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, 2013, the Company had $828.8 million in consolidated total assets.
The Company is headquartered
in Manhattan, Kansas and has expanded its geographic presence through past acquisitions. Effective November 1, 2013, the Company
completed the acquisition of Citizens Bank, National Association (“Citizens Bank”). Effective April 1, 2012, the Company
completed the acquisition of The Wellsville Bank. In May 2009, the Company acquired an additional branch in Lawrence, Kansas.
The company completed several other mergers and acquisitions prior to 2009.
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 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 sales of one-to-four family residential mortgage loans, 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 (the “Federal Reserve”)
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 central, eastern, southeast, and southwest
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 flat commercial and
residential real estate values, unemployment levels above historical norms and slow growth in 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 four geographic areas and the
communities which the Bank serves is set forth below.
The central region
of the Bank’s market area consists of the Bank’s locations in Auburn, Manhattan, Osage, City, Junction City, Wamego
and Topeka, Kansas and includes the counties of Riley, Geary, Osage, Pottawatomie and Shawnee. The economies are significantly
impacted by employment at Fort Riley Military Base in Junction City and Kansas State University, the second largest university
in Kansas, which is located in Manhattan. Topeka is the capital of Kansas and strongly influenced by the State of Kansas. Topeka
and Manhattan are regional destinations for retail shopping as well as home to regional hospitals. 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. Construction of the facility began in 2013 and is expected to be
completed in five to seven years. Additionally, manufacturing and service industries also play a key role within the central Kansas
market.
The Bank’s eastern
Kansas branches are located in the communities of Lawrence, Lenexa, Louisburg, Osawatomie, Overland Park, Paola and Wellsville.
The Bank’s Lawrence locations are located in Douglas County and are significantly impacted by the University of Kansas,
the largest university in Kansas. The eastern region is strongly influenced by the Kansas City market, which is the highest growth
area in the State of Kansas. The region is influenced by public and private industries and businesses of all sizes. In addition,
housing growth and commercial real estate are major drivers of the region’s economy. The Citizens Bank acquisition expanded
the Bank’s presence in the eastern Kansas market with branches in Lenexa and Overland Park.
The southeast region
of the Bank’s market area consists of the Bank’s locations in Fort Scott, Iola, Kincaid, Mound City and Pittsburg,
Kansas. Agriculture, oil, and gas are the predominant industries in the southeast Kansas region. Both Fort Scott and Pittsburg
are recognized as regional commercial centers within the southeast region of the state, which attracts small retail businesses
to the region. Additionally, Pittsburg State University and Fort Scott Community College attract a number of individuals from
the surrounding area to live within the communities to participate in educational programs and pursue a degree. Fort Scott is
also home to a regional hospital. Additionally, manufacturing and service industries also play a key role within the southeast
Kansas market. This market area primarily consists of branches acquired from Citizens Bank.
The Bank’s southwest
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 southwest 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 individuals from the
surrounding areas.
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, 2013,
the Bank had a total of 292 employees (275 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 Citizens Bank during 2013; 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 as a strategy to reduce risk. However, recently loan
demand has begun to increase slightly for this type of loan.
Commercial Real
Estate Lending
. Commercial real estate loans, including multi-family 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’s commercial real estate loan portfolio increased primarily as a result of the acquisition of Citizens Bank during
2013. The Bank continues to focus on generating additional commercial real estate loan relationships as well.
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 generally not active in the origination of municipal loans and leases; however, the Bank may 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. While the 95% increase
in the Bank’s agriculture loan portfolio in 2013 was primarily a result of the acquisition of Citizens Bank, the Bank continues
to focus on generating additional agriculture loan relationships in each of its market areas.
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. Excluding the acquisition of Citizens Bank, which increased consumer loans during 2013,
the Bank has experienced weak consumer loan demand and does not expect consumer loan demand to increase unless economic conditions
continue to improve and the unemployment rate declines further.
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, commercial real estate and agriculture loans to grow and diversify the loan portfolio. However,
the challenging economic environment has materially impacted 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 unless the economic outlook continues
to improve 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 ensure 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 agencies, including
the OCC, the Federal Reserve, the Federal Deposit Insurance Corporation (the “FDIC”) and the recently 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 Securities and Exchange Commission (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 the 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 shareholders. These federal and state laws, and the regulations of the bank regulatory agencies 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. Moreover, 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 has an
investment.
This supervisory and
regulatory framework subjects banks and bank holding companies to regular examination by their respective regulatory agencies,
which results in examination reports and ratings that are not publicly available and that can impact the conduct and growth of
their businesses. 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 and 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 U.S. supervisory and regulatory framework applicable to financial institutions
and capital markets in the wake of the global financial crisis, certain aspects of which are described below in more detail. In
particular, and among other things, the Dodd-Frank Act: (i) created a Financial Stability Oversight Council as part of a regulatory
structure for identifying emerging systemic risks and improving interagency cooperation; (ii) created the CFPB, which is authorized
to regulate providers of consumer credit, savings, payment and other consumer financial products and services; (iii) narrowed
the scope of federal preemption of state consumer laws enjoyed by national banks and federal savings associations and expanded
the authority of state attorneys general to bring actions to enforce federal consumer protection legislation; (iv) imposed more
stringent capital requirements on bank holding companies and subjected certain activities, including interstate mergers and acquisitions,
to heightened capital conditions; (v) with respect to mortgage lending, (a) significantly expanded requirements applicable to
loans secured by 1-4 family residential real property, (b) imposed strict rules on mortgage servicing, and (c) required 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; (vi) repealed the prohibition
on the payment of interest on business checking accounts; (vii) restricted the interchange fees payable on debit card transactions
for issuers with $10 billion in assets or greater; (viii) in the so-called “Volcker Rule,” subject to numerous
exceptions, prohibited depository institutions and affiliates from certain investments in, and sponsorship of, hedge funds and
private equity funds and from engaging in proprietary trading; (ix) provided for enhanced regulation of advisers to private funds
and of the derivatives markets; (x) enhanced oversight of credit rating agencies; and (xi) prohibited banking agency requirements
tied to credit ratings. These statutory changes shifted the regulatory framework for financial institutions, impacted the way
in which they do business and have the potential to constrain revenues.
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
the Bank will continue to evaluate the effect of the Dodd-Frank Act changes; however, in many respects, the ultimate impact of
the Dodd-Frank Act will not be fully known for years, and no 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
Regulatory capital
represents the net assets of a financial institution available to absorb losses. Because of the risks attendant to their businesses,
depository institutions are generally required to hold more capital than other businesses, which directly affects earnings capabilities.
While capital has historically been one of the key measures of the financial health of both bank holding companies and banks,
its role is becoming fundamentally more important in the wake of the global financial crisis, as the banking regulators recognized
that the amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses during periods of severe
stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish strengthened capital standards for
banks and bank holding companies, require more capital to be held in the form of common stock and disallow certain funds from
being included in capital determinations. Once fully implemented, these standards will represent regulatory capital requirements
that are meaningfully more stringent than those in place historically.
The 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, 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 hybrid instruments,
such as 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, subject to certain restrictions, 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.
Under current federal
regulations, the Bank is 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 adjusted
book 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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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%.
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For these purposes,
“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 nonpermanent 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 lease losses.
Further, “risk-weighted assets” for the purposes of the risk-weighted ratio calculations are balance sheet assets
and off-balance-sheet exposures to which required risk-weightings of 0% to 100% are applied.
The capital standards
described above are minimum requirements and will be increased under Basel III, as discussed below. Bank regulatory agencies are
uniformly encouraging banks and bank holding companies to be “well-capitalized” and, to that end, 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
OCC and Federal Reserve, in order to be “well-capitalized,” a banking organization, under current federal regulations,
must maintain:
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leverage ratio of Tier 1 Capital to total assets of 5% or greater,
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ratio of Tier 1 Capital to total risk-weighted assets of 6% or greater, and
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ratio of Total Capital to total risk-weighted assets of 10% or greater.
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The OCC and Federal
Reserve guidelines also provide that banks and bank holding companies experiencing internal growth or making acquisitions will
be expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible
assets. Furthermore, the guidelines indicate that the agencies will continue to consider a “tangible Tier 1 leverage
ratio” (deducting all intangibles) in evaluating proposals for expansion or to engage in new activities.
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 that 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,
2013: (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, 2013, the Company had
regulatory capital in excess of the Federal Reserve’s requirements and met the Dodd-Frank Act capital requirements.
The Basel International
Capital Accords.
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 was intended to be effective globally
on January 1, 2013, with phase-in of certain elements continuing until January 1, 2019, and it is currently effective in many
countries.
U.S. Implementation
of Basel III.
After an extended rulemaking process that included a prolonged comment period, in July 2013, the U.S. federal
banking agencies approved the implementation of the Basel III regulatory capital reforms in pertinent part, and, at the same time,
promulgated rules effecting certain changes required by the Dodd-Frank Act (the “Basel III Rule”). In contrast to
capital requirements historically, which were in the form of guidelines, Basel III was released in the form of regulations by
each of the agencies. The Basel III Rule is applicable to all U.S. banks that are subject to minimum capital requirements, including
federal and state banks and savings and loan associations, 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).
The Basel III Rule
not only increases most of the required minimum capital ratios, but it introduces the concept of Common Equity Tier 1 Capital,
which consists primarily of common stock, related surplus (net of treasury stock), retained earnings, and Common Equity Tier 1
minority interests subject to certain regulatory adjustments. The Basel III Rule also expanded the definition of capital as in
effect currently by establishing more stringent criteria that instruments must meet to be considered Additional Tier 1 Capital
(Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that now qualify as Tier 1 Capital will
not qualify, or their qualifications will change. For example, cumulative preferred stock and certain hybrid capital instruments,
including trust preferred securities, will no longer qualify as Tier 1 Capital of any kind, with the exception, subject to certain
restrictions, of such instruments issued before May 10, 2010, by bank holding companies with total consolidated assets of less
than $15 billion as of December 31, 2009. For those institutions, trust preferred securities and other nonqualifying capital instruments
currently included in consolidated Tier 1 Capital are permanently grandfathered under the Basel III Rule, subject to certain restrictions.
Noncumulative perpetual preferred stock, which now qualifies as simple Tier 1 Capital, will not qualify as Common Equity Tier
1 Capital, but will qualify as Additional Tier 1 Capital. The Basel III Rule also constrains the inclusion of minority interests,
mortgage-servicing assets, and deferred tax assets in capital and requires deductions from Common Equity Tier 1 Capital in
the event such assets exceed a certain percentage of a bank’s Common Equity Tier 1 Capital.
The Basel III Rule
requires:
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A
new required ratio of minimum Common Equity Tier 1 equal to 4.5% of risk-weighted assets;
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·
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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;
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·
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A
continuation of the current minimum required amount of Total Capital (Tier 1 plus Tier
2) at 8% of risk-weighted assets; and
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·
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A
minimum leverage ratio of Tier 1 Capital to total assets equal to 4% in all circumstances.
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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% of risk-weighted assets in Common Equity Tier 1 attributable
to a capital conservation buffer to be phased in over three years beginning in 2016. 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 fully phased-in conservation buffer increases the minimum ratios depicted above to 7% for Common Equity Tier
1, 8.5% for Tier 1 Capital and 10.5% for Total Capital. The leverage ratio is not impacted by the conservation buffer.
The Basel III Rule
maintained the general structure of the current prompt corrective action framework, while incorporating the increased requirements.
The prompt corrective action guidelines were also revised to add the Common Equity Tier 1 Capital ratio. In order to be a “well-capitalized”
depository institution under the new regime, a bank and holding company must maintain a Common Equity Tier 1 Capital ratio
of 6.5% or more, a Tier 1 Capital ratio of 8% or more, a Total Capital ratio of 10% or more, and a leverage ratio of 5% or more.
It is possible under the Basel III Rule to be well-capitalized while remaining out of compliance with the capital conservation
buffer discussed above.
The Basel III Rule
revises a 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 Basel III Rule requires a more complex, detailed and calibrated assessment of credit risk
and calculation of risk weightings. While Basel III would have changed the risk-weighting for residential mortgage loans based
on loan-to-value ratios and certain product and underwriting characteristics, there was concern in the United States that the
proposed methodology for risk weighting residential mortgage exposures and the higher risk weightings for certain types of mortgage
products would increase costs to consumers and reduce their access to mortgage credit. As a result, the Basel III Rule did not
effect this change, and banks will continue to apply a risk weight of 50% or 100% to their exposure from residential mortgages,
with the risk weighting depending on, among other things, whether the mortgage was a prudently underwritten first lien mortgage.
Furthermore, there
was 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”). Basel III requires 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. Recognizing
the problem for community banks, the U.S. bank regulatory agencies adopted the Basel III Rule with a one-time election for smaller
institutions like the Company and the Bank to opt out of including most elements of AOCI in regulatory capital. This opt-out,
which must be made in the first quarter of 2015, would exclude from regulatory capital both unrealized gains and losses on available-for-sale
debt securities and accumulated net gains and losses on cash-flow hedges and amounts attributable to defined benefit post-retirement
plans. The Company is currently evaluating whether it will make the opt-out election.
Generally, financial
institutions (except for large, internationally active financial institutions) become subject to the new rules on January 1, 2015.
However, there will be separate phase-in/phase-out periods for: (i) the capital conservation buffer; (ii) regulatory capital adjustments
and deductions; (iii) nonqualifying capital instruments; and (iv) changes to the prompt corrective action rules. The phase-in
periods commence on January 1, 2016 and extend until 2019.
The Company
General.
The Company, as the sole shareholder 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. The Company does not currently 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 capital in accordance with Federal Reserve capital adequacy requirements,
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 leading up to the global financial
crisis, including deterioration of the worldwide credit markets, created significant challenges for financial institutions throughout
the country beginning in 2008. 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 a program that provided Tier 1 Capital (in the form of perpetual preferred stock and common stock warrants)
to eligible financial institutions. This program, known as the TARP Capital Purchase Program (the “CPP”), allocated
$250 billion from the $700 billion authorized by EESA to the Treasury for the purchase of senior preferred shares from qualifying
financial institutions. Eligible institutions were able to sell equity interests to the Treasury in amounts equal to between 1%
and 3% of the institutions’ risk-weighted assets. The Company determined not to participate in the CPP.
Dividend Payments.
The Company’s ability to pay dividends to its shareholders may be affected by both general corporate law considerations
and the 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 has indicated that the board of directors of a bank holding company should eliminate, defer or significantly
reduce dividends to shareholders 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 nonbank 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 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 protections, corporate governance and executive compensation matters that will
affect most U.S. publicly traded companies. The Dodd-Frank Act will increase shareholder influence over boards of directors by
requiring companies to give shareholders a nonbinding vote on executive compensation and so-called “golden parachute”
payments, and authorizing the SEC to promulgate rules that would allow shareholders 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 executives of bank holding companies, regardless of whether such companies are 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 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 FDIC, as administrator of the DIF, also has regulatory authority over the Bank.
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 three 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, was returned to the institution
and normal quarterly payments resumed.
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, that program expired on 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.
The FICO assessment rate is adjusted quarterly and for the fourth quarter of 2013 was approximately 0.0064%, 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, 2013, the Bank paid supervisory assessments to the OCC totaling $177,000.
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, 2013.
As of December 31, 2013, approximately $6.2 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 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
enhanced 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 shareholders of the Company and to “related interests”
of such directors, officers and principal shareholders. 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 shareholder of the Company, may obtain
credit from banks with which the Bank maintains a correspondent relationship.
Safety and Soundness
Standards/ Risk Management.
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.
During the past decade,
the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong internal
controls when evaluating the activities of the institutions they supervise. Properly managing risks has been identified
as critical to the conduct of safe and sound banking activities and has become even more important as new technologies, product
innovation, and the size and speed of financial transactions have changed the nature of banking markets. The agencies
have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity, operational,
legal, and reputational risk. In particular, recent regulatory pronouncements have focused on operational risk, which arises from
the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes
will result in unexpected losses. The Bank is expected to have active board and senior management oversight; adequate policies,
procedures, and limits; adequate risk measurement, monitoring, and management information systems; and comprehensive internal
controls.
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 2014: the first $13.3 million of otherwise reservable balances
are exempt from the reserve requirements; for transaction accounts aggregating more than $13.3 million to $89.0 million, the reserve
requirement is 3% of total transaction accounts; and for net transaction accounts in excess of $89.0 million, the reserve requirement
is $2,271,000 plus 10% of the aggregate amount of total transaction accounts in excess of $89.0 million. These reserve requirements
are subject to annual adjustment by the Federal Reserve. The Bank is in compliance with the foregoing requirements.
Federal Home
Loan Bank System.
The Bank is a member of the FHLB, which serves as a central credit facility for its members. The FHLB
is funded primarily from proceeds from the sale of obligations of the FHLB system. It makes loans to member banks in the form
of FHLB advances. All advances from the FHLB are required to be fully collateralized as determined by the FHLB.
Community Reinvestment
Act Requirements.
The Community Reinvestment Act requires the Bank to have a continuing and affirmative obligation in
a safe and sound manner to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods.
Federal regulators regularly assess the Bank’s record of meeting the credit needs of its communities. Applications for additional
acquisitions would be affected by the evaluation of the Bank’s effectiveness in meeting its Community Reinvestment Act requirements.
Anti-Money Laundering.
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act
of 2001 (the “Patriot Act”) is designed to deny terrorists and criminals the ability to obtain access to the U.S.
financial system and has significant implications for depository institutions, brokers, dealers and other businesses involved
in the transfer of money. The Patriot Act mandates financial services companies to have policies and procedures with respect to
measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money laundering;
(iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes;
and (vi) cooperation between financial institutions and law enforcement authorities.
Commercial Real
Estate Guidance.
The interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance
(“CRE Guidance”) provides supervisory criteria, including the following numerical indicators, to assist bank examiners
in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory
scrutiny: (i) commercial real estate loans exceeding 300% of capital and increasing 50% or more in the preceding three years;
or (ii) construction and land development loans exceeding 100% of capital. The CRE Guidance does not limit banks’ levels
of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels
of capital that are commensurate with the level and nature of their commercial real estate concentrations. Based on the Bank’s
loan portfolio as of December 31, 2013, it did not exceed these guidelines at such time.
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. Below are additional recent regulatory developments relating to consumer mortgage lending activities. The Company
does not currently expect these provisions to have a significant impact on Bank operations; however, additional compliance resources
will be needed to monitor changes.
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.” 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, that 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 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 the Company’s business.
Servicing.
On
January 17, 2013, the CFPB announced rules to implement certain provisions of the Dodd-Frank Act relating to mortgage servicing.
The new servicing rules require servicers to meet certain benchmarks for loan servicing and customer service in general. Servicers
must provide periodic billing statements and certain required notices and acknowledgments, promptly credit borrowers’ accounts
for payments received and promptly investigate complaints by borrowers and are required to take additional steps before purchasing
insurance to protect the lender’s interest in the property. The new servicing rules also call for additional notice, review
and timing requirements with respect to delinquent borrowers, including early intervention, ongoing access to servicer personnel
and specific loss mitigation and foreclosure procedures. The rules provide for an exemption from most of these requirements for
“small servicers.” A small servicer is defined as a loan servicer that services 5,000 or fewer mortgage loans and
services only mortgage loans that they or an affiliate originated or own. The new servicing rules took effect on January 10,
2014. Bank management is continuing to evaluate the full impact of these rules and their impact on mortgage servicing operations.
Additional Constraints on the Company
and the Bank
Monetary Policy.
The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank holding
companies and their subsidiaries. Among the tools available to the Federal Reserve to affect the money supply are open market
transactions in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements
against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank
loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
The Volcker
Rule.
In addition to other implications of the Dodd-Frank Act discussed above, the act amends the BHCA to require the
federal regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing
in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). This statutory
provision is commonly called the “Volcker Rule.” On December 10, 2013, the federal regulatory agencies issued
final rules to implement the prohibitions required by the Volcker Rule. Thereafter, in reaction to industry concern over the adverse
impact to community banks of the treatment of certain collateralized debt instruments in the final rule, the federal regulatory
agencies approved an interim final rule to permit banking entities to retain interests in collateralized debt obligations backed
primarily by trust preferred securities (“TruPS CDOs”) from the investment prohibitions contained in the final rule.
Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities
under $15 billion in assets if the following qualifications are met:
|
·
|
The
TruPS CDO was established, and the interest was issued, before May 19, 2010;
|
|
·
|
The
banking entity reasonably believes that the offering proceeds received by the TruPS CDO
were invested primarily in qualifying TruPS collateral; and
|
|
·
|
The
banking entity's interest in the TruPS CDO was acquired on or before December 10, 2013.
|
Although the Volcker
Rule has significant implications for many large financial institutions, the Company does not currently anticipate that the Volcker Rule
will have a material effect on the operations of the Company or the Bank. The Company may incur costs if it is required to adopt
additional policies and systems to ensure compliance with the Volcker Rule, but any such costs are not expected to be material.
Until the application of the final rules is fully understood, the precise financial impact of the rule on the Company, the Bank,
their customers or the financial industry more generally, cannot be determined.
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. Unless otherwise noted, 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, 2013.
The statistical data required by Guide
3 of the Securities Act of 1933 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,
|
|
|
|
2013 vs 2012
|
|
|
2012 vs 2011
|
|
|
|
Increase/(decrease) attributable to
|
|
|
Increase/(decrease) attributable to
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Net
|
|
|
Volume
|
|
|
Rate
|
|
|
Net
|
|
|
|
(Dollars in thousands)
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits at banks
|
|
$
|
(1
|
)
|
|
$
|
3
|
|
|
$
|
2
|
|
|
$
|
17
|
|
|
$
|
6
|
|
|
$
|
23
|
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
43
|
|
|
|
(184
|
)
|
|
|
(141
|
)
|
|
|
432
|
|
|
|
(263
|
)
|
|
|
169
|
|
Tax-exempt
|
|
|
2,191
|
|
|
|
(2,240
|
)
|
|
|
(49
|
)
|
|
|
(44
|
)
|
|
|
39
|
|
|
|
(5
|
)
|
Loans
|
|
|
992
|
|
|
|
(812
|
)
|
|
|
180
|
|
|
|
74
|
|
|
|
(769
|
)
|
|
|
(695
|
)
|
Total
|
|
|
3,225
|
|
|
|
(3,233
|
)
|
|
|
(8
|
)
|
|
|
479
|
|
|
|
(987
|
)
|
|
|
(508
|
)
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
83
|
|
|
|
(855
|
)
|
|
|
(772
|
)
|
|
|
324
|
|
|
|
(935
|
)
|
|
|
(611
|
)
|
Borrowings
|
|
|
178
|
|
|
|
(235
|
)
|
|
|
(57
|
)
|
|
|
(303
|
)
|
|
|
165
|
|
|
|
(138
|
)
|
Total
|
|
|
261
|
|
|
|
(1,090
|
)
|
|
|
(829
|
)
|
|
|
21
|
|
|
|
(770
|
)
|
|
|
(749
|
)
|
Net interest income
|
|
$
|
2,964
|
|
|
$
|
(2,143
|
)
|
|
$
|
821
|
|
|
$
|
458
|
|
|
$
|
(217
|
)
|
|
$
|
241
|
|
The following table
sets forth information relating to average balances of interest-earning assets and interest-bearing liabilities for the years
ended December 31, 2013, 2012 and 2011. 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, 2013
|
|
|
Year ended
December 31, 2012
|
|
|
Year ended
December 31, 2011
|
|
|
|
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
|
|
$
|
11,716
|
|
|
$
|
29
|
|
|
|
0.25
|
%
|
|
$
|
11,927
|
|
|
$
|
27
|
|
|
|
0.23
|
%
|
|
$
|
3,295
|
|
|
$
|
4
|
|
|
|
0.12
|
%
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
162,288
|
|
|
|
2,772
|
|
|
|
1.71
|
%
|
|
|
160,043
|
|
|
|
2,913
|
|
|
|
1.82
|
%
|
|
|
126,512
|
|
|
|
2,744
|
|
|
|
2.17
|
%
|
Tax-exempt
(1)
|
|
|
83,287
|
|
|
|
3,523
|
|
|
|
4.23
|
%
|
|
|
75,334
|
|
|
|
3,572
|
|
|
|
4.74
|
%
|
|
|
66,854
|
|
|
|
3,576
|
|
|
|
5.35
|
%
|
Loans
receivable, net (2)
|
|
|
341,021
|
|
|
|
17,091
|
|
|
|
5.01
|
%
|
|
|
315,213
|
|
|
|
16,911
|
|
|
|
5.37
|
%
|
|
|
313,918
|
|
|
|
17,607
|
|
|
|
5.61
|
%
|
Total
interest-earning assets
|
|
|
598,312
|
|
|
|
23,415
|
|
|
|
3.91
|
%
|
|
|
562,517
|
|
|
|
23,423
|
|
|
|
4.16
|
%
|
|
|
510,579
|
|
|
|
23,931
|
|
|
|
4.69
|
%
|
Non-interest-earning
assets
|
|
|
71,010
|
|
|
|
|
|
|
|
|
|
|
|
69,163
|
|
|
|
|
|
|
|
|
|
|
|
67,461
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
669,322
|
|
|
|
|
|
|
|
|
|
|
$
|
631,680
|
|
|
|
|
|
|
|
|
|
|
$
|
578,040
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market and NOW
accounts
|
|
$
|
222,112
|
|
|
$
|
188
|
|
|
|
0.08
|
%
|
|
$
|
203,741
|
|
|
$
|
313
|
|
|
|
0.15
|
%
|
|
$
|
171,295
|
|
|
$
|
371
|
|
|
|
0.22
|
%
|
Savings accounts
|
|
|
52,933
|
|
|
|
17
|
|
|
|
0.03
|
%
|
|
|
44,289
|
|
|
|
29
|
|
|
|
0.07
|
%
|
|
|
36,004
|
|
|
|
48
|
|
|
|
0.13
|
%
|
Certificates of deposit
|
|
|
167,191
|
|
|
|
1,172
|
|
|
|
0.70
|
%
|
|
|
178,508
|
|
|
|
1,807
|
|
|
|
1.01
|
%
|
|
|
178,364
|
|
|
|
2,341
|
|
|
|
1.31
|
%
|
Total deposits
|
|
|
442,236
|
|
|
|
1,377
|
|
|
|
0.31
|
%
|
|
|
426,538
|
|
|
|
2,149
|
|
|
|
0.50
|
%
|
|
|
385,663
|
|
|
|
2,760
|
|
|
|
0.72
|
%
|
FHLB
advances and other borrowings
|
|
|
63,672
|
|
|
|
1,704
|
|
|
|
2.68
|
%
|
|
|
59,287
|
|
|
|
1,761
|
|
|
|
2.97
|
%
|
|
|
68,929
|
|
|
|
1,899
|
|
|
|
2.76
|
%
|
Total
interest-bearing liabilities
|
|
|
505,908
|
|
|
|
3,081
|
|
|
|
0.61
|
%
|
|
|
485,825
|
|
|
|
3,910
|
|
|
|
0.80
|
%
|
|
|
454,592
|
|
|
|
4,659
|
|
|
|
1.02
|
%
|
Non-interest-bearing liabilities
|
|
|
99,918
|
|
|
|
|
|
|
|
|
|
|
|
84,303
|
|
|
|
|
|
|
|
|
|
|
|
67,238
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity
|
|
|
63,496
|
|
|
|
|
|
|
|
|
|
|
|
61,552
|
|
|
|
|
|
|
|
|
|
|
|
56,210
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
669,322
|
|
|
|
|
|
|
|
|
|
|
$
|
631,680
|
|
|
|
|
|
|
|
|
|
|
$
|
578,040
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate spread (3)
|
|
|
|
|
|
|
|
|
|
|
3.30
|
%
|
|
|
|
|
|
|
|
|
|
|
3.36
|
%
|
|
|
|
|
|
|
|
|
|
|
3.67
|
%
|
Net
interest margin (4)
|
|
|
|
|
|
$
|
20,334
|
|
|
|
3.40
|
%
|
|
|
|
|
|
$
|
19,513
|
|
|
|
3.47
|
%
|
|
|
|
|
|
$
|
19,272
|
|
|
|
3.77
|
%
|
Tax
equivalent interest - imputed (1) (2)
|
|
|
|
|
|
|
1,303
|
|
|
|
|
|
|
|
|
|
|
|
1,371
|
|
|
|
|
|
|
|
|
|
|
|
1,345
|
|
|
|
|
|
Net
interest income
|
|
|
|
|
|
$
|
19,031
|
|
|
|
|
|
|
|
|
|
|
$
|
18,142
|
|
|
|
|
|
|
|
|
|
|
$
|
17,927
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of average interest-earning assets
to average interest-bearing liabilities
|
|
|
|
|
|
|
118.3
|
%
|
|
|
|
|
|
|
|
|
|
|
115.8
|
%
|
|
|
|
|
|
|
|
|
|
|
112.3
|
%
|
|
|
|
|
|
(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, 2013 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,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
|
(Dollars in thousands)
|
|
Investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury securities
|
|
$
|
500
|
|
|
$
|
-
|
|
|
$
|
-
|
|
U.S. federal agency obligations
|
|
|
19,643
|
|
|
|
8,848
|
|
|
|
9,164
|
|
Municipal obligations tax-exempt
|
|
|
91,793
|
|
|
|
77,286
|
|
|
|
69,629
|
|
Municipal obligations taxable
|
|
|
52,472
|
|
|
|
38,142
|
|
|
|
19,135
|
|
Mortgage-backed securities
|
|
|
125,593
|
|
|
|
81,848
|
|
|
|
94,472
|
|
Common stocks
|
|
|
1,103
|
|
|
|
902
|
|
|
|
819
|
|
Pooled trust preferred securities
|
|
|
-
|
|
|
|
-
|
|
|
|
405
|
|
Certificates of deposits
|
|
|
9,142
|
|
|
|
6,274
|
|
|
|
4,590
|
|
Total available-for-sale investment securities, at fair value
|
|
$
|
300,246
|
|
|
$
|
213,300
|
|
|
$
|
198,214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FHLB stock
|
|
|
3,240
|
|
|
|
3,360
|
|
|
|
4,850
|
|
Federal Reserve Bank stock
|
|
|
1,920
|
|
|
|
1,765
|
|
|
|
1,761
|
|
Correspondent bank common stock
|
|
|
111
|
|
|
|
113
|
|
|
|
60
|
|
Total other securities, at cost
|
|
$
|
5,271
|
|
|
$
|
5,238
|
|
|
$
|
6,671
|
|
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, 2013. 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, 2013
|
|
|
|
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. treasury
securities
|
|
$
|
-
|
|
|
|
0.00
|
%
|
|
$
|
500
|
|
|
|
0.37
|
%
|
|
$
|
-
|
|
|
|
0.00
|
%
|
|
$
|
-
|
|
|
|
0.00
|
%
|
|
$
|
500
|
|
|
|
0.37
|
%
|
U.S. federal agency obligations
|
|
|
80
|
|
|
|
3.60
|
%
|
|
|
13,014
|
|
|
|
1.06
|
%
|
|
|
6,147
|
|
|
|
1.35
|
%
|
|
|
402
|
|
|
|
2.10
|
%
|
|
|
19,643
|
|
|
|
1.18
|
%
|
Municipal obligations tax-exempt
|
|
|
6,133
|
|
|
|
4.38
|
%
|
|
|
31,465
|
|
|
|
3.53
|
%
|
|
|
47,079
|
|
|
|
4.24
|
%
|
|
|
7,116
|
|
|
|
6.25
|
%
|
|
|
91,793
|
|
|
|
4.16
|
%
|
Municipal obligations taxable
|
|
|
918
|
|
|
|
1.18
|
%
|
|
|
34,272
|
|
|
|
1.68
|
%
|
|
|
13,653
|
|
|
|
2.15
|
%
|
|
|
3,629
|
|
|
|
4.05
|
%
|
|
|
52,472
|
|
|
|
1.96
|
%
|
Mortgage-backed securities
|
|
|
1,542
|
|
|
|
2.57
|
%
|
|
|
81,872
|
|
|
|
2.00
|
%
|
|
|
22,491
|
|
|
|
2.33
|
%
|
|
|
19,688
|
|
|
|
1.85
|
%
|
|
|
125,593
|
|
|
|
2.04
|
%
|
Certificates of deposits
|
|
|
3,382
|
|
|
|
0.82
|
%
|
|
|
5,760
|
|
|
|
0.82
|
%
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
9,142
|
|
|
|
0.82
|
%
|
Total
|
|
$
|
12,055
|
|
|
|
2.90
|
%
|
|
$
|
166,883
|
|
|
|
2.10
|
%
|
|
$
|
89,370
|
|
|
|
3.24
|
%
|
|
$
|
30,835
|
|
|
|
3.13
|
%
|
|
$
|
299,143
|
|
|
|
2.58
|
%
|
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,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
|
(Dollars in thousands)
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
$
|
125,087
|
|
|
$
|
88,454
|
|
|
$
|
79,108
|
|
|
$
|
79,631
|
|
|
$
|
89,295
|
|
Construction and land
|
|
|
23,776
|
|
|
|
23,435
|
|
|
|
21,672
|
|
|
|
23,652
|
|
|
|
36,864
|
|
Commercial real estate
|
|
|
119,390
|
|
|
|
88,790
|
|
|
|
93,786
|
|
|
|
92,124
|
|
|
|
99,459
|
|
Commercial loans
|
|
|
61,383
|
|
|
|
64,570
|
|
|
|
57,006
|
|
|
|
57,286
|
|
|
|
61,347
|
|
Agriculture loans
|
|
|
62,287
|
|
|
|
31,935
|
|
|
|
39,052
|
|
|
|
38,836
|
|
|
|
38,205
|
|
Municipal loans
|
|
|
8,846
|
|
|
|
9,857
|
|
|
|
10,366
|
|
|
|
5,393
|
|
|
|
5,672
|
|
Consumer loans
|
|
|
18,600
|
|
|
|
13,417
|
|
|
|
13,584
|
|
|
|
14,385
|
|
|
|
16,922
|
|
Total gross loans
|
|
|
419,369
|
|
|
|
320,458
|
|
|
|
314,574
|
|
|
|
311,307
|
|
|
|
347,764
|
|
Net deferred loan costs and loans in process
|
|
|
187
|
|
|
|
37
|
|
|
|
214
|
|
|
|
328
|
|
|
|
442
|
|
Allowance for loan losses
|
|
|
(5,540
|
)
|
|
|
(4,581
|
)
|
|
|
(4,707
|
)
|
|
|
(4,967
|
)
|
|
|
(5,468
|
)
|
Loans, net
|
|
$
|
414,016
|
|
|
$
|
315,914
|
|
|
$
|
310,081
|
|
|
$
|
306,668
|
|
|
$
|
342,738
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
|
29.8
|
%
|
|
|
27.6
|
%
|
|
|
25.2
|
%
|
|
|
25.6
|
%
|
|
|
25.7
|
%
|
Construction and land
|
|
|
5.7
|
%
|
|
|
7.3
|
%
|
|
|
6.9
|
%
|
|
|
7.6
|
%
|
|
|
10.6
|
%
|
Commercial real estate
|
|
|
28.5
|
%
|
|
|
27.7
|
%
|
|
|
29.8
|
%
|
|
|
29.6
|
%
|
|
|
28.6
|
%
|
Commercial loans
|
|
|
14.6
|
%
|
|
|
20.1
|
%
|
|
|
18.1
|
%
|
|
|
18.4
|
%
|
|
|
17.6
|
%
|
Agriculture loans
|
|
|
14.9
|
%
|
|
|
10.0
|
%
|
|
|
12.4
|
%
|
|
|
12.5
|
%
|
|
|
11.0
|
%
|
Municipal loans
|
|
|
2.1
|
%
|
|
|
3.1
|
%
|
|
|
3.3
|
%
|
|
|
1.7
|
%
|
|
|
1.6
|
%
|
Consumer loans
|
|
|
4.4
|
%
|
|
|
4.2
|
%
|
|
|
4.3
|
%
|
|
|
4.6
|
%
|
|
|
4.9
|
%
|
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, 2013. The table does not include unscheduled prepayments.
|
|
As of December 31, 2013
|
|
|
|
< 1 year
|
|
|
1-5 years
|
|
|
> 5 years
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
$
|
15,888
|
|
|
$
|
51,243
|
|
|
$
|
57,956
|
|
|
$
|
125,087
|
|
Construction and land
|
|
|
17,565
|
|
|
|
4,398
|
|
|
|
1,813
|
|
|
|
23,776
|
|
Commercial real estate
|
|
|
19,276
|
|
|
|
47,308
|
|
|
|
52,806
|
|
|
|
119,390
|
|
Commercial loans
|
|
|
40,012
|
|
|
|
18,773
|
|
|
|
2,598
|
|
|
|
61,383
|
|
Agriculture loans
|
|
|
32,764
|
|
|
|
13,678
|
|
|
|
15,845
|
|
|
|
62,287
|
|
Municipal loans
|
|
|
1,722
|
|
|
|
1,691
|
|
|
|
5,433
|
|
|
|
8,846
|
|
Consumer loans
|
|
|
5,294
|
|
|
|
8,369
|
|
|
|
4,937
|
|
|
|
18,600
|
|
Total gross loans
|
|
$
|
132,521
|
|
|
$
|
145,460
|
|
|
$
|
141,388
|
|
|
$
|
419,369
|
|
The following table
sets forth the dollar amount of all loans due after December 31, 2014 and whether such loans had fixed interest rates or adjustable
interest rates:
|
|
As of December 31, 2013
|
|
|
|
Fixed
|
|
|
Adjustable
|
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
$
|
73,332
|
|
|
$
|
35,867
|
|
|
$
|
109,199
|
|
Construction and land
|
|
|
3,807
|
|
|
|
2,404
|
|
|
|
6,211
|
|
Commercial real estate
|
|
|
28,602
|
|
|
|
71,512
|
|
|
|
100,114
|
|
Commercial loans
|
|
|
13,639
|
|
|
|
7,732
|
|
|
|
21,371
|
|
Agriculture loans
|
|
|
17,016
|
|
|
|
12,507
|
|
|
|
29,523
|
|
Municipal loans
|
|
|
7,124
|
|
|
|
-
|
|
|
|
7,124
|
|
Consumer loans
|
|
|
3,238
|
|
|
|
10,068
|
|
|
|
13,306
|
|
Total gross loans
|
|
$
|
146,758
|
|
|
$
|
140,090
|
|
|
$
|
286,848
|
|
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, 2013, interest earned on such loans for the years
ended December 31, 2013, 2012 and 2011 would have increased interest income by $511,000, $164,000 and $47,000, respectively, if
included in the Company’s interest income for those years. No interest income related to non-accrual loans was included
in interest income for the years ended December 31, 2013, 2012 and 2011.
|
|
As of December 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-accrual loans
|
|
$
|
9,836
|
|
|
$
|
9,108
|
|
|
$
|
1,419
|
|
|
$
|
4,817
|
|
|
$
|
11,830
|
|
Accruing loans over 90 days past due
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Non-performing investments
|
|
|
-
|
|
|
|
-
|
|
|
|
1,104
|
|
|
|
1,125
|
|
|
|
1,528
|
|
Real estate owned, net
|
|
|
400
|
|
|
|
2,444
|
|
|
|
2,264
|
|
|
|
3,194
|
|
|
|
1,129
|
|
Total non-performing assets
|
|
$
|
10,236
|
|
|
$
|
11,552
|
|
|
$
|
4,787
|
|
|
$
|
9,136
|
|
|
$
|
14,487
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Performing TDRs
|
|
$
|
6,920
|
|
|
$
|
5,846
|
|
|
$
|
1,071
|
|
|
$
|
531
|
|
|
$
|
531
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-performing loans to total gross loans
|
|
|
2.35
|
%
|
|
|
2.84
|
%
|
|
|
0.45
|
%
|
|
|
1.55
|
%
|
|
|
3.45
|
%
|
Total non-performing assets to total assets
|
|
|
1.24
|
%
|
|
|
1.88
|
%
|
|
|
0.80
|
%
|
|
|
1.63
|
%
|
|
|
2.48
|
%
|
Allowance for loan losses to non-performing loans
|
|
|
94.30
|
%
|
|
|
50.30
|
%
|
|
|
331.71
|
%
|
|
|
103.11
|
%
|
|
|
46.22
|
%
|
The increase in non-accrual
loans during 2013 was principally associated with a $4.0 million commercial loan relationship which was placed on non-accrual
status as the business performance deteriorated and the borrower agreed to sell the business. Partially offsetting that increase
during 2013 was the return to accrual status of $1.5 million of a $2.2 million land loan that was subject to a troubled debt restructuring
(“TDR”) in 2012 after a payment history was established based on the terms of the TDR. Also reducing our non-accrual
loan balances in 2013 was the pay down of a $1.1 million commercial loan with proceeds from the liquidation of the borrower’s
assets in 2013. The remaining loan balance of $192,000 was charged off. The increase in non-accrual loans during 2012 was principally
associated with the two loans discussed above as well as 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. 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 status 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.
At December 31, 2013,
the $400,000 of real estate owned primarily consisted of a few residential real estate properties. The decline in real estate
owned during 2013 was principally associated with the sale of a residential subdivision development, a commercial real estate
building and land previously acquired by the Bank for expansion. 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 in 2012 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 noted above, this residential subdivision development
was sold by the Company in 2013. 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 of Item 7. “Management’s Discussion
and Analysis of Financial Condition and Results of Operations,” as of December 31, 2013 the Company believed its allowance
for loan losses was adequate based on the evaluation of the loan portfolio’s inherent risk.
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 and for the periods indicated:
|
|
As of and for the year ending December 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at beginning of year
|
|
$
|
4,581
|
|
|
$
|
4,707
|
|
|
$
|
4,967
|
|
|
$
|
5,468
|
|
|
$
|
3,871
|
|
Provision for loan losses
|
|
|
800
|
|
|
|
1,900
|
|
|
|
2,000
|
|
|
|
5,900
|
|
|
|
3,300
|
|
Charge-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
|
(93
|
)
|
|
|
(70
|
)
|
|
|
(110
|
)
|
|
|
(387
|
)
|
|
|
(153
|
)
|
Construction and land
|
|
|
(53
|
)
|
|
|
(1,749
|
)
|
|
|
(1,173
|
)
|
|
|
(3,474
|
)
|
|
|
(330
|
)
|
Commercial real estate
|
|
|
(11
|
)
|
|
|
-
|
|
|
|
(434
|
)
|
|
|
(96
|
)
|
|
|
(17
|
)
|
Commercial loans
|
|
|
(200
|
)
|
|
|
(70
|
)
|
|
|
(590
|
)
|
|
|
(8
|
)
|
|
|
(1,404
|
)
|
Agriculture loans
|
|
|
-
|
|
|
|
-
|
|
|
|
(1
|
)
|
|
|
(2,327
|
)
|
|
|
-
|
|
Municipal loans
|
|
|
(65
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer loans
|
|
|
(194
|
)
|
|
|
(238
|
)
|
|
|
(132
|
)
|
|
|
(178
|
)
|
|
|
(122
|
)
|
Total charge-offs
|
|
|
(616
|
)
|
|
|
(2,127
|
)
|
|
|
(2,440
|
)
|
|
|
(6,470
|
)
|
|
|
(2,026
|
)
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential real estate
|
|
|
202
|
|
|
|
20
|
|
|
|
41
|
|
|
|
10
|
|
|
|
6
|
|
Construction and land
|
|
|
523
|
|
|
|
4
|
|
|
|
4
|
|
|
|
-
|
|
|
|
200
|
|
Commercial real estate
|
|
|
-
|
|
|
|
-
|
|
|
|
37
|
|
|
|
-
|
|
|
|
-
|
|
Commercial loans
|
|
|
20
|
|
|
|
12
|
|
|
|
14
|
|
|
|
17
|
|
|
|
72
|
|
Agriculture loans
|
|
|
-
|
|
|
|
39
|
|
|
|
35
|
|
|
|
10
|
|
|
|
-
|
|
Consumer loans
|
|
|
30
|
|
|
|
26
|
|
|
|
49
|
|
|
|
32
|
|
|
|
45
|
|
Total recoveries
|
|
|
775
|
|
|
|
101
|
|
|
|
180
|
|
|
|
69
|
|
|
|
323
|
|
Net recoveries (charge-offs)
|
|
|
159
|
|
|
|
(2,026
|
)
|
|
|
(2,260
|
)
|
|
|
(6,401
|
)
|
|
|
(1,703
|
)
|
Balances at end of year
|
|
$
|
5,540
|
|
|
$
|
4,581
|
|
|
$
|
4,707
|
|
|
$
|
4,967
|
|
|
$
|
5,468
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses as a percent of total gross loans outstanding
|
|
|
1.32
|
%
|
|
|
1.43
|
%
|
|
|
1.50
|
%
|
|
|
1.60
|
%
|
|
|
1.57
|
%
|
Net loans (recovered) charged off as a percent of average net loans outstanding
|
|
|
(0.05
|
%)
|
|
|
0.66
|
%
|
|
|
0.74
|
%
|
|
|
1.93
|
%
|
|
|
0.48
|
%
|
During 2013, we had
net loan recoveries of $159,000. The net loan recoveries were primarily associated with a previously charged-off $4.3 million
construction loan and recoveries on the payoff of a one-to-four family residential real estate loan which had been partially charged-off
as part of a TDR in 2010. 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 TDRs, resulting in charge-offs
to reduce the loans down to the market value of the collateral. The net loan charge-offs in 2011 and 2010 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 $3.3 million in 2010 and the remaining $1.0 million balance on this loan in
2011. We recovered a portion of this loan in 2013 and continue to pursue additional 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. In addition to the construction loan noted above, the 2010 charge-offs
were primarily related to a $2.4 million agriculture loan. The 2009 charge-offs were primarily related to a commercial loan relationship
that was liquidated in bankruptcy.
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,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
|
|
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
|
|
$
|
732
|
|
|
|
29.8
|
%
|
|
$
|
714
|
|
|
|
27.6
|
%
|
|
$
|
560
|
|
|
|
25.2
|
%
|
|
$
|
395
|
|
|
|
25.6
|
%
|
|
$
|
625
|
|
|
|
25.7
|
%
|
Construction and land
|
|
|
1,343
|
|
|
|
5.7
|
%
|
|
|
1,214
|
|
|
|
7.3
|
%
|
|
|
928
|
|
|
|
6.9
|
%
|
|
|
1,193
|
|
|
|
7.6
|
%
|
|
|
1,326
|
|
|
|
10.6
|
%
|
Commercial real estate
|
|
|
1,970
|
|
|
|
28.5
|
%
|
|
|
1,313
|
|
|
|
27.7
|
%
|
|
|
1,791
|
|
|
|
29.8
|
%
|
|
|
1,571
|
|
|
|
29.6
|
%
|
|
|
705
|
|
|
|
28.6
|
%
|
Commercial loans
|
|
|
769
|
|
|
|
14.6
|
%
|
|
|
707
|
|
|
|
20.1
|
%
|
|
|
745
|
|
|
|
18.1
|
%
|
|
|
1,173
|
|
|
|
18.4
|
%
|
|
|
623
|
|
|
|
17.6
|
%
|
Agriculture loans
|
|
|
545
|
|
|
|
14.9
|
%
|
|
|
367
|
|
|
|
10.0
|
%
|
|
|
433
|
|
|
|
12.4
|
%
|
|
|
397
|
|
|
|
12.5
|
%
|
|
|
2,103
|
|
|
|
11.0
|
%
|
Municipal loans
|
|
|
47
|
|
|
|
2.1
|
%
|
|
|
107
|
|
|
|
3.1
|
%
|
|
|
130
|
|
|
|
3.3
|
%
|
|
|
99
|
|
|
|
1.7
|
%
|
|
|
-
|
|
|
|
1.6
|
%
|
Consumer loans
|
|
|
134
|
|
|
|
4.4
|
%
|
|
|
159
|
|
|
|
4.2
|
%
|
|
|
120
|
|
|
|
4.3
|
%
|
|
|
139
|
|
|
|
4.6
|
%
|
|
|
86
|
|
|
|
4.9
|
%
|
Total
|
|
$
|
5,540
|
|
|
|
100.0
|
%
|
|
$
|
4,581
|
|
|
|
100.0
|
%
|
|
$
|
4,707
|
|
|
|
100.0
|
%
|
|
$
|
4,967
|
|
|
|
100.0
|
%
|
|
$
|
5,468
|
|
|
|
100.0
|
%
|
The increase in the
allocation of the allowance for loan losses on our one-to-four family residential real estate loans during 2013 and 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, 2009 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 2013 and 2012 as a result of increases in loan balances
and 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 increased in 2013 as a result of higher outstanding loan balances while the 2012 decline was the result of lower
outstanding loan balances. 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 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 of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
As of December 31, 2013, we believed the Company’s allowance for loan losses continued to be adequate based on the Company’s
evaluation of the loan portfolio’s inherent risk.
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,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
Non-interest bearing demand
|
|
$
|
90,964
|
|
|
|
|
|
|
$
|
75,828
|
|
|
|
|
|
|
$
|
59,859
|
|
|
|
|
|
Money market and NOW accounts
|
|
|
222,112
|
|
|
|
0.08
|
%
|
|
|
203,741
|
|
|
|
0.15
|
%
|
|
|
171,295
|
|
|
|
0.22
|
%
|
Savings accounts
|
|
|
52,933
|
|
|
|
0.03
|
%
|
|
|
44,289
|
|
|
|
0.07
|
%
|
|
|
36,004
|
|
|
|
0.13
|
%
|
Certificates of deposit
|
|
|
167,191
|
|
|
|
0.70
|
%
|
|
|
178,508
|
|
|
|
1.01
|
%
|
|
|
178,364
|
|
|
|
1.31
|
%
|
Total
|
|
$
|
533,200
|
|
|
|
|
|
|
$
|
502,366
|
|
|
|
|
|
|
$
|
445,522
|
|
|
|
|
|
The following table presents the maturities
of jumbo certificates of deposit (amounts of $100,000 or more).
(Dollars in thousands)
|
|
As of December 31,
|
|
|
|
2013
|
|
|
2012
|
|
Three months or less
|
|
$
|
17,259
|
|
|
$
|
17,110
|
|
Over three months through six months
|
|
|
9,928
|
|
|
|
10,287
|
|
Over six months through 12 months
|
|
|
15,424
|
|
|
|
15,896
|
|
Over 12 months
|
|
|
17,631
|
|
|
|
15,742
|
|
Total
|
|
$
|
60,242
|
|
|
$
|
59,035
|
|
VI. Return on Equity
and Assets
The following table presents information
on return on average equity, return on average assets, equity to total assets and our dividend payout ratio.
|
|
As of or for the years ended December 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
Return on average assets
|
|
|
0.70
|
%
|
|
|
1.01
|
%
|
|
|
0.78
|
%
|
Return on average equity
|
|
|
7.33
|
%
|
|
|
10.34
|
%
|
|
|
7.98
|
%
|
Equity to total assets
|
|
|
7.57
|
%
|
|
|
10.31
|
%
|
|
|
9.88
|
%
|
Dividend payout ratio
|
|
|
48.32
|
%
|
|
|
33.33
|
%
|
|
|
44.72
|
%
|
VII. Short-term
Borrowings
Information on short-term borrowings is
excluded as the average balances of each category of short-term borrowings was less than 30 percent of stockholders’ equity
at December 31, 2013, 2012 and 2011.
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.
We operate in a highly
regulated industry and the laws and regulations to which we are subject, or changes in them, or our failure to comply with them,
may adversely affect us.
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.
Economic conditions
in recent years, 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.
Recent legislative
and regulatory reforms applicable to the financial services industry may have a significant impact on our business, financial
condition and results of operations.
The laws, regulations,
rules, policies and regulatory interpretations governing us are constantly evolving and may change significantly over time as
Congress and various regulatory agencies react to adverse economic conditions or other matters. The global financial crisis of
2008–09 served as a catalyst for a number of significant changes in the financial services industry, including the Dodd-Frank
Act, which reformed the regulation of financial institutions in a comprehensive manner, and the Basel III regulatory capital reforms,
which will increase both the amount and quality of capital that financial institutions must hold.
The Dodd-Frank Act,
together with the regulations developed and to be developed thereunder, affects large and small financial institutions alike,
including several provisions that impact how community banks, thrifts and small bank and thrift holding companies will operate
in the future. Among other things, the Dodd-Frank Act changes the base for FDIC insurance assessments to a bank’s average
consolidated total assets minus average tangible equity, rather than its deposit base, permanently raises the current standard
deposit insurance limit to $250,000, and expands the FDIC’s authority to raise the premiums we pay for deposit insurance.
The legislation allows financial institutions to pay interest on business checking accounts, contains provisions on mortgage-related
matters (such as steering incentives, determinations as to a borrower’s ability to repay and prepayment penalties) and establishes
the CFPB as an independent entity within the Federal Reserve. This entity has broad rulemaking, supervisory and enforcement authority
over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit
cards. Moreover, the Dodd-Frank Act includes provisions that affect corporate governance and executive compensation at all publicly
traded companies.
In addition, in July
2013, the U.S. federal banking authorities approved the implementation of the Basel III Rule. The Basel III Rule is applicable
to all U.S. banks that are subject to minimum capital requirements as well as to bank and saving and loan holding companies, other
than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $500 million).
The Basel III Rule not only increases most of the required minimum regulatory capital ratios, it introduces a new Common Equity
Tier 1 Capital ratio and the concept of a capital conservation buffer. The Basel III Rule also expands the current definition
of capital by establishing additional criteria that capital instruments must meet to be considered Additional Tier 1 Capital (i.e.,
Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that now generally qualify as Tier 1
Capital will not qualify or their qualifications will change when the Basel III Rule is fully implemented. However, the Basel
III Rule permits banking organizations with less than $15 billion in assets to retain, through a one-time election, the existing
treatment for accumulated other comprehensive income, which currently does not affect regulatory capital. The Basel III Rule has
maintained the general structure of the current prompt corrective action thresholds while incorporating the increased requirements,
including the Common Equity Tier 1 Capital ratio. In order to be a “well-capitalized” depository institution under
the new regime, an institution must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more, a Tier 1 Capital ratio of 8%
or more, a Total Capital ratio of 10% or more, and a leverage ratio of 5% or more. Institutions must also maintain a capital conservation
buffer consisting of Common Equity Tier 1 Capital. Generally, financial institutions will become subject to the Basel III Rule
on January 1, 2015 with a phase-in period through 2019 for many of the changes.
The implementation of
these provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to
the financial industry, will impact the profitability of our business activities and may 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 is actively reviewing
the provisions of the Dodd-Frank Act and the Basel III Rule, many of which are to be phased-in over the next several months and
years, and assessing the probable impact on our operations. However, the ultimate effect of these changes on the financial services
industry in general, and us in particular, is uncertain at this time.
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 levels above historical norms, including in the state of Kansas, where most of our customers are located. In addition, local
governments and many businesses continue to experience difficulty due to suppressed levels of consumer spending and 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 had a significant negative impact on the capitalization level of the DIF, which, in turn, 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.
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.
In the past 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, 2013 and 2012 our allowance for loan losses as a percentage of total loans
was 1.32% and 1.43%, respectively, and as a percentage of total non-performing loans was 56.32% and 50.30%, respectively. Although
management believes that the allowance for loan losses is appropriate to absorb probable 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.
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 $125.1 million and $88.5 million, or 29.8% and 27.6%, of our loan portfolio at December 31,
2013 and 2012, 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.
Depressed residential
real estate market prices and historically lower levels of home sales of recent years, have 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 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.
Although this development has not meaningfully impacted our interest expense in the current low-rate,
high-liquidity environment in which competition among financial institutions for deposits is generally low, if
competitive
pressures
in the future
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.
Commercial loans make up a significant
portion of our loan portfolio.
Commercial
loans comprised $61.4 million and $64.6 million, or 14.6% and 20.1%, of our loan portfolio at December 31, 2013 and 2012, 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 $35.2 million and $25.8 million, or 8.4% and 8.1%, of our loan portfolio at December 31, 2013 and 2012, 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, 2013 and 2012, agricultural real estate loans totaled $27.1 million and $6.1 million,
or 6.5% and 1.9% of our total loan portfolio, respectively. The increase was primarily a result of our acquisition of Citizens
Bank during 2013. 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, southeast and
southwest Kansas.
We operate primarily
in eastern, central, southeast and southwest 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 Citizens Bank could result in the loss of key employees of Citizens 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 Citizens 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. Also, technology and other changes have lowered barriers to entry and made it
possible for non-banks to offer products and services traditionally provided by banks. For example, consumers can maintain funds
that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions
such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries,
known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and
the related income generated from those deposits. 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 “Item 7.A Quantitative and Qualitative Disclosures About Market Risk.” 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.
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 declines in value that are considered other-than-temporary.
If the credit quality of the securities in our investment portfolio 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, 2013, we had
$144.3 million of municipal securities, which represented 48.0% of our total securities portfolio. With the economic crisis that
began to unfold in 2008, several of these insurers came 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.
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 continue to improve, 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, 2013, our non-performing
loans (which consist of non-accrual loans and loans past due 90 days or more and still accruing interest) totaled 9.8 million,
or 2.35% of our loan portfolio, and our non-performing assets (which include non-performing loans plus real estate owned) totaled
$10.2 million, or 1.24% of total assets. In addition, we had $1.4 million in accruing loans that were 30-89 days delinquent
as of December 31, 2013.
Our non-performing assets adversely affect
our net income in various ways. We do not record interest income on non-accrual 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 $268.3
million, or approximately 64.0% of our total loan portfolio as of December 31, 2013, as compared to $200.7 million, or approximately
62.6%, as of December 31, 2012. 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 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 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. 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 $21.7 million
of subordinated debentures are held by three 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.
We are subject to changes in accounting
principles, policies or guidelines.
Our financial performance
is impacted by accounting principles, policies and guidelines. Some of these policies require the use of estimates and assumptions
that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because
they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because
it is likely that materially different amounts would be reported under different conditions or using different assumptions. If
such estimates or assumptions underlying our financial statements are incorrect, we may experience material losses.
From time to time,
the Financial Accounting Standards Board and the SEC change the financial accounting and reporting standards or the interpretation
of those standards that govern the preparation of our financial statements. These changes are beyond our control, can be difficult
to predict and could materially impact how we report our financial condition and results of operations. Changes in these standards
are continuously occurring, and given recent economic conditions, more drastic changes may occur. The implementation of such changes
could have a material adverse effect on our financial condition and results of operations.
Our framework for managing risks may
not be effective in mitigating risk and loss to us.
Our risk management
framework seeks to mitigate risk and loss to us. We have established processes and procedures intended to identify, measure, monitor,
report and analyze the types of risk to which we are subject, including liquidity risk, credit risk, market risk, interest rate
risk, operational risk, compensation risk, legal and compliance risk, and reputational risk, among others. However, as with any
risk management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in
the future, risks that we have not appropriately anticipated or identified. Our ability to successfully identify and manage risks
facing us is an important factor that can significantly impact our results. If our risk management framework proves ineffective,
we could suffer unexpected losses and could be materially adversely affected.
We are subject to environmental liability
risk associated with lending activities.
A significant portion
of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title
to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these
properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury
and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s
value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or
enforcement policies with respect to existing laws may increase our exposure to environmental liability. Environmental reviews
of real property before initiating foreclosure actions may not be sufficient to detect all potential environmental hazards. The
remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect
on our business, financial condition and results of operations.
Financial services companies depend
on the accuracy and completeness of information about customers and counterparties.
In deciding whether
to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties,
including financial statements, credit reports and other financial information. We may also rely on representations of those customers,
counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information.
Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material
adverse impact on our business, financial condition and results of operations.