securities
authorities have an impact on the business of the Company. The effect of these statutes, regulations, regulatory policies and accounting
rules are significant to the operations and results of the Company and Bank, and the nature and extent of future legislative, regulatory
or other changes affecting financial institutions are impossible to predict with any certainty.
Federal and state banking
laws impose a comprehensive system of supervision, regulation and enforcement on the operations of financial institutions, their
holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks,
rather than stockholders. These federal and state laws, and the regulations of the bank regulatory authorities issued under them,
affect, among other things, the scope of business, the kinds and amounts of investments banks may make, reserve requirements, capital
levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, the ability to merge,
consolidate and acquire, dealings with insiders and affiliates and the payment of dividends. In addition, turmoil in the credit
markets in recent years prompted the enactment of unprecedented legislation that has allowed the U.S. Department of the Treasury
(the “Treasury”) to make equity capital available to qualifying financial institutions to help restore confidence and
stability in the U.S. financial markets, which imposes additional requirements on institutions in which the Treasury invests.
In addition, the Company
and Bank are subject to regular examination by their respective regulatory authorities, which results in examination reports and
ratings that are not publicly available and that can impact the conduct and growth of business. These examinations consider not
only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance,
earnings, liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions
and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations
are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory
policies of these agencies.
The following is a
summary of the material elements of the supervisory and regulatory framework applicable to the Company and the Bank. It does not
describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those
that are described. The descriptions are qualified in their entirety by reference to the particular statutory or regulatory provision.
Financial Regulatory Reform
On July 21, 2010, President
Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. The Dodd-Frank
Act represents a sweeping reform of the supervisory and regulatory framework applicable to financial institutions and capital markets
in the United States, certain aspects of which are described below in more detail. The Dodd-Frank Act creates new federal governmental
entities responsible for overseeing different aspects of the U.S. financial services industry, including identifying emerging systemic
risks. It also shifts certain authorities and responsibilities among federal financial institution regulators, including the supervision
of holding company affiliates and the regulation of consumer financial services and products. In particular, and among other things,
the Dodd-Frank Act: creates the CFPB, which is authorized to regulate providers of consumer credit, savings, payment and other
consumer financial products and services; narrows the scope of federal preemption of state consumer laws enjoyed by national banks
and federal savings associations and expands the authority of state attorneys general to bring actions to enforce federal consumer
protection legislation; imposes more stringent capital requirements on bank holding companies and subjects certain activities,
including interstate mergers and acquisitions, to heightened capital conditions; significantly expands underwriting requirements
applicable to loans secured by 1-4 family residential real property; restricts the interchange fees payable on debit card transactions
for issuers with $10 billion in assets or greater; requires the originator of a securitized loan, or the sponsor of a securitization,
to retain at least 5% of the credit risk of securitized exposures unless the underlying exposures are qualified residential mortgages
or meet certain underwriting standards to be determined by regulation; creates a Financial Stability Oversight Council as part
of a regulatory structure for identifying emerging systemic risks and improving interagency cooperation; provides for enhanced
regulation of advisers to private funds and of the derivatives markets; enhances oversight of credit rating agencies; and prohibits
banking agency requirements tied to credit ratings.
Numerous
provisions of the Dodd-Frank Act are required to be implemented through rulemaking by the appropriate federal regulatory agencies.
Many of the required regulations have been issued and others have been released for public comment, but there remain a number that
have yet to be released in any form. Furthermore, while the reforms primarily target systemically important financial service providers,
their influence is expected to filter down in varying degrees to smaller institutions over time. Management of the Company and
Bank will continue to evaluate the effect of the changes; however, in many respects, the ultimate impact of the Dodd-Frank Act
will not be fully known for years, and
n
o current assurance may be given that the Dodd-Frank
Act, or any other new legislative changes, will not have a negative impact on the results of operations and financial condition
of the Company and the Bank.
The Increasing Regulatory Emphasis on Capital
The Company is subject
to various regulatory capital requirements administered by the federal banking regulators noted above. Failure to meet regulatory
capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory
framework for “prompt corrective action” (described below), the Company must meet specific capital guidelines that
involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting
policies. The Company’s capital amounts and classifications are also subject to judgments by the regulators regarding qualitative
components, risk weightings and other factors.
While capital has historically
been one of the key measures of the financial health of both bank holding companies and depository institutions, its role is becoming
fundamentally more important in the wake of the financial crisis, as the regulators have recognized that the amount and quality
of capital held by banking organizations was insufficient to absorb losses during periods of severe stress. Certain provisions
of the Dodd-Frank Act and Basel III, discussed below, will ultimately establish strengthened capital standards for banks and bank
holding companies, will require more capital to be held in the form of common stock and will disallow certain funds from being
included in capital determinations. Once fully implemented, these provisions will represent regulatory capital requirements
that are meaningfully more stringent than those in place currently.
Company and Bank
Required Capital Levels.
Bank holding companies have historically had to comply with less stringent capital standards
than their bank subsidiaries and were able to raise capital with hybrid instruments such as trust preferred securities. The Dodd-Frank
Act mandated the Federal Reserve to establish minimum capital levels for bank holding companies on a consolidated basis that are
as stringent as those required for insured depository institutions. As a consequence, over a phase-in period of three years, the
components of holding company permanent capital known as “Tier 1 capital” are being restricted to capital instruments
that are considered to be Tier 1 capital for insured depository institutions. A result of this change is that the proceeds of trust
preferred securities are being excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank
holding companies with less than $15 billion of assets. Because the Company has assets of less than $15 billion, it is able to
maintain its trust preferred proceeds as Tier 1 capital but will have to comply with new capital mandates in other respects, and
will not be able to raise Tier 1 capital in the future through the issuance of trust preferred securities. In addition, the Basel
III proposal, discussed below, includes a phase-out of trust preferred securities for all bank holding companies, including the
Company.
Under current federal
regulations, the Bank is subject to, and, after the phase-in period, the Company will be subject to, the following minimum capital
standards:
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a leverage requirement, consisting of
a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least
4% for all others, and
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a risk-based capital requirement, consisting
of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted
assets of 4%. For this purpose, “Tier 1 capital” consists primarily of common stock, noncumulative perpetual preferred
stock and related surplus less intangible assets (other than certain loan servicing rights and purchased credit card relationships).
Total capital consists primarily of Tier 1 capital plus “Tier 2 capital,” which includes other non-permanent capital
items, such as certain other debt and equity instruments that do not qualify as Tier 1 capital, and a portion of the Bank’s
allowance for loan and leases losses.
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The capital standards
described above are minimum requirements. Federal law and regulations provide various incentives for banking organizations to maintain
regulatory capital at levels in excess of minimum regulatory requirements. For example, a banking organization that is “well-capitalized”
may: (i) qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities;
(ii) qualify for expedited processing of other required notices or applications; and (iii) accept brokered deposits. Under the
capital regulations of the Federal Reserve, in order to be “well-capitalized,” a banking organization must maintain
a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets
of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater. The Federal Reserve’s guidelines also provide
that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions
substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines
indicate that the Federal Reserve will continue to consider a “tangible Tier 1 leverage ratio” (deducting all
intangibles) in evaluating proposals for expansion or to engage in new activity.
Higher capital levels
may also be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example,
the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of,
among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities
trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain
capital ratios, including tangible capital positions (
i.e.
, Tier 1 capital less all intangible assets), well above the minimum
levels.
Prompt Corrective
Action
.
A banking organization’s capital plays an important role in connection with regulatory enforcement as well.
Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of
undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “adequately
capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,”
in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’
corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s
asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional
voting stock) or to be acquired; (iv) restricting transactions between the institution and its affiliates; (v) restricting the
interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring
that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent
banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated
debt; and (xi) ultimately, appointing a receiver for the institution.
As of December 31,
2012: (i) the Bank was not subject to a directive from the OCC to increase its capital to an amount in excess of the minimum regulatory
capital requirements; (ii) the Bank exceeded its minimum regulatory capital requirements under OCC capital adequacy guidelines;
and (iii) the Bank was “well-capitalized,” as defined by OCC regulations. As of December 31, 2012, the Company had
regulatory capital in excess of the Federal Reserve’s requirements and met the Dodd-Frank Act capital requirements.
Basel III.
The current risk-based capital guidelines described above, which apply to the Bank and are being phased in for the Company, are
based upon the 1988 capital accord known as “Basel I” adopted by the international Basel Committee on Banking Supervision,
a committee of central banks and bank supervisors, as implemented by the U.S. federal banking regulators on an interagency basis. In
2008, the banking agencies collaboratively began to phase-in capital standards based on a second capital accord, referred to as
“Basel II,” for large or “core” international banks (generally defined for U.S. purposes as having total
assets of $250 billion or more, or consolidated foreign exposures of $10 billion or more). Basel II emphasized internal assessment
of credit, market and operational risk, as well as supervisory assessment and market discipline in determining minimum capital
requirements.
On September 12,
2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced
agreement on a strengthened set of capital requirements for banking organizations around the world, known as Basel III, to address
deficiencies recognized in connection with the global financial crisis. Basel III requires, among other things:
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a new required ratio of minimum common
equity equal to 4.5% of risk-weighted assets,
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an increase in the minimum required amount
of Tier 1 capital from the current level of 4% of total assets to 6% of risk-weighted assets, and
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a continuation of the current minimum
required amount of total capital at 8% of risk weighted assets.
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In addition, institutions
that seek the freedom to make capital distributions (including for dividends and repurchases of stock) and pay discretionary bonuses
to executive officers without restriction must also maintain 2.5% in common equity attributable to a capital conservation buffer
to be phased in over three years. The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that
can be used to absorb losses during periods of financial and economic stress. Factoring in the conservation buffer increases the
ratios depicted above to 7% for common equity, 8.5% for Tier 1 capital and 10.5% for total capital.
On June 12, 2012,
the federal banking regulators (the OCC, the Federal Reserve and the FDIC) (the “Agencies”) formally proposed for comment,
in three separate but related proposals, rules to implement Basel III in the United States. The proposals are: (i) the “Basel
III Proposal,” which applies the Basel III capital framework to almost all U.S. banking organizations; (ii) the
“Standardized Approach Proposal,” which applies certain elements of the Basel II standardized approach for credit risk
weightings to almost all U.S. banking organizations; and (iii) the “Advanced Approaches Proposal,” which
applies changes made to Basel II and Basel III in the past few years to large U.S. banking organizations subject to the advanced
Basel II capital framework. The comment period for these notices of proposed rulemaking ended October 22, 2012.
The Basel III Proposal
and the Standardized Approach Proposal are expected to have a direct impact on the Company and the Bank. The Basel III Proposal
is applicable to all U.S. banks that are subject to minimum capital requirements, including federal and state banks, as well
as to bank and savings and loan holding companies other than “small bank holding companies” (generally bank holding
companies with consolidated assets of less than $500 million). There will be separate phase-in/phase-out periods for: (i) minimum
capital ratios; (ii) regulatory capital adjustments and deductions; (iii) nonqualifying capital instruments; (iv) capital
conservation and countercyclical capital buffers; (v) a supplemental leverage ratio for advanced approaches banks; and (vi) changes
to the FDIC’s prompt corrective action rules.
The criteria in the
U.S. proposal for common equity and additional Tier 1 capital instruments, as well as Tier 2 capital instruments,
are broadly consistent with the Basel III criteria. A number of instruments that now qualify as Tier 1 capital will not qualify,
or their qualification will change, if the Basel III Proposal becomes final. For example, cumulative preferred stock and certain
hybrid capital instruments, including trust preferred securities, which the Company may retain under the Dodd-Frank Act, will no
longer qualify as Tier 1 capital of any kind. Noncumulative perpetual preferred stock, which now qualifies as simple Tier 1
capital, would not qualify as common equity Tier 1 capital, but would qualify as additional Tier 1 capital.
In addition to the
changes in capital requirements included within the Basel III Proposal, the Standardized Approach Proposal revises a large number
of the risk weightings (or their methodologies) for bank assets that are used to determine the capital ratios. For nearly every
class of assets, the proposal requires a more complex, detailed and calibrated assessment of credit risk and calculation of risk
weightings. For example, under the current risk-weighting rules, residential mortgages have a risk weighting of 50%. Under the
proposed new rules, two categories of residential mortgage lending would be created: (i) traditional lending would be category 1,
where the risk weightings range from 35 to 100%; and (ii) nontraditional loans would fall within category 2, where the
risk weightings would range from 50 to 150%. There is concern in the U.S. that the proposed methodology for risk weighting residential
mortgage exposures and the higher risk weightings for certain types of mortgage products will increase costs to consumers and reduce
their access to mortgage credit.
In addition, there
is significant concern noted by the financial industry in connection with the Basel III rulemaking as to the proposed treatment
of accumulated other comprehensive income (“AOCI”). The proposed treatment of AOCI would require unrealized gains and
losses on available-for-sale securities to flow through to regulatory capital as opposed to the current treatment, which neutralizes
such effects. There is concern that this treatment would introduce capital volatility, due not only to credit risk but also to
interest rate risk, and affect the composition of firms’ securities holdings.
While the Basel III
accord called for national jurisdictions to implement the new requirements beginning January 1, 2013, in light of the volume
of comments received by the Agencies and the concerns expressed above, the Agencies have indicated that the commencement date for
the proposed Basel III rules has been delayed and it is unclear when the Basel III regime, as it may be implemented by final rules,
will become effective in the United States.
The Company
General.
The Company, as the sole stockholder of the Bank, is a bank holding company. As a bank holding company, the Company is registered
with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”).
In accordance with Federal Reserve policy, and as now codified by the Dodd-Frank Act, the Company is legally obligated to act as
a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might
not otherwise do so. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve. The Company is required
to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the
Company and its subsidiaries as the Federal Reserve may require.
Acquisitions,
Activities and Change in Control
.
The primary purpose of a bank holding company is to control and manage banks.
The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition
by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration
limits established by the BHCA and the Dodd-Frank Act), the Federal Reserve may allow a bank holding company to acquire banks located
in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable
state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured
depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate
against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have
been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding
company. Furthermore, in accordance with the Dodd-Frank Act, bank holding companies must be well-capitalized and well-managed in
order to effect interstate mergers or acquisitions. For a discussion of the capital requirements, see “—The Increasing
Regulatory Emphasis on Capital” above.
The BHCA generally
prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company
that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services
to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows
bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve
prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.” This authority
would permit the Company to engage in a variety of banking-related businesses, including the ownership and operation of a savings
association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including
software development) and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic
activities of nonbank subsidiaries of bank holding companies.
Additionally, bank
holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies
may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance
underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of
the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that the
Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk to
the safety or soundness of depository institutions or the financial system generally. As of the date of this filing, the Company
has not applied for approval to operate as a financial holding company.
Federal law also prohibits
any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without
prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the acquisition
of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances
between 10% and 24.99% ownership.
Capital Requirements.
Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines,
as affected by the Dodd-Frank Act and Basel III. For a discussion of capital requirements, see “—The Increasing Regulatory
Emphasis on Capital” above.
U.S. Government
Investment in Bank Holding Companies.
Events in the U.S. and global financial markets in 2008 and 2009, including deterioration
of the worldwide credit markets, created significant challenges for financial institutions throughout the country. In response
to this crisis affecting the U.S. banking system and financial markets, on October 3, 2008, the U.S. Congress passed, and the President
signed into law, the Emergency Economic Stabilization Act of 2008 (the “EESA”). The EESA authorized the Secretary of
the Treasury to implement various temporary emergency programs designed to strengthen the capital positions of financial institutions
and stimulate the availability of credit within the U.S. financial system. Financial institutions participating in certain of the
programs established under the EESA are required to adopt the Treasury’s standards for executive compensation and corporate
governance.
On October 14, 2008,
the Treasury announced that it would provide Tier 1 capital (in the form of perpetual preferred stock) to eligible financial institutions.
This program, known as the TARP Capital Purchase Program (the “CPP”), allocated $250 billion from the $700 billion
authorized by the EESA to the Treasury for the purchase of senior preferred shares from qualifying financial institutions (the
“CPP Preferred Stock”). Under the program, eligible institutions were able to sell equity interests to the Treasury
in amounts equal to between 1% and 3% of the institution’s risk-weighted assets. The CPP Preferred Stock is nonvoting and
pays dividends at the rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum. In conjunction with
the purchase of the CPP Preferred Stock, the Treasury received warrants to purchase common stock from the participating public
institutions with an aggregate market price equal to 15% of the preferred stock investment. Participating financial institutions
were required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during
which the Treasury holds equity issued under the CPP. The Company elected not to participate in the CPP.
Dividend Payments.
The Company’s ability to pay dividends to its stockholders may be affected by both general corporate law considerations
and policies of the Federal Reserve applicable to bank holding companies. As a Delaware corporation, the Company is subject to
the limitations of the Delaware General Corporation Law (the “DGCL”). The DGCL allows the Company to pay dividends
only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or if the Company has no such surplus,
out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.
As a general matter,
the Federal Reserve indicates that the board of directors of a bank holding company should eliminate, defer or significantly reduce
the dividends if: (i) the company’s net income available to shareholders for the past four quarters, net of dividends
previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention
is inconsistent with the company’s capital needs and overall current and prospective financial condition; or (iii) the
company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve also
possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent
unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe
the payment of dividends by banks and bank holding companies.
Federal Securities
Regulation.
The Company’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and
the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, the Company is subject to
the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.
Corporate Governance
.
The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect
most U.S. publicly traded companies. The Dodd-Frank Act will increase stockholder influence over boards of directors by requiring
companies to give stockholders a nonbinding vote on executive compensation and so-called “golden parachute” payments,
and authorizing the SEC to promulgate rules that would allow stockholders to nominate and solicit voters for their own candidates
using a company’s proxy materials. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive
compensation paid to bank holding company executives, regardless of whether the Company is publicly traded.
The Bank
General.
The Bank is a national bank, chartered by the OCC under the National Bank Act. The deposit accounts of the Bank are insured
by the FDIC’s Deposit Insurance Fund (the “DIF”) to the maximum extent provided under federal law and FDIC regulations,
and the Bank is a member of the Federal Reserve System. As a national bank, the Bank is subject to the examination, supervision,
reporting and enforcement requirements of the OCC, the chartering authority for national banks. The FDIC, as administrator of the
DIF, also has regulatory authority over the Bank. The Bank is also a member of the Federal Home Loan Bank System, which provides
a central credit facility primarily for member institutions.
Deposit Insurance
.
As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The
FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based
on their risk classification. An institution’s risk classification is assigned based on its capital levels and
the level of supervisory concern the institution poses to the regulators.
On November 12, 2009,
the FDIC adopted a final rule that required insured depository institutions to prepay on December 30, 2009, their estimated quarterly
risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012. As such, on December 31, 2009, the Bank
prepaid its assessments based on its actual September 30, 2009 assessment base, adjusted quarterly by an estimated 5% annual growth
rate through the end of 2012. The FDIC also used the institution’s total base assessment rate in effect on September 30,
2009, increasing it by an annualized 3 basis points beginning in 2011. The FDIC began to offset prepaid assessments on March 30,
2010, representing payment of the regular quarterly risk-based deposit insurance assessment for the fourth quarter of 2009. Any
prepaid assessment not exhausted after collection of the amount due on June 30, 2013, will be returned to the institution.
Amendments to the Federal
Deposit Insurance Act also revise the assessment base against which an insured depository institution’s deposit insurance
premiums paid to the DIF will be calculated. Under the amendments, the assessment base will no longer be the institution’s
deposit base, but rather its average consolidated total assets less its average tangible equity. This may shift the burden
of deposit insurance premiums toward those large depository institutions that rely on funding sources other than U.S. deposits.
Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from
1.15% to 1.35% of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to
depository institutions when the reserve ratio exceeds certain thresholds. The FDIC is given until September 3, 2020 to meet
the 1.35% reserve ratio target. Several of these provisions could increase the Bank’s FDIC deposit insurance premiums.
The Dodd-Frank Act
permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per
insured depositor, retroactive to January 1, 2009. Although the legislation provided that non-interest-bearing transaction
accounts had unlimited deposit insurance coverage through December 31, 2012.
FICO Assessments
.
The Financing Corporation (“FICO”) is a mixed-ownership governmental corporation chartered by the former
Federal Home Loan Bank Board pursuant to the Competitive Equality Banking Act of 1987 to function as a financing vehicle for the
recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year noncallable bonds of approximately
$8.1 billion that mature in 2017 through 2019. FICO’s authority to issue bonds ended on December 12, 1991. Since 1996, federal
legislation has required that all FDIC-insured depository institutions pay assessments to cover interest payments on FICO’s
outstanding obligations. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the
year ended December 31, 2012, the FICO assessment rate was approximately 0.0066%, which reflects the change from an assessment
base computed on deposits to an assessment base computed on assets as required by the Dodd-Frank Act.
Supervisory Assessments
.
National banks are required to pay supervisory assessments to the OCC to fund the operations of the OCC. The amount of the assessment
is calculated using a formula that takes into account the bank’s size and its supervisory condition.
During the year
ended December 31, 2012, the Bank paid supervisory assessments to the OCC totaling $161,000.
Capital Requirements.
Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital requirements,
see “—The Increasing Regulatory Emphasis on Capital” above.
Dividend Payments.
The primary source of funds for the Company is dividends from the Bank. Under the National Bank Act, a national bank may pay dividends
out of its undivided profits in such amounts and at such times as the bank’s board of directors deems prudent. Without prior
OCC approval, however, a national bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank’s
year-to-date net income plus the bank’s retained net income for the two preceding years.
The payment of dividends
by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy
guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment
thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under
applicable guidelines as of December 31, 2012.
As of December 31, 2012, approximately $2.0 million was available
to be paid as dividends by the Bank. Notwithstanding the availability of funds for dividends, however, the OCC may prohibit the
payment of dividends by the Bank if it determines such payment would constitute an unsafe or unsound practice.
Insider Transactions.
The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between the Bank and its
“affiliates.” The Company is an affiliate of the Bank for purposes of these restrictions, and covered transactions
subject to the restrictions include extensions of credit to the Company, investments in the stock or other securities of the Company
and the acceptance of the stock or other securities of the Company as collateral for loans made by the Bank. The Dodd-Frank Act
enhances the requirements for certain transactions with affiliates as of July 21, 2011, including an expansion of the definition
of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered
transactions must be maintained.
Certain limitations
and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and
officers of the Company and its subsidiaries, to principal stockholders of the Company and to “related interests” of
such directors, officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any
person who is a director or officer of the Company or the Bank, or a principal stockholder of the Company, may obtain credit from
banks with which the Bank maintains a correspondent relationship.
Safety and Soundness
Standards.
The federal banking agencies have adopted guidelines that establish operational and managerial standards to
promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal
controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth,
compensation, fees and benefits, asset quality and earnings.
In general, the safety
and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing
its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines,
the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance.
If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan
that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution
to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s
rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require
the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established
by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators,
including cease and desist orders and civil money penalty assessments.
Branching Authority
.
National banks headquartered in Kansas, such as the Bank, have the same branching rights in Kansas as banks chartered
under Kansas law, subject to OCC approval. Kansas law grants Kansas-chartered banks the authority to establish branches anywhere
in the State of Kansas, subject to receipt of all required regulatory approvals.
Federal law permits
state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit
concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period
of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual
branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) has historically been
permitted only in those states the laws of which expressly authorize such expansion. However, the Dodd-Frank Act permits well-capitalized
and well-managed banks to establish new branches across state lines without these impediments.
Financial Subsidiaries.
Under federal law and OCC regulations, national banks are authorized to engage, through “financial subsidiaries,”
in any activity that is permissible for a financial holding company and any activity that the Secretary of the Treasury, in consultation
with the Federal Reserve, determines is financial in nature or incidental to any such financial activity, except: (i) insurance
underwriting; (ii) real estate development or real estate investment activities (unless otherwise permitted by law); (iii) insurance
company portfolio investments; and (iv) merchant banking. The authority of a national bank to invest in a financial subsidiary
is subject to a number of conditions, including, among other things, requirements that the bank must be well-managed and well-capitalized
(after deducting from capital the bank’s outstanding investments in financial subsidiaries). The Bank has not applied for
approval to establish any financial subsidiaries.
Transaction Account
Reserves.
Federal Reserve regulations require depository institutions to maintain reserves against
their transaction accounts (primarily NOW and regular checking accounts). For 2013: the first $12.4 million of otherwise reservable
balances are exempt from the reserve requirements; for transaction accounts aggregating more than $12.4 million to $79.5 million,
the reserve requirement is 3% of total transaction accounts; and for net transaction accounts in excess of $79.5 million, the reserve
requirement is $2,013,000 plus 10% of the aggregate amount of total transaction accounts in excess of $79.5 million. These reserve
requirements are subject to annual adjustment by the Federal Reserve. The Bank is in compliance with the foregoing requirements.
Consumer Financial Services
There are numerous
developments in federal and state laws regarding consumer financial products and services that impact the Bank’s business.
Importantly, the current structure of federal consumer protection regulation applicable to all providers of consumer financial
products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce
consumer protection laws. The CFPB has broad rulemaking authority for a wide range of consumer protection laws that apply to all
providers of consumer products and services, including the Bank, as well as the authority to prohibit “unfair, deceptive
or abusive” acts and practices. The CFPB has examination and enforcement authority over providers with more than $10 billion
in assets. Banks and savings institutions with $10 billion or less in assets, like the Bank, will continue to be examined
by their applicable bank regulators.
Ability-to-Repay
Requirement and Qualified Mortgage Rule.
The Dodd-Frank Act contains additional provisions that affect consumer mortgage
lending. First, it significantly expands underwriting requirements applicable to loans secured by 1-4 family residential real property
and augments federal law combating predatory lending practices. In addition to numerous new disclosure requirements, the Dodd-Frank
Act imposes new standards for mortgage loan originations on all lenders, including banks and savings associations, in an effort
to strongly encourage lenders to verify a borrower’s ability to repay, while also establishing a presumption of compliance
for certain “qualified mortgages.” Most significantly, the new standards limit the total points and fees that the Bank
and/or a broker may charge on conforming and jumbo loans to 3% of the total loan amount. In addition, the Dodd-Frank Act generally
requires lenders or securitizers to retain an economic interest in the credit risk relating to loans that the lender sells and
other asset-backed securities that the securitizer issues if the loans have not complied with the ability-to-repay standards. The
risk retention requirement generally will be 5%, but could be increased or decreased by regulation.
On January 10, 2013,
the CFPB issued a final rule, effective January 10, 2014, which implements the Dodd-Frank Act’s ability-to-repay requirements
and clarifies the presumption of compliance for “qualified mortgages.” In assessing a borrower’s ability to repay
a mortgage-related obligation, lenders generally must consider eight underwriting factors: (i) current or reasonably expected income
or assets; (ii) current employment status; (iii) monthly payment on the subject transaction; (iv) monthly payment on any simultaneous
loan; (v) monthly payment for all mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii)
monthly debt-to-income ratio or residual income; and (viii) credit history. The final rule also includes guidance regarding the
application of, and methodology for evaluating, these factors.
Further, the final
rule also clarifies that qualified mortgages do not include “no-doc” loans and loans with negative amortization, interest-only
payments, balloon payments, terms in excess of 30 years, or points and fees paid by the borrower that exceed 3% of the loan amount,
subject to certain exceptions. In addition, for qualified mortgages, the monthly payment must be calculated on the highest payment
that will occur in the first five years of the loan, and the borrower’s total debt-to-income ratio generally may not be more
than 43%. The final rule also provides that certain mortgages that satisfy the general product feature requirements for qualified
mortgages and that also satisfy the underwriting requirements of Fannie Mae and Freddie Mac (while they operate under federal conservatorship
or receivership) or the U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of Agriculture
or Rural Housing Service are also considered to be qualified mortgages. This second category of qualified mortgages will phase
out as the aforementioned federal agencies issue their own rules regarding qualified mortgages, the conservatorship of Fannie Mae
and Freddie Mac ends, and, in any event, after seven years.
As set forth in the
Dodd-Frank Act, subprime (or higher-priced) mortgage loans are subject to the ability-to-repay requirement, and the final rule
provides for a rebuttable presumption of lender compliance for those loans. The final rule also applies the ability-to-repay requirement
to prime loans, while also providing a conclusive presumption of compliance (
i.e.
, a safe harbor) for prime loans that are
also qualified mortgages. Additionally, the final rule generally prohibits prepayment penalties (subject to certain exceptions)
and sets forth a 3-year record retention period with respect to documenting and demonstrating the ability-to-repay requirement
and other provisions.
Changes to Mortgage
Loan Originator Compensation.
Effective April 2, 2011, previously existing regulations concerning the compensation
of mortgage loan originators were amended. As a result of these amendments, mortgage loan originators may not receive compensation
based on a mortgage transaction’s terms or conditions other than the amount of credit extended under the mortgage loan. Further,
the new standards limit the total points and fees that a bank and/or a broker may charge on conforming and jumbo loans to 3% of
the total loan amount. Mortgage loan originators may receive compensation from a consumer or from a lender, but not both. These
rules contain requirements designed to prohibit mortgage loan originators from “steering” consumers to loans that provide
mortgage loan originators with greater compensation. In addition, the rules contain other requirements concerning recordkeeping.
Foreclosure and
Loan Modifications.
Federal and state laws further impact foreclosures and loan modifications, with many of such laws having
the effect of delaying or impeding the foreclosure process on real estate secured loans in default. Mortgages on commercial
property can be modified, such as by reducing the principal amount of the loan or the interest rate, or by extending the term of
the loan, through plans confirmed under Chapter 11 of the U.S. Bankruptcy Code. In recent years, legislation has been introduced
in the U.S. Congress that would amend the Bankruptcy Code to permit the modification of mortgages secured by residences, although
at this time the enactment of such legislation is not presently proposed. The scope, duration and terms of potential future
legislation with similar effect continue to be discussed. The Company cannot predict whether any such legislation will be passed
or the impact, if any, it would have on its business.
Company Web site
The Company maintains
a corporate Web site at
www.landmarkbancorpinc.com
. In addition, the Company has an investor relations link at the Bank’s
corporate Web site at
www.banklandmark.com
. The Company makes available free of charge on or through its Web site its Annual
Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files
such material with, or furnishes it to, the SEC. Copies of the Company’s filings with the SEC are also available from the
SEC’s website (
http://www.sec.gov
) free of charge. Many of the Company’s policies, including its code of ethics,
committee charters and other investor information are available on the Web site. The Company will also provide copies of its filings
free of charge upon written request to our Corporate Secretary at the address listed on the front of this Form 10-K.
Statistical
Data
The Company has a fiscal
year ending on December 31. The information presented in this Annual Report on Form 10-K presents information on behalf of the
Company as of and for the year ended December 31, 2012.
The statistical data
required by Guide 3 of the Securities Act Industry Guides is set forth in the following pages. This data should be read in conjunction
with the consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition
and Results of Operations.”
I. Distribution of Assets, Liabilities,
and Stockholders’ Equity; Interest Rates and Interest Differential
The following table
describes the extent to which changes in tax equivalent interest income and interest expense for major components of interest-earning
assets and interest-bearing liabilities affected the Company’s interest income and expense during the periods indicated.
The table distinguishes between (i) changes attributable to rate (changes in rate multiplied by prior volume), (ii) changes attributable
to volume (changes in volume multiplied by prior rate), and (iii) net change (the sum of the previous columns). The net changes
attributable to the combined effect of volume and rate, which cannot be segregated, have been allocated proportionately to the
change due to volume and the change due to rate.
|
|
Years Ended December 31,
|
|
|
|
2012 vs 2011
|
|
|
2011 vs 2010
|
|
|
|
Increase/(decrease) attributable to
|
|
|
Increase/(decrease) attributable to
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Net
|
|
|
Volume
|
|
|
Rate
|
|
|
Net
|
|
|
|
(Dollars in thousands)
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits at banks
|
|
$
|
17
|
|
|
$
|
6
|
|
|
$
|
23
|
|
|
$
|
(3
|
)
|
|
$
|
(1
|
)
|
|
$
|
(4
|
)
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
432
|
|
|
|
(263
|
)
|
|
|
169
|
|
|
|
309
|
|
|
|
(210
|
)
|
|
|
99
|
|
Tax-exempt
|
|
|
(44
|
)
|
|
|
39
|
|
|
|
(5
|
)
|
|
|
(38
|
)
|
|
|
(25
|
)
|
|
|
(63
|
)
|
Loans
|
|
|
74
|
|
|
|
(769
|
)
|
|
|
(695
|
)
|
|
|
(1,441
|
)
|
|
|
(332
|
)
|
|
|
(1,773
|
)
|
Total
|
|
|
479
|
|
|
|
(987
|
)
|
|
|
(508
|
)
|
|
|
(1,173
|
)
|
|
|
(568
|
)
|
|
|
(1,741
|
)
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
324
|
|
|
|
(935
|
)
|
|
|
(611
|
)
|
|
|
44
|
|
|
|
(1,070
|
)
|
|
|
(1,026
|
)
|
Borrowings
|
|
|
(303
|
)
|
|
|
165
|
|
|
|
(138
|
)
|
|
|
(267
|
)
|
|
|
(353
|
)
|
|
|
(620
|
)
|
Total
|
|
|
21
|
|
|
|
(770
|
)
|
|
|
(749
|
)
|
|
|
(223
|
)
|
|
|
(1,423
|
)
|
|
|
(1,646
|
)
|
Net interest income
|
|
$
|
458
|
|
|
$
|
(217
|
)
|
|
$
|
241
|
|
|
$
|
(950
|
)
|
|
$
|
855
|
|
|
$
|
(95
|
)
|
The following table
sets forth information relating to average balances of interest-earning assets and interest-bearing liabilities for the years ended
December 31, 2012, 2011 and 2010. Average balances are derived from daily average balances. Non-accrual loans were included in
the computation of average balances but have been reflected in the table as loans carrying a zero yield. The yields set forth in
the table below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or
interest expense. This table reflects the average yields on assets and average costs of liabilities for the periods indicated (derived
by dividing income or expense by the monthly average balance of assets or liabilities, respectively) as well as the "net interest
margin" (which reflects the effect of the net earnings balance) for the periods shown.
|
|
Year ended December 31, 2012
|
|
|
Year ended December 31, 2011
|
|
|
Year ended December 31, 2010
|
|
|
|
Average
balance
|
|
|
Interest
|
|
|
Yield/
cost
|
|
|
Average
balance
|
|
|
Interest
|
|
|
Yield/
cost
|
|
|
Average
balance
|
|
|
Interest
|
|
|
Yield/
cost
|
|
|
|
(Dollars in thousands)
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits at banks
|
|
$
|
11,927
|
|
|
$
|
27
|
|
|
|
0.23
|
%
|
|
$
|
3,295
|
|
|
$
|
4
|
|
|
|
0.12
|
%
|
|
$
|
5,286
|
|
|
$
|
8
|
|
|
|
0.15
|
%
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
160,043
|
|
|
|
2,913
|
|
|
|
1.82
|
%
|
|
|
126,512
|
|
|
|
2,744
|
|
|
|
2.17
|
%
|
|
|
99,188
|
|
|
|
2,645
|
|
|
|
2.67
|
%
|
Tax-exempt (1)
|
|
|
75,334
|
|
|
|
3,572
|
|
|
|
4.74
|
%
|
|
|
66,854
|
|
|
|
3,576
|
|
|
|
5.35
|
%
|
|
|
67,554
|
|
|
|
3,639
|
|
|
|
5.39
|
%
|
Loans receivable, net (2)
|
|
|
315,213
|
|
|
|
16,911
|
|
|
|
5.37
|
%
|
|
|
313,918
|
|
|
|
17,607
|
|
|
|
5.61
|
%
|
|
|
339,698
|
|
|
|
19,380
|
|
|
|
5.71
|
%
|
Total interest-earning assets
|
|
|
562,517
|
|
|
|
23,423
|
|
|
|
4.16
|
%
|
|
|
510,579
|
|
|
|
23,931
|
|
|
|
4.69
|
%
|
|
|
511,726
|
|
|
|
25,672
|
|
|
|
5.02
|
%
|
Non-interest-earning assets
|
|
|
69,163
|
|
|
|
|
|
|
|
|
|
|
|
67,461
|
|
|
|
|
|
|
|
|
|
|
|
65,877
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
631,680
|
|
|
|
|
|
|
|
|
|
|
$
|
578,040
|
|
|
|
|
|
|
|
|
|
|
$
|
577,603
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market and NOW accounts
|
|
$
|
203,741
|
|
|
$
|
313
|
|
|
|
0.15
|
%
|
|
$
|
171,295
|
|
|
$
|
371
|
|
|
|
0.22
|
%
|
|
$
|
162,437
|
|
|
$
|
471
|
|
|
|
0.29
|
%
|
Savings accounts
|
|
|
44,289
|
|
|
|
29
|
|
|
|
0.07
|
%
|
|
|
36,004
|
|
|
|
48
|
|
|
|
0.13
|
%
|
|
|
31,754
|
|
|
|
66
|
|
|
|
0.21
|
%
|
Certificates of deposit
|
|
|
178,508
|
|
|
|
1,807
|
|
|
|
1.01
|
%
|
|
|
178,364
|
|
|
|
2,341
|
|
|
|
1.31
|
%
|
|
|
187,236
|
|
|
|
3,249
|
|
|
|
1.74
|
%
|
Total deposits
|
|
|
426,538
|
|
|
|
2,149
|
|
|
|
0.50
|
%
|
|
|
385,663
|
|
|
|
2,760
|
|
|
|
0.72
|
%
|
|
|
381,427
|
|
|
|
3,786
|
|
|
|
0.99
|
%
|
FHLB advances and other borrowings
|
|
|
59,287
|
|
|
|
1,761
|
|
|
|
2.97
|
%
|
|
|
68,929
|
|
|
|
1,899
|
|
|
|
2.76
|
%
|
|
|
77,645
|
|
|
|
2,519
|
|
|
|
3.24
|
%
|
Total interest-bearing liabilities
|
|
|
485,825
|
|
|
|
3,910
|
|
|
|
0.80
|
%
|
|
|
454,592
|
|
|
|
4,659
|
|
|
|
1.02
|
%
|
|
|
459,072
|
|
|
|
6,305
|
|
|
|
1.37
|
%
|
Non-interest-bearing liabilities
|
|
|
84,303
|
|
|
|
|
|
|
|
|
|
|
|
67,238
|
|
|
|
|
|
|
|
|
|
|
|
63,797
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
61,552
|
|
|
|
|
|
|
|
|
|
|
|
56,210
|
|
|
|
|
|
|
|
|
|
|
|
54,734
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
631,680
|
|
|
|
|
|
|
|
|
|
|
$
|
578,040
|
|
|
|
|
|
|
|
|
|
|
$
|
577,603
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate spread (3)
|
|
|
|
|
|
|
|
|
|
|
3.36
|
%
|
|
|
|
|
|
|
|
|
|
|
3.67
|
%
|
|
|
|
|
|
|
|
|
|
|
3.65
|
%
|
Net interest margin (4)
|
|
|
|
|
|
$
|
19,513
|
|
|
|
3.47
|
%
|
|
|
|
|
|
$
|
19,272
|
|
|
|
3.77
|
%
|
|
|
|
|
|
$
|
19,367
|
|
|
|
3.78
|
%
|
Tax equivalent interest - imputed (1) (2)
|
|
|
|
|
|
|
1,371
|
|
|
|
|
|
|
|
|
|
|
|
1,345
|
|
|
|
|
|
|
|
|
|
|
|
1,321
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
18,142
|
|
|
|
|
|
|
|
|
|
|
$
|
17,927
|
|
|
|
|
|
|
|
|
|
|
$
|
18,046
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of average interest-earning assets to average interest-bearing liabilities
|
|
|
|
|
|
|
115.8
|
%
|
|
|
|
|
|
|
|
|
|
|
112.3
|
%
|
|
|
|
|
|
|
|
|
|
|
111.5
|
%
|
|
|
|
|
|
(1)
|
Income on tax-exempt investment securities is presented on a fully taxable equivalent basis, using a 34% federal tax rate.
|
|
(2)
|
Income on tax-exempt loans is presented on a fully taxable equivalent basis, using a 34% federal tax rate.
|
|
(3)
|
Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of
interest-bearing liabilities.
|
|
(4)
|
Net interest margin represents net interest income divided
by average interest-earning assets.
|
II. Investment Portfolio
Investment Securities
.
The following table sets forth the carrying value of the Company’s investment securities at the dates indicated. None of
the investment securities issued by an individual issuer held as of December 31, 2012 were in excess of 10% of the Company’s
stockholders’ equity, excluding U.S. federal agency obligations. The Company’s federal agency obligations consist of
obligations of U.S. government-sponsored enterprises, primarily the FHLB. The Company’s mortgage-backed securities portfolio
consists of securities predominantly underwritten to the standards and guaranteed by the government-sponsored agencies of Federal
Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) and Government
National Mortgage Association (“GNMA”). The Company’s investments in certificates of deposits consists of FDIC-insured
certificates of deposits with other financial institutions.
|
|
As of December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
|
(Dollars in thousands)
|
|
Investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. federal agency obligations
|
|
$
|
8,848
|
|
|
$
|
9,164
|
|
|
$
|
22,187
|
|
Municipal obligations tax-exempt
|
|
|
77,286
|
|
|
|
69,629
|
|
|
|
65,287
|
|
Municipal obligations taxable
|
|
|
38,142
|
|
|
|
19,135
|
|
|
|
4,188
|
|
Mortgage-backed securities
|
|
|
81,848
|
|
|
|
94,472
|
|
|
|
60,804
|
|
Common stocks
|
|
|
902
|
|
|
|
819
|
|
|
|
828
|
|
Pooled trust preferred securities
|
|
|
-
|
|
|
|
405
|
|
|
|
236
|
|
Certificates of deposits
|
|
|
6,274
|
|
|
|
4,590
|
|
|
|
14,159
|
|
Total available-for-sale investment securities, at fair value
|
|
$
|
213,300
|
|
|
$
|
198,214
|
|
|
$
|
167,689
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FHLB stock
|
|
|
3,360
|
|
|
|
4,850
|
|
|
|
6,364
|
|
FRB stock
|
|
|
1,765
|
|
|
|
1,761
|
|
|
|
1,759
|
|
Correspondent bank common stock
|
|
|
113
|
|
|
|
60
|
|
|
|
60
|
|
Total other securities, at cost
|
|
$
|
5,238
|
|
|
$
|
6,671
|
|
|
$
|
8,183
|
|
The following table
sets forth certain information regarding the carrying values, weighted average yields, and maturities of the Company's investment
securities portfolio, excluding common stocks, as of December 31, 2012. Yields on tax-exempt obligations have been computed on
a tax equivalent basis, using a 34% federal tax rate. Mortgage-backed investment securities include scheduled principal payments
and estimated prepayments based on observable market inputs. Actual prepayments will differ from contractual maturities because
borrowers have the right to prepay obligations with or without prepayment penalties.
|
|
As of December 31, 2012
|
|
|
|
One year or less
|
|
|
One to five years
|
|
|
Five to ten years
|
|
|
More than ten years
|
|
|
Total
|
|
|
|
Carrying
|
|
|
Average
|
|
|
Carrying
|
|
|
Average
|
|
|
Carrying
|
|
|
Average
|
|
|
Carrying
|
|
|
Average
|
|
|
Carrying
|
|
|
Average
|
|
|
|
value
|
|
|
yield
|
|
|
value
|
|
|
yield
|
|
|
value
|
|
|
yield
|
|
|
value
|
|
|
yield
|
|
|
value
|
|
|
yield
|
|
|
|
(Dollars in thousands)
|
|
Investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. federal agency obligations
|
|
$
|
4,046
|
|
|
|
0.77
|
%
|
|
$
|
1,659
|
|
|
|
1.38
|
%
|
|
$
|
3,143
|
|
|
|
1.41
|
%
|
|
$
|
-
|
|
|
|
0.00
|
%
|
|
$
|
8,848
|
|
|
|
1.11
|
%
|
Municipal obligations tax-exempt
|
|
|
4,127
|
|
|
|
5.24
|
%
|
|
|
25,274
|
|
|
|
4.15
|
%
|
|
|
39,485
|
|
|
|
4.98
|
%
|
|
|
8,400
|
|
|
|
6.13
|
%
|
|
|
77,286
|
|
|
|
4.85
|
%
|
Municipal obligations taxable
|
|
|
1,896
|
|
|
|
1.94
|
%
|
|
|
20,065
|
|
|
|
1.65
|
%
|
|
|
11,799
|
|
|
|
2.36
|
%
|
|
|
4,382
|
|
|
|
3.98
|
%
|
|
|
38,142
|
|
|
|
2.15
|
%
|
Mortgage-backed securities
|
|
|
4,287
|
|
|
|
2.55
|
%
|
|
|
76,575
|
|
|
|
1.92
|
%
|
|
|
404
|
|
|
|
3.26
|
%
|
|
|
582
|
|
|
|
2.37
|
%
|
|
|
81,848
|
|
|
|
1.96
|
%
|
Certificates of deposits
|
|
|
1,954
|
|
|
|
0.89
|
%
|
|
|
4,320
|
|
|
|
0.83
|
%
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
6,274
|
|
|
|
0.85
|
%
|
Total
|
|
$
|
16,310
|
|
|
|
2.52
|
%
|
|
$
|
127,893
|
|
|
|
2.27
|
%
|
|
$
|
54,831
|
|
|
|
4.20
|
%
|
|
$
|
13,364
|
|
|
|
5.26
|
%
|
|
$
|
212,398
|
|
|
|
2.98
|
%
|
III.
Loan Portfolio
Loan Portfolio
Composition
.
The following table sets forth the composition of the loan portfolio by type of loan at the dates indicated.
|
|
As of December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
(Dollars in thousands)
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
$
|
88,454
|
|
|
$
|
79,108
|
|
|
$
|
79,631
|
|
|
$
|
89,295
|
|
|
$
|
104,369
|
|
Construction and land
|
|
|
23,435
|
|
|
|
21,672
|
|
|
|
23,652
|
|
|
|
36,864
|
|
|
|
41,107
|
|
Commercial real estate
|
|
|
88,790
|
|
|
|
93,786
|
|
|
|
92,124
|
|
|
|
99,459
|
|
|
|
98,320
|
|
Commercial loans
|
|
|
64,570
|
|
|
|
57,006
|
|
|
|
57,286
|
|
|
|
61,347
|
|
|
|
63,387
|
|
Agriculture loans
|
|
|
31,935
|
|
|
|
39,052
|
|
|
|
38,836
|
|
|
|
38,205
|
|
|
|
43,144
|
|
Municipal loans
|
|
|
9,857
|
|
|
|
10,366
|
|
|
|
5,393
|
|
|
|
5,672
|
|
|
|
2,613
|
|
Consumer loans
|
|
|
13,417
|
|
|
|
13,584
|
|
|
|
14,385
|
|
|
|
16,922
|
|
|
|
16,383
|
|
Total gross loans
|
|
|
320,458
|
|
|
|
314,574
|
|
|
|
311,307
|
|
|
|
347,764
|
|
|
|
369,323
|
|
Net deferred loan costs, fees and loans in process
|
|
|
37
|
|
|
|
214
|
|
|
|
328
|
|
|
|
442
|
|
|
|
320
|
|
Allowance for loan losses
|
|
|
(4,581
|
)
|
|
|
(4,707
|
)
|
|
|
(4,967
|
)
|
|
|
(5,468
|
)
|
|
|
(3,871
|
)
|
Loans, net
|
|
$
|
315,914
|
|
|
$
|
310,081
|
|
|
$
|
306,668
|
|
|
$
|
342,738
|
|
|
$
|
365,772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
|
27.6
|
%
|
|
|
25.2
|
%
|
|
|
25.6
|
%
|
|
|
25.7
|
%
|
|
|
28.3
|
%
|
Construction and land
|
|
|
7.3
|
%
|
|
|
6.9
|
%
|
|
|
7.6
|
%
|
|
|
10.6
|
%
|
|
|
11.1
|
%
|
Commercial real estate
|
|
|
27.7
|
%
|
|
|
29.8
|
%
|
|
|
29.6
|
%
|
|
|
28.6
|
%
|
|
|
26.6
|
%
|
Commercial loans
|
|
|
20.1
|
%
|
|
|
18.1
|
%
|
|
|
18.4
|
%
|
|
|
17.6
|
%
|
|
|
17.2
|
%
|
Agriculture loans
|
|
|
10.0
|
%
|
|
|
12.4
|
%
|
|
|
12.5
|
%
|
|
|
11.0
|
%
|
|
|
11.7
|
%
|
Municipal loans
|
|
|
3.1
|
%
|
|
|
3.3
|
%
|
|
|
1.7
|
%
|
|
|
1.6
|
%
|
|
|
0.7
|
%
|
Consumer loans
|
|
|
4.2
|
%
|
|
|
4.3
|
%
|
|
|
4.6
|
%
|
|
|
4.9
|
%
|
|
|
4.4
|
%
|
Total gross loans
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
The following table
sets forth the contractual maturities of loans as of December 31, 2012. The table does not include unscheduled prepayments.
|
|
As of December 31, 2012
|
|
|
|
≤ 1 year
|
|
|
1-5 years
|
|
|
> 5 years
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
$
|
15,553
|
|
|
$
|
35,090
|
|
|
$
|
37,811
|
|
|
$
|
88,454
|
|
Construction and land
|
|
|
19,680
|
|
|
|
3,120
|
|
|
|
635
|
|
|
|
23,435
|
|
Commercial real estate
|
|
|
18,161
|
|
|
|
35,802
|
|
|
|
34,827
|
|
|
|
88,790
|
|
Commercial loans
|
|
|
43,467
|
|
|
|
17,171
|
|
|
|
3,932
|
|
|
|
64,570
|
|
Agriculture loans
|
|
|
22,975
|
|
|
|
5,628
|
|
|
|
3,332
|
|
|
|
31,935
|
|
Municipal loans
|
|
|
4,357
|
|
|
|
1,892
|
|
|
|
3,608
|
|
|
|
9,857
|
|
Consumer loans
|
|
|
4,017
|
|
|
|
6,054
|
|
|
|
3,346
|
|
|
|
13,417
|
|
Total gross loans
|
|
$
|
128,210
|
|
|
$
|
104,757
|
|
|
$
|
87,491
|
|
|
$
|
320,458
|
|
The following table
sets forth the dollar amount of all loans due after December 31, 2013 and whether such loans had fixed interest rates or adjustable
interest rates:
|
|
As of December 31, 2012
|
|
|
|
Fixed
|
|
|
Adjustable
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
$
|
37,113
|
|
|
$
|
35,788
|
|
|
$
|
72,901
|
|
Construction and land
|
|
|
2,722
|
|
|
|
1,033
|
|
|
|
3,755
|
|
Commercial real estate
|
|
|
22,154
|
|
|
|
48,475
|
|
|
|
70,629
|
|
Commercial loans
|
|
|
11,317
|
|
|
|
9,786
|
|
|
|
21,103
|
|
Agriculture loans
|
|
|
3,723
|
|
|
|
5,237
|
|
|
|
8,960
|
|
Municipal loans
|
|
|
5,500
|
|
|
|
-
|
|
|
|
5,500
|
|
Consumer loans
|
|
|
7,373
|
|
|
|
2,027
|
|
|
|
9,400
|
|
Total gross loans
|
|
$
|
89,902
|
|
|
$
|
102,346
|
|
|
$
|
192,248
|
|
Non-performing
Assets
.
The following table sets forth information with respect to non-performing assets, including non-accrual
loans and real estate acquired through foreclosure or by deed in lieu of foreclosure (“real estate owned”). Under the
original terms of the Company’s non-accrual loans as of December 31, 2012, interest earned on such loans for the years ended
December 31, 2012, 2011 and 2010 would have increased interest income by $164,000, $47,000 and $217,000, respectively, if included
in the Company’s interest income for those years.
|
|
As of December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-accrual loans
|
|
$
|
9,108
|
|
|
$
|
1,419
|
|
|
$
|
4,817
|
|
|
$
|
11,830
|
|
|
$
|
5,748
|
|
Accruing loans over 90 days past due
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Non-performing investments
|
|
|
-
|
|
|
|
1,104
|
|
|
|
1,125
|
|
|
|
1,528
|
|
|
|
-
|
|
Real estate owned, net
|
|
|
2,444
|
|
|
|
2,264
|
|
|
|
3,194
|
|
|
|
1,129
|
|
|
|
1,934
|
|
Total non-performing assets
|
|
$
|
11,552
|
|
|
$
|
4,787
|
|
|
$
|
9,136
|
|
|
$
|
14,487
|
|
|
$
|
7,682
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-performing loans to total gross loans
|
|
|
2.84
|
%
|
|
|
0.45
|
%
|
|
|
1.55
|
%
|
|
|
3.45
|
%
|
|
|
1.56
|
%
|
Total non-performing assets to total assets
|
|
|
1.88
|
%
|
|
|
0.80
|
%
|
|
|
1.63
|
%
|
|
|
2.48
|
%
|
|
|
1.28
|
%
|
Allowance for loan losses to non-performing loans
|
|
|
50.30
|
%
|
|
|
331.71
|
%
|
|
|
103.11
|
%
|
|
|
46.22
|
%
|
|
|
67.35
|
%
|
The increase in non-accrual
loans during 2012 was principally associated with a commercial loan relationship consisting of $4.4 million in real estate and
land loans, which was placed on non-accrual status after the borrower declared bankruptcy. A $2.2 million land loan that was subject
to a troubled debt restructuring in 2012 was also classified as non-accrual as of December 31, 2012. In addition, during 2012
a $1.1 million commercial loan was placed on non-accrual status after the borrower failed to raise additional capital required
to continue operations. The increase in non-accrual loans did not require an increase in the allowance for loan losses as the
evaluation of the collateral securing the impaired loans did not require an increase in the specific allowances. The Company’s
non-accrual loans decreased $10.4 million from December 31, 2009 to December 31, 2011 primarily as a result of the charge-off
of two loans which were placed on non-accrual during 2009. These two loans consisted of a $4.3 million construction loan and a
$2.4 million commercial agriculture loan and were primarily responsible for the increase in the Company’s non-accrual loans
during 2009. During 2010, the Company charged off the remaining balance of $2.3 million associated with the commercial agriculture
loan and $3.3 million of the construction loan. The remaining $1.0 million balance of the construction loan was charged-off in
2011.
The increase in real
estate owned during 2012 was primarily associated with $587,000 of real estate owned acquired in The Wellsville Bank acquisition.
Partially offsetting the increase was a charge of $175,000 to reflect declines in the fair value of certain real estate owned
and from the sales of residential properties. The decline in real estate owned during 2011 was primarily related to recording
a charge of $517,000 to reflect declines in the fair value of certain real estate owned and from the sales of residential properties.
During 2010, real estate owned increased by $2.1 million primarily as the result of foreclosure on loans that were non-performing
at December 31, 2009. The increase was primarily the result of the foreclosure on a residential subdivision development as the
Company took possession of the real estate after the development slowed and the borrower was unable to comply with the contractual
terms of the loan and a loan settlement where the Company took possession of a commercial real estate building. As part of the
Company’s credit risk management, the Company continues to aggressively manage the loan portfolio to identify problem loans
and has placed additional emphasis on its commercial real estate relationships. As discussed in more detail in the “Asset
Quality and Distribution” section, the Company believes its allowance for loan losses is adequate based on the evaluation
of the loan portfolio’s inherent risk as of December 31, 2012.
IV.
Summary of Loan Loss Experience
The following table sets forth information
with respect to the Company’s allowance for loan losses at the dates indicated:
|
|
As of December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at beginning of year
|
|
$
|
4,707
|
|
|
$
|
4,967
|
|
|
$
|
5,468
|
|
|
$
|
3,871
|
|
|
$
|
4,172
|
|
Provision for loan losses
|
|
|
1,900
|
|
|
|
2,000
|
|
|
|
5,900
|
|
|
|
3,300
|
|
|
|
2,400
|
|
Charge-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
|
(70
|
)
|
|
|
(110
|
)
|
|
|
(387
|
)
|
|
|
(153
|
)
|
|
|
(1,439
|
)
|
Construction and land
|
|
|
(1,749
|
)
|
|
|
(1,173
|
)
|
|
|
(3,474
|
)
|
|
|
(330
|
)
|
|
|
(453
|
)
|
Commercial real estate
|
|
|
-
|
|
|
|
(434
|
)
|
|
|
(96
|
)
|
|
|
(17
|
)
|
|
|
-
|
|
Commercial loans
|
|
|
(70
|
)
|
|
|
(590
|
)
|
|
|
(8
|
)
|
|
|
(1,404
|
)
|
|
|
(728
|
)
|
Agriculture loans
|
|
|
-
|
|
|
|
(1
|
)
|
|
|
(2,327
|
)
|
|
|
-
|
|
|
|
-
|
|
Consumer loans
|
|
|
(238
|
)
|
|
|
(132
|
)
|
|
|
(178
|
)
|
|
|
(122
|
)
|
|
|
(149
|
)
|
Total charge-offs
|
|
|
(2,127
|
)
|
|
|
(2,440
|
)
|
|
|
(6,470
|
)
|
|
|
(2,026
|
)
|
|
|
(2,769
|
)
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
|
20
|
|
|
|
41
|
|
|
|
10
|
|
|
|
6
|
|
|
|
2
|
|
Construction and land
|
|
|
4
|
|
|
|
4
|
|
|
|
-
|
|
|
|
200
|
|
|
|
-
|
|
Commercial real estate
|
|
|
-
|
|
|
|
37
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Commercial loans
|
|
|
12
|
|
|
|
14
|
|
|
|
17
|
|
|
|
72
|
|
|
|
9
|
|
Agriculture loans
|
|
|
39
|
|
|
|
35
|
|
|
|
10
|
|
|
|
-
|
|
|
|
-
|
|
Consumer loans
|
|
|
26
|
|
|
|
49
|
|
|
|
32
|
|
|
|
45
|
|
|
|
57
|
|
Total recoveries
|
|
|
101
|
|
|
|
180
|
|
|
|
69
|
|
|
|
323
|
|
|
|
68
|
|
Net charge-offs
|
|
|
(2,026
|
)
|
|
|
(2,260
|
)
|
|
|
(6,401
|
)
|
|
|
(1,703
|
)
|
|
|
(2,701
|
)
|
Balances at end of year
|
|
$
|
4,581
|
|
|
$
|
4,707
|
|
|
$
|
4,967
|
|
|
$
|
5,468
|
|
|
$
|
3,871
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses as a percent of total gross loans outstanding
|
|
|
1.43
|
%
|
|
|
1.50
|
%
|
|
|
1.60
|
%
|
|
|
1.57
|
%
|
|
|
1.05
|
%
|
Net loans charged off as a percent of average net loans outstanding
|
|
|
0.66
|
%
|
|
|
0.74
|
%
|
|
|
1.93
|
%
|
|
|
0.48
|
%
|
|
|
0.72
|
%
|
During 2012, we had
net loan charge-offs of $2.0 million compared to $2.3 million during 2011. The net loan charge-offs in 2012 were primarily associated
with two land loans that were the subject of troubled debt restructurings, resulting in charge-offs to reduce the loans down to
the market value of the collateral. The net loan charge-offs in 2011 were primarily related to a previously identified and impaired
construction loan totaling $4.3 million, which had previously experienced a significant decline in the appraised value of the
collateral securing the loan. Due to additional delays associated with the litigation to collect payment from the guarantor, we
charged-off the remaining $1.0 million balance on this loan in 2011. We continue to pursue recovery from the guarantor of this
loan. In addition to the charge-off of the construction loan, the 2011 period also reflects a charge-off related to a previously
identified and impaired commercial relationship consisting of $2.0 million in real estate and operating loans, which were charged
down to market value after we acquired ownership of the property securing the loans during 2011. The commercial real estate property
was sold during 2011 without incurring any further losses. The 2009 charge-offs were primarily related to a commercial loan relationship
that was liquidated in bankruptcy. The increase in the 2008 one-to-four family residential real estate charge-offs is primarily
from the liquidation of a pool of non-owner-occupied, one-to-four family residential loans, made to a single entity in the Kansas
City, Missouri area. The loans were secured by houses located in deteriorating neighborhoods and originally obtained as part of
an acquisition and are not representative of the quality and performance of the remaining loans in our one-to-four family residential
mortgage loan portfolio. The loans were sold in early 2009.
The distribution of
the Company’s allowance for losses on loans at the dates indicated and the percent of loans in each category to total loans
is summarized in the following table. This allocation reflects management’s judgment as to risks inherent in the types of
loans indicated, but in general the Company’s total allowance for loan losses included in the table is not restricted and
is available to absorb all loan losses. The amount allocated in the following table to any category should not be interpreted
as an indication of expected actual charge-offs in that category.
|
|
As of December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
|
|
Amount
|
|
|
% Loan
type to
total loans
|
|
|
Amount
|
|
|
% Loan
type to
total loans
|
|
|
Amount
|
|
|
% Loan
type to
total loans
|
|
|
Amount
|
|
|
% Loan
type to
total loans
|
|
|
Amount
|
|
|
% Loan
type to
total loans
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
$
|
714
|
|
|
|
27.6
|
%
|
|
$
|
560
|
|
|
|
25.2
|
%
|
|
$
|
395
|
|
|
|
25.6
|
%
|
|
$
|
625
|
|
|
|
25.7
|
%
|
|
$
|
672
|
|
|
|
28.3
|
%
|
Construction and land
|
|
|
1,214
|
|
|
|
7.3
|
%
|
|
|
928
|
|
|
|
6.9
|
%
|
|
|
1,193
|
|
|
|
7.6
|
%
|
|
|
1,326
|
|
|
|
10.6
|
%
|
|
|
833
|
|
|
|
11.1
|
%
|
Commercial real estate
|
|
|
1,313
|
|
|
|
27.7
|
%
|
|
|
1,791
|
|
|
|
29.8
|
%
|
|
|
1,571
|
|
|
|
29.6
|
%
|
|
|
705
|
|
|
|
28.6
|
%
|
|
|
701
|
|
|
|
26.6
|
%
|
Commercial loans
|
|
|
707
|
|
|
|
20.1
|
%
|
|
|
745
|
|
|
|
18.1
|
%
|
|
|
1,173
|
|
|
|
18.4
|
%
|
|
|
623
|
|
|
|
17.6
|
%
|
|
|
1,121
|
|
|
|
17.2
|
%
|
Agriculture loans
|
|
|
367
|
|
|
|
10.0
|
%
|
|
|
433
|
|
|
|
12.4
|
%
|
|
|
397
|
|
|
|
12.5
|
%
|
|
|
2,103
|
|
|
|
11.0
|
%
|
|
|
415
|
|
|
|
11.7
|
%
|
Municipal loans
|
|
|
107
|
|
|
|
3.1
|
%
|
|
|
130
|
|
|
|
3.3
|
%
|
|
|
99
|
|
|
|
1.7
|
%
|
|
|
-
|
|
|
|
1.6
|
%
|
|
|
-
|
|
|
|
0.7
|
%
|
Consumer loans
|
|
|
159
|
|
|
|
4.2
|
%
|
|
|
120
|
|
|
|
4.3
|
%
|
|
|
139
|
|
|
|
4.6
|
%
|
|
|
86
|
|
|
|
4.9
|
%
|
|
|
129
|
|
|
|
4.4
|
%
|
Total
|
|
$
|
4,581
|
|
|
|
100.0
|
%
|
|
$
|
4,707
|
|
|
|
100.0
|
%
|
|
$
|
4,967
|
|
|
|
100.0
|
%
|
|
$
|
5,468
|
|
|
|
100.0
|
%
|
|
$
|
3,871
|
|
|
|
100.0
|
%
|
The increase in the
allocation of the allowance for loan losses on our one-to-four family residential real estate loans during 2012 was related to
an increase in outstanding loan balances while the 2011 increase was related to higher levels of non-accrual loans in the loan
category. The decline in the allocation of the allowance for loan losses on our one-to-four family residential real estate loans
between December 31, 2008 and December 31, 2010 was primarily the result of the decline in the outstanding balances. The allocation
of the allowance for loan losses on construction and land loans increased in 2012 as a result of an increase in the specific allowance
related to an impaired land loan after declining in each of 2010 and 2011 as a result of a decline in outstanding loan balances
as well as increased charge-offs. The allocation of the allowance for loan losses on commercial real estate loans declined in
2012 as a result of lower outstanding loan balances, while the increases in 2010 and 2011 were related primarily to declines in
the estimated fair value of certain collateral dependent impaired loans, increased historical charge-offs and management’s
judgment to increase the risk factors used to determine the allowance for loan losses. The increase in 2010 and decline in 2011
of the allocation of the allowance for loan losses on commercial loans was primarily due to a specific allowance recorded on the
operating loans associated with a $2.0 million commercial loan relationship. The increase in 2009 and decline in 2010 allocation
of the allowance for loan losses on agriculture loans was primarily related to a $2.3 million commercial agriculture loan that
was impaired during 2009 and charged off in 2010. The allowance for loan losses is discussed in more detail in the “Non-performing
Assets” and “Asset Quality and Distribution” sections. We believe the Company’s allowance for loan losses
continues to be adequate based on the Company’s evaluation of the loan portfolio’s inherent risk as of December 31,
2012.
V. Deposits
The following table presents the average
deposit balances and the average rate paid on those balances for the years ended:
(Dollars in thousands)
|
|
Years ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
Non-interest bearing demand
|
|
$
|
75,828
|
|
|
|
|
|
|
$
|
59,859
|
|
|
|
|
|
|
$
|
56,303
|
|
|
|
|
|
Money market and NOW accounts
|
|
|
203,741
|
|
|
|
0.15
|
%
|
|
|
171,295
|
|
|
|
0.22
|
%
|
|
|
162,437
|
|
|
|
0.29
|
%
|
Savings accounts
|
|
|
44,289
|
|
|
|
0.07
|
%
|
|
|
36,004
|
|
|
|
0.13
|
%
|
|
|
31,754
|
|
|
|
0.21
|
%
|
Certificates of deposit
|
|
|
178,508
|
|
|
|
1.01
|
%
|
|
|
178,364
|
|
|
|
1.31
|
%
|
|
|
187,236
|
|
|
|
1.74
|
%
|
Total
|
|
$
|
502,366
|
|
|
|
0.50
|
%
|
|
$
|
445,522
|
|
|
|
0.72
|
%
|
|
$
|
437,730
|
|
|
|
0.99
|
%
|
The following table presents the maturities
of jumbo certificates of deposit (amounts of $100,000 or more).
(Dollars in thousands)
|
|
As of December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Three months or less
|
|
$
|
17,110
|
|
|
$
|
20,913
|
|
Over three months through six months
|
|
|
10,287
|
|
|
|
28,613
|
|
Over six months through 12 months
|
|
|
15,896
|
|
|
|
10,681
|
|
Over 12 months
|
|
|
15,742
|
|
|
|
3,167
|
|
Total
|
|
$
|
59,035
|
|
|
$
|
63,374
|
|
VI. Return on Equity
and Assets
|
|
As of or for the years ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
Return on average assets
|
|
|
1.01
|
%
|
|
|
0.78
|
%
|
|
|
0.35
|
%
|
Return on average equity
|
|
|
10.34
|
%
|
|
|
7.98
|
%
|
|
|
3.73
|
%
|
Equity to total assets
|
|
|
10.31
|
%
|
|
|
9.88
|
%
|
|
|
9.58
|
%
|
Dividend payout ratio
|
|
|
33.33
|
%
|
|
|
44.72
|
%
|
|
|
92.31
|
%
|
ITEM 1A. RISK FACTORS
An investment in our
securities is subject to certain risks inherent in our business. Before making an investment decision, you should carefully consider
the risks and uncertainties described below together with all of the other information included in this report. In addition to
the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem
to be immaterial also may materially and adversely affect our business, financial condition and results of operations. The value
or market price of our securities could decline due to any of these identified or other risks, and you could lose all or part of
your investment.
Difficult economic and market conditions have adversely affected
our industry.
Difficult conditions
in the housing market over the past few years, with decreased home prices and increased delinquencies and foreclosures, have negatively
impacted the credit performance of mortgage and commercial real estate loans and resulted in significant write-downs of assets
by many financial institutions across the United States. Difficult economic conditions, reduced availability of commercial credit
and heightened levels of unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting
in write-downs. Concerns over the economy, both by financial institutions and prospective borrowers, have resulted in decreased
lending by many financial institutions to their customers and to each other. These economic conditions have led to heightened commercial
and consumer delinquencies, lack of customer confidence, increased market volatility and inconsistent general business activity.
The resulting economic pressure on consumers and businesses has adversely affected our industry and may adversely affect our business,
results of operations and financial condition. More recently, the economy has begun to stabilize. The housing market has improved
over recent years, and asset write-downs have slowed. However, there remain risks that could undermine the more recent improvements
in the economy's stabilization. In particular, we may face the following risks in connection with these events:
|
·
|
We may face further increased regulation of our industry, especially in light of the myriad regulations
passed, and yet to be passed, pursuant to the Dodd-Frank Act, and compliance with such regulation may increase our costs and limit
our ability to pursue business opportunities.
|
|
·
|
Customer demand for loans secured by real estate could be reduced due to weaker economic conditions,
an increase in unemployment, a decrease in real estate values or an increase in interest rates.
|
|
·
|
The process we use to estimate losses inherent in our credit exposure requires difficult, subjective
and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of
our borrowers to repay their loans. The level of uncertainty concerning economic conditions may adversely affect the accuracy of
our estimates which may, in turn, impact the reliability of the process.
|
|
·
|
The value of the portfolio of investment securities that we hold may be adversely affected.
|
|
·
|
Our ability to assess the creditworthiness of our customers may be impaired if the models and approaches
we use to select, manage and underwrite the loans become less predictive of future behaviors.
|
|
·
|
Our ability to borrow from other financial institutions or to engage in sales of mortgage loans
to third parties on favorable terms, or at all, could be adversely affected by disruptions in the capital markets or other events,
including deteriorating investor expectations.
|
|
·
|
We expect to face increased capital requirements, both at the Company level and at the Bank level.
In this regard, the Collins Amendment to the Dodd-Frank Act requires the federal banking agencies to establish minimum leverage
and risk-based capital requirements that will apply to both insured banks and their holding companies. Furthermore, the Group of
Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, have announced an agreement
to a strengthened set of capital requirements for internationally active banking organizations, known as Basel III. On November
9, 2012, the U.S. banking organizations announced that the implementation of the proposed rules under Basel III was indefinitely
delayed in the United States. However, these rules may limit our ability to pursue business opportunities and adversely affect
our results of operations and growth prospects in the future.
|
|
·
|
Declines in our stock price, as well as changes to other risk factors discussed herein, could result
in impairment of our goodwill which would have an adverse effect on our earnings.
|
Legislative and regulatory
actions taken now or in the future may increase our costs and impact our business, governance structure, financial condition or
results of operations.
The Company and the
Bank are subject to extensive regulation by multiple regulatory bodies. These regulations may affect the manner and terms
of delivery of our services. If we do not comply with governmental regulations, we may be subject to fines, penalties, lawsuits
or material restrictions on our businesses in the jurisdiction where the violation occurred, which may adversely affect our business
operations. Changes in these regulations can significantly affect the services that we provide, as well as our costs of compliance
with such regulations. In addition, adverse publicity and damage to our reputation arising from the failure or perceived failure
to comply with legal, regulatory or contractual requirements could affect our ability to attract and retain customers.
Recent economic conditions,
particularly in the financial markets, have resulted in government regulatory agencies and political bodies placing increased focus
and scrutiny on the financial services industry. In recent years the U.S. government has intervened on an unprecedented
scale by temporarily enhancing the liquidity support available to financial institutions, establishing a commercial paper funding
facility, temporarily guaranteeing money market funds and certain types of debt issuances and increasing insurance on bank deposits.
This environment has
subjected financial institutions to additional restrictions, oversight and costs. In addition, new legislative and regulatory
proposals continue to be introduced that could further substantially increase oversight of the financial services industry, impose
restrictions on the operations and general ability of firms within the industry to conduct business consistent with historical
practices, including in the areas of compensation, interest rates, financial product offerings and disclosures, and have an effect
on bankruptcy proceedings with respect to consumer residential real estate mortgages, among other things. If these regulatory
trends continue, they could adversely affect our business and, in turn, our consolidated results of operations.
Monetary policies
and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.
In addition to being
affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An
important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used
by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments
of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations
to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also
affects interest rates charged on loans or paid on deposits.
The monetary policies
and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and
are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and
results of operations cannot be predicted.
Legislative and regulatory
reforms applicable to the financial services industry may, if enacted or adopted, have a significant impact on our business, financial
condition and results of operations.
On July 21, 2010,
the Dodd-Frank Act was signed into law, which requires significant changes to the regulation of financial institutions and the
financial services industry. The Dodd-Frank Act, together with the regulations to be developed thereunder, includes provisions
affecting large and small financial institutions alike, including several provisions that will affect how community banks, thrifts
and small bank and thrift holding companies will be regulated in the future.
Ultimately, the Dodd-Frank
Act will, among other things, impose new capital requirements on bank holding companies; change the base for FDIC insurance assessments
to a bank’s average consolidated total assets minus average tangible equity, rather than upon its deposit base, and permanently
raise the current standard deposit insurance limit to $250,000; and expand the FDIC’s authority to raise insurance premiums.
The legislation also called for the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes
by September 30, 2020 and to “offset the effect” of increased assessments on insured depository institutions with
assets of less than $10 billion. The Dodd-Frank Act also authorized the Federal Reserve to limit interchange fees payable
on debit card transactions, established the CFPB as an independent entity within the Federal Reserve, which will have broad rulemaking,
supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages,
home-equity loans and credit cards, and contained provisions on mortgage-related matters, such as steering incentives, determinations
as to a borrower’s ability to repay and prepayment penalties. The Dodd-Frank Act also included provisions that have
affected, and will further affect in the future, corporate governance and executive compensation at all publicly-traded companies.
The Collins Amendment
to the Dodd-Frank Act, among other things, eliminates certain trust preferred securities from Tier 1 capital, but permits
trust preferred securities issued prior to May 19, 2010 by bank holding companies with total consolidated assets of $15 billion
or less to continue to qualify as Tier 1 capital. This provision also requires the federal banking agencies to establish
minimum leverage and risk-based capital requirements that will apply to both insured banks and their holding companies.
These provisions, or
any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, if enacted
or adopted, may impact the profitability of our business activities or change certain of our business practices, including the
ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could
expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant
management attention and resources to make any necessary changes to operations in order to comply, and could therefore also materially
and adversely affect our business, financial condition and results of operations. Our management continues to stay abreast
of developments with respect to the Dodd-Frank Act, many provisions of which will continue to be phased-in over the next several
months and years, and continues to assess its impact on our operations. However, the ultimate effect of the Dodd-Frank Act
on the financial services industry in general, and us in particular, cannot be quantified at this time.
The U.S. Congress
has also recently adopted additional consumer protection laws such as the Credit Card Accountability Responsibility and Disclosure
Act of 2009, and the Federal Reserve has adopted numerous new regulations addressing banks’ credit card, overdraft and mortgage
lending practices. Additional consumer protection legislation and regulatory activity is anticipated in the near future.
The Group of Governors
and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010,
which constitutes a strengthened set of capital requirements for banking organizations in the United States and around the world.
Basel III is currently the subject of notices of proposed rulemakings released in June of 2012 by the respective U.S. federal banking
agencies. The comment period for these notices of proposed rulemakings ended on October 22, 2012, but final regulations have not
yet been released. Basel III was intended to be implemented beginning January 1, 2013 and to be fully-phased in on a global basis
on January 1, 2019. However, on November 9, 2012, the U.S. federal bank regulatory agencies announced that the implementation of
the proposed rules to affect Basel III in the United States was indefinitely delayed. Basel III would require capital to be held
in the form of tangible common equity, generally increase the required capital ratios, phase out certain kinds of intangibles treated
as capital and certain types of instruments, like trust preferred securities, and change the risk weightings of assets used to
determine required capital ratios.
Such proposals and
legislation, if finally adopted, would change banking laws and our operating environment and that of our subsidiaries in substantial
and unpredictable ways. We cannot determine whether such proposals and legislation will be adopted, or the ultimate effect
that such proposals and legislation, if enacted, or regulations issued to implement the same, would have upon our business, financial
condition or results of operations.
In addition to the
foregoing laws and regulations, the policies of the Federal Reserve also have a significant impact on us. Among other things, the
Federal Reserve’s monetary policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings
and interest-bearing deposits, and can also affect the value of financial instruments we hold and the ability of borrowers to repay
their loans, which could have a material adverse effect on us.
Our business is subject
to domestic and, to a lesser extent, international economic conditions and other factors, many of which are beyond our control
and could materially and adversely affect us.
From December 2007
through June 2009, the U.S. economy was in recession. Business activity across a wide range of industries and regions in the U.S.
was greatly reduced. Although general economic conditions have improved, certain sectors remain weak, and unemployment remains
at historically high levels, including the State of Kansas, where most of our customers are located. In addition, local governments
and many businesses continue to experience serious difficulty due to depressed levels of consumer spending and decreased liquidity
in the credit markets.
Market conditions also
led to the failure or merger of several prominent financial institutions and numerous regional and community-based financial institutions.
These failures, as well as projected future failures, have had a significant negative impact on the capitalization level of the
DIF, which, in turn, has led to a significant increase in deposit insurance premiums paid by financial institutions.
Our financial performance
generally, and in particular the ability of customers to pay interest on and repay principal of outstanding loans and the value
of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent upon
the business environment not only in the markets where we operate, but also in the state of Kansas generally and in the United
States as a whole. A favorable business environment is generally characterized by, among other factors: economic growth; efficient
capital markets; low inflation; low unemployment; high business and investor confidence; and strong business earnings. Unfavorable
or uncertain economic and market conditions can be caused by: declines in economic growth, business activity or investor or business
confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest
rates; high unemployment; natural disasters; or a combination of these or other factors.
Further, concerns about
the European Union's sovereign debt crisis have also caused uncertainty for financial markets globally in recent years. Such risks
could indirectly affect us by affecting our hedging or other counterparties, as well as our customers with European businesses
or assets denominated in the euro or companies in our market with European businesses or affiliates.
Overall, although showing
signs of improvement, the business environment in recent years was unfavorable for many households and businesses in the United
States While economic conditions in the state of Kansas and the United States have generally improved since the recession, there
can be no assurance that this improvement will continue or occur at a meaningful rate. Such conditions could materially and adversely
affect us.
The soundness of other financial institutions could negatively
affect us.
Our ability to engage
in routine funding and other transactions could be negatively affected by the actions and commercial soundness of other financial
institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships.
Defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry
generally, have led to market-wide liquidity problems and losses of depositor, creditor and counterparty confidence and could lead
to losses or defaults by us or by other institutions. We could experience increases in deposits and assets as a result of the difficulties
or failures of other banks, which would increase the capital we need to support our growth.
Our allowance for loan losses may prove to be insufficient
to absorb losses in our loan portfolio.
We established our
allowance for loan losses and maintain it at a level considered appropriate by management to absorb loan losses that are inherent
in the portfolio. Additionally, our Board of Directors regularly monitors the appropriateness of our allowance for loan loses.
The allowance is also subject to regulatory examinations and a determination by the regulatory agencies as to the appropriate level
of the allowance. The amount of future loan losses is susceptible to changes in economic, operating and other conditions, including
changes in interest rates and the value of the underlying collateral, which may be beyond our control, and such losses may exceed
current estimates. At December 31, 2012 and 2011 our allowance for loan losses as a percentage of total loans was 1.43% and
1.50%, respectively, and as a percentage of total non-performing loans was 50.30% and 331.71%, respectively. Although management
believes that the allowance for loan losses is appropriate to absorb losses on any existing loans that may become uncollectible,
we cannot predict loan losses with certainty nor can we assure you that our allowance for loan losses will prove sufficient to
cover actual loan losses in the future. Loan losses in excess of our reserves will adversely affect our business, financial condition
and results of operations. The increased levels of provision for loan losses experienced during recent years, as compared to historical
levels, may continue for some period of time.
Declines in value may adversely impact
the carrying amount of our investment portfolio and result in other-than-temporary impairment charges.
We may be required
to record impairment charges on our investment securities if they suffer further declines in value that are considered other-than-temporary.
If the credit quality of the securities in our investment portfolio further deteriorates, we may also experience a loss in interest
income from the suspension of either interest or dividend payments. Numerous factors, including lack of liquidity for resales of
certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate
or adverse actions by regulators could have a negative effect on our investment portfolio in future periods.
Downgrades in the credit rating of one
or more insurers that provide credit enhancement for our state and municipal securities portfolio may have an adverse impact on
the market for and valuation of these types of securities.
We invest in tax-exempt
state and local municipal investment securities, some of which are insured by monoline insurers. As of December 31, 2012, we had
$115.4 million of municipal securities, which represented 54.1% of our total securities portfolio. Since the economic crisis unfolded
in 2008, several of these insurers have come under scrutiny by rating agencies. Even though management generally purchases municipal
securities on the overall credit strength of the issuer, the reduction in the credit rating of an insurer may negatively impact
the market for and valuation of our investment securities. Such downgrade could adversely affect our liquidity, financial condition
and results of operations.
Our concentration of one-to-four family
residential mortgage loans may result in lower yields and profitability.
One-to-four family
residential mortgage loans comprised $88.5 million and $79.1 million, or 27.6% and 25.2%, of our loan portfolio at December 31,
2012 and 2011, respectively. These loans are secured primarily by properties located in the state of Kansas. Our concentration
of these loans results in lower yields relative to other loan categories within our loan portfolio. While these loans generally
possess higher yields than investment securities, their repayment characteristics are not as well defined and they generally possess
a higher degree of interest rate risk versus other loans and investment securities within our portfolio. This increased interest
rate risk is due to the repayment and prepayment options inherent in residential mortgage loans which are exercised by borrowers
based upon the overall level of interest rates. These residential mortgage loans are generally made on the basis of the borrower’s
ability to make repayments from his or her employment and the value of the property securing the loan. Thus, as a result, repayment
of these loans is also subject to general economic and employment conditions within the communities and surrounding areas where
the property is located.
The effects of the
mortgage market challenges of recent years, combined with depressed residential real estate market prices and historically lower
levels of home sales, has the potential to adversely affect our one-to-four family residential mortgage
portfolio in several
ways, each of which could adversely affect our operating results and/or financial condition.
The Bank may be required to repurchase
mortgage loans in some circumstances, which could harm our liquidity, results of operations and financial condition.
When the Bank sells
mortgage loans, we are required to make certain representations and warranties to the purchaser about the loans and the manner
in which they were originated. Our sales agreements require us to repurchase mortgage loans in the event we breach any of these
representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower fraud or in
the event of early payment default of the borrower on a mortgage loan. If repurchase and indemnity demands increase, our liquidity,
results of operations and financial condition will be adversely affected.
The recent repeal of federal prohibitions
on payment of interest on business demand deposits could increase our interest expense and have a material adverse effect on us.
All federal prohibitions
on the ability of financial institutions to pay interest on business demand deposit accounts were repealed as part of the Dodd-Frank
Act. As a result, some financial institutions have commenced offering interest on these demand deposits to compete for customers.
If competitive pressures require us to pay interest on these demand deposits to attract and retain business customers, our interest
expense would increase and our net interest margin would decrease. This could have a material adverse effect on us. Further, the
effect of the repeal of the prohibition could be more significant in a higher interest rate environment as business customers would
have a greater incentive to seek interest on demand deposits.
Commercial loans make up a significant
portion of our loan portfolio.
Commercial
loans comprised $64.6 million and $57.0 million, or 20.1% and 18.1%, of our loan portfolio at December 31, 2012 and 2011, respectively.
Our commercial loans are made based primarily on the identified cash flow of the borrower and secondarily on the underlying collateral
provided by the borrower. Most often, this collateral is accounts receivable, inventory, or machinery. Credit support provided
by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral
and enforcement of a personal guarantee, if any exists. As a result, in the case of loans secured by accounts receivable, the availability
of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due
from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate
in value based on the success of the business. Due to the larger average size of each commercial loan as compared with other loans
such as residential loans, as well as collateral that is generally less readily-marketable, losses incurred on a small number of
commercial loans could have a material adverse impact on our financial condition and results of operations.
Our agricultural loans involve a greater
degree of risk than other loans, and the ability of the borrower to repay may be affected by many factors outside of the borrower’s
control.
Agriculture operating
loans comprised $25.8 million and $33.4 million, or 8.1% and 10.7%, of our loan portfolio at December 31, 2012 and 2011, respectively.
The repayment of agriculture operating loans is dependent on the successful operation or management of the farm property. Likewise,
agricultural operating loans involve a greater degree of risk than lending on residential properties, particularly in the case
of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment, livestock or crops. We generally
secure agricultural operating loans with a blanket lien on livestock, equipment, food, hay, grain and crops. Nevertheless, any
repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance as
a result of the greater likelihood of damage, loss or depreciation.
We also originate agriculture
real estate loans. At December 31, 2012 and 2011, agricultural real estate loans totaled $6.1 million and $5.6 million, or 1.9%
and 1.7% of our total loan portfolio, respectively. Agricultural real estate lending involves a greater degree of risk and typically
involves larger loans to single borrowers than lending on single-family residences. As with agriculture operating loans, payments
on agricultural real estate loans are dependent on the profitable operation or management of the farm property securing the loan.
The success of the farm may be affected by many factors outside the control of the farm borrower, including adverse weather conditions
that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or
other factors, declines in market prices for agricultural products (both domestically and internationally) and the impact of government
regulations (including changes in price supports, subsidies and environmental regulations). In addition, many farms are dependent
on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm. If
the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired. The primary
crops in our market areas are wheat, corn and soybean. Accordingly, adverse circumstances affecting wheat, corn and soybean crops
could have an adverse effect on our agricultural real estate loan portfolio.
Our business is concentrated in and
dependent upon the continued growth and welfare of the markets in which we operate, including eastern, central and southwestern
Kansas.
We operate primarily
in eastern, central and southwestern Kansas, and as a result, our financial condition, results of operations and cash flows are
subject to changes in the economic conditions in those areas. Although each market we operate in is geographically and economically
diverse, our success depends upon the business activity, population, income levels, deposits and real estate activity in each of
these markets. Although our customers’ business and financial interests may extend well beyond our market area, adverse economic
conditions that affect our specific market area could reduce our growth rate, affect the ability of our customers to repay their
loans to us and generally affect our financial condition and results of operations. Because of our geographic concentration, we
are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.
We may experience difficulties in managing
our growth and our growth strategy involves risks that may negatively impact our net income.
As part of our general
strategy, we may acquire banks, branches and related businesses that we believe provide a strategic fit with our business. In the
past, we have acquired a number of local banks and branches and, to the extent that we grow through future acquisitions, we cannot
assure you that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses will involve
risks commonly associated with acquisitions, including:
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potential exposure to unknown or contingent liabilities of banks and businesses we acquire;
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exposure to potential asset quality issues of the acquired bank or related business;
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difficulty and expense of integrating the operations and personnel of banks and businesses we acquire;
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potential disruption to our business;
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potential diversion of our management’s time and attention; and
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the possible loss of key employees and customers of the banks and businesses we acquire.
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In addition to acquisitions,
we may expand into additional communities or attempt to strengthen our position in our current markets by undertaking additional
branch openings. We believe that it generally takes several years for new banking facilities to first achieve operational profitability,
due to the impact of organization and overhead expenses and the start-up phase of generating loans and deposits. To the extent
that we undertake additional branch openings, we are likely to experience the effects of higher operating expenses relative to
operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average
equity and return on average assets.
Finally, it is possible
that the integration of The Wellsville Bank could result in the loss of key employees of The Wellsville Bank or disruption of our
ongoing business or inconsistencies in standards, procedures and policies that would adversely affect our ability to maintain relationships
with clients or employees. If we have difficulties with the integration process, we not achieve the benefits, economic or otherwise,
of our acquisition of The Wellsville Bank.
We face intense competition in all phases
of our business from other banks and financial institutions.
The banking and financial
services business in our market is highly competitive. Our competitors include large regional banks, local community banks, savings
and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market
mutual funds, credit unions and other non-bank financial service providers, many of which have greater financial, marketing and
technological resources than us. Many of these competitors are not subject to the same regulatory restrictions that we are and
may able to compete more effectively as a result. Increased competition in our market may result in a decrease in the amounts of
our loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are more favorable to the borrower.
Any of these results could have a material adverse effect on our ability to grow and remain profitable. If increased competition
causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest
income could be adversely impacted. If increased competition causes us to relax
our underwriting standards, we could be
exposed to higher losses from lending activities. Additionally, many of our competitors are much larger in total assets and capitalization,
have greater access to capital markets and offer a broader range of financial services than we can offer.
Interest rates and other conditions
impact our results of operations.
Our profitability is
in part a function of the spread between the interest rates earned on investments and loans and the interest rates paid on deposits
and other interest-bearing liabilities. Like most banking institutions, our net interest spread and margin will be affected by
general economic conditions and other factors, including fiscal and monetary policies of the federal government, that influence
market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities will be
such that they are affected differently by a given change in interest rates. As a result, an increase or decrease in rates, the
length of loan terms or the mix of adjustable and fixed rate loans in our portfolio could have a positive or negative effect on
our net income, capital and liquidity. We measure interest rate risk under various rate scenarios and using specific criteria and
assumptions. A summary of this process, along with the results of our net interest income simulations is presented in the section
entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Although we
believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest
rates may have an adverse effect on our business, financial condition and results of operations.
Changes in interest
rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the
ability of borrowers to pay the principal or interest on loans may lead to an increase in non-performing assets and a reduction
of income recognized, which could have a material adverse effect on our results of operations and cash flows. Further, when we
place a loan on nonaccrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income. Subsequently,
we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the
associated funding expense. Thus, an increase in the amount of non-performing assets would have an adverse impact on net interest
income.
Rising interest rates
will result in a decline in value of our fixed-rate debt securities. The unrealized losses resulting from holding these securities
would be recognized in other comprehensive income and reduce total stockholders' equity. Unrealized losses do not negatively impact
our regulatory capital ratios; however, tangible common equity and the associated ratios would be reduced. If debt securities in
an unrealized loss position are sold, such losses become realized and will reduce our regulatory capital ratios.
We must effectively manage our credit
risk.
There are risks inherent in making any loan,
including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting from uncertainties as to the
future value of collateral and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit
risk through prudent loan application approval procedures, careful monitoring of the concentration of our loans within specific
industries and periodic independent reviews of outstanding loans by our credit review department. However, we cannot assure you
that such approval and monitoring procedures will reduce these credit risks. If the overall economic climate in the United States,
generally, and our market areas, specifically, fails to improve meaningfully, or even if it does, our borrowers may experience
difficulties in repaying their loans, and the level of non-performing loans, charge-offs and delinquencies could rise and require
increases in the provision for loan losses, which would cause our net income and return on equity to decrease.
Most of our loans are commercial, real estate,
or agriculture loans, each of which is subject to distinct types of risk. To reduce the lending risks we face, we generally take
a security interest in borrowers’ property for all three types of loans. In addition, we sell certain residential real estate
loans to third parties. Nevertheless, the risk of non-payment is inherent in all three types of loans and if we are unable to collect
amounts owed, it may materially affect our operations and financial performance. For a more complete discussion of our lending
activities see Item 1 of this Annual Report on Form 10-K.
Non-performing assets take significant time to resolve and
adversely affect our results of operations and financial condition, and could result in further losses in the future.
As of December 31, 2012, our non-performing
loans (which consist of nonaccrual loans and loans past due 90 days or more and still accruing interest) totaled $9.1 million,
or 2.84% of our loan portfolio, and our non-performing assets (which include non-performing loans plus real estate owned) totaled
$11.6 million, or 1.88% of total assets. In addition, we had $2.2 million in accruing loans that were 30-89 days delinquent
as of December 31, 2012.
Our non-performing assets adversely affect
our net income in various ways. We do not record interest income on nonaccrual loans or other real estate, thereby adversely affecting
our net income and returns on assets and equity, increasing our loan administration costs and adversely affecting our efficiency
ratio. When we take collateral in foreclosure and similar proceedings, we are required to mark the collateral to its then-fair
market value, which may result in a loss. These non-performing loans and other real estate also increase our risk profile and the
capital our regulators believe is appropriate in light of such risks. The resolution of non-performing assets requires significant
time commitments from management and can be detrimental to the performance of their other responsibilities. If we experience increases
in non-performing loans and non-performing assets, our net interest income may be negatively impacted and our loan administration
costs could increase, each of which could have an adverse effect on our net income and related ratios, such as return on assets
and equity.
Our loan portfolio has a large concentration
of real estate loans, which involve risks specific to real estate value.
Real estate lending
(including commercial, construction, land and residential) is a large portion of our loan portfolio. These categories were $200.7
million, or approximately 62.6% of our total loan portfolio as of December 31, 2012, as compared to $194.6 million, or approximately
61.9%, as of December 31, 2011. The market value of real estate can fluctuate significantly in a short period of time as a result
of market conditions in the geographic area in which the real estate is located. Although a significant portion of such loans are
secured by a secondary form of collateral, adverse developments affecting real estate values in one or more of our markets could
increase the credit risk associated with our loan portfolio. Additionally, real estate lending typically involves higher loan principal
amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing
the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the
borrower or lender could negatively impact the future cash flow and market values of the affected properties.
If the loans that are
collateralized by real estate become troubled during a time when market conditions are declining or have declined, then we may
not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to
increase our provision for loan losses and adversely affect our operating results and financial condition. In particular, if the
general declines in values that have occurred in the past few years in the residential and commercial real estate markets continue,
particularly within our market area, the value of collateral securing our real estate loans could decline further. In light of
the uncertainty that exists in the economy and credit markets nationally, there can be no guarantee that we will not experience
additional deterioration resulting from the downturn in credit performance by our real estate loan customers.
Our growth or future losses may require
us to raise additional capital in the future, but that capital may not be available when it is needed.
We are required by
federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our
existing capital resources will satisfy our capital requirements for the foreseeable future and this is a major reason why we did
not participate in the U.S. Department of Treasury’s Capital Purchase Program. However, we may at some point need to raise
additional capital to support continuing growth. Our ability to raise additional capital is particularly important to our strategy
of continual growth through acquisitions. Our ability to raise additional capital depends on conditions in the capital markets,
economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions
and governmental activities, and on our financial condition and performance. Accordingly, we cannot assure you of our ability to
raise additional capital if needed on terms acceptable to us. If we cannot raise additional capital when needed, our ability to
further expand our operations through internal growth and acquisitions could be materially impaired.
Attractive acquisition opportunities may not be available
to us in the future.
We expect that other
banking and financial service companies, many of which have significantly greater resources than us, will compete with us in acquiring
other financial institutions if we pursue such acquisitions. This competition could increase prices for potential acquisitions
that we believe are attractive. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate
regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things,
our regulators consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill and intangibles when
considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and stockholders' equity per
share of our common stock.
Our community banking strategy relies
heavily on our management team, and the unexpected loss of key managers may adversely affect our operations.
Much of our success
to date has been influenced strongly by our ability to attract and to retain senior management experienced in banking and financial
services and familiar with the communities in our market area. Our ability to retain executive officers, the current management
teams, branch managers and loan officers of our operating subsidiaries will continue to be important to the successful implementation
of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers
with the appropriate level of experience and knowledge about our market area to implement our community-based operating strategy.
The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in
the future, could have an adverse effect on our business, financial condition and results of operations.
We have a continuing need for technological
change and we may not have the resources to effectively implement new technology.
The financial services
industry continues to undergo rapid technological changes with frequent introductions of new technology-driven products and services.
In addition to better serving customers, the effective use of technology increases efficiency as well as enables financial institutions
to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology
to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies
in our operations as we continue to grow and expand our market area. Many of our larger competitors have substantially greater
resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those
that we will be able to offer, which would put us at a competitive disadvantage. Accordingly, we cannot provide you with assurance
that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products
and services to our customers.
There is a limited trading market for
our common shares, and you may not be able to resell your shares at or above the price you paid for them.
Although our common
shares are listed for trading on the Nasdaq Global Market under the symbol “LARK”, the trading in our common shares
has substantially less liquidity than many other publicly traded companies. A public trading market having the desired characteristics
of depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at
any given time. This presence depends on the individual decisions of investors and general economic and market conditions over
which we have no control. We cannot assure you that volume of trading in our common shares will increase in the future.
System failure or breaches of our network
security, including with respect to our internet banking activities, could subject us to increased operating costs as well as litigation
and other liabilities.
The computer systems
and network infrastructure we use in our operations and internet banking activities could be vulnerable to unforeseen problems.
Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power
loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks,
viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations
could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other
disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network
infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain from
doing business with us. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments
could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer
transaction data. A failure of such security measures could have a material adverse effect on our financial condition and results
of operations. Although we, with the help of third-party service providers, intend to continue to implement security technology
and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful.
Any interruption in, or breach in security of, our computer systems and network infrastructure could damage our reputation, result
in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial
liability, any of which could have a material adverse effect on our financial condition and results of operations.
We are subject to certain operational
risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.
Employee errors and
misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees
could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper
use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take
to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims
for negligence.
We maintain a system
of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and
errors and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if any resulting
loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial
condition and results of operations.
Failure to pay interest on our debt
may adversely impact our ability to pay dividends.
Our $16.5 million of
subordinated debentures are held by two business trusts that we control. Interest payments on the debentures must be paid before
we pay dividends on our capital stock, including our common stock. We have the right to defer interest payments on the debentures
for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we
may pay dividends on our capital stock. Deferral of interest payments could also cause a decline in the market price of our common
stock.