Toggle SGML Header (+)


Section 1: 10-K (FORM 10-K)

lmst20191231_10k.htm
 

Table of Contents


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-K


 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

   
  For the Fiscal Year Ended December 31, 2019

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

  For the transition period from              to             

 

Commission file number: 001-33033

 


LIMESTONE BANCORP, INC.

(Exact name of registrant as specified in its charter)


 

Kentucky

61-1142247

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer Identification No.)

 

2500 Eastpoint Parkway, Louisville, Kentucky

40223

(Address of principal executive offices)

(Zip Code)

 

Registrant’s telephone number, including area code: (502) 499-4800

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, no par value

LMST

Nasdaq Capital Market

 

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act).    Yes  ☐    No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No  ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “accelerated filer,” “large accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer  ☐ Accelerated filer  ☒     Non-accelerated filer  ☐    Smaller reporting company  ☒  Emerging growth company  ☐

           

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act.    Yes  ☐    No  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the close of business on June 30, 2019, was $79,993,646 based upon the last sales price reported (for purposes of this calculation, the market value of non-voting common shares was based on the market value of the common shares into which they are convertible upon transfer).

6,271,143 Common Shares and 1,220,000 Non-Voting Common Shares were outstanding as of February 28, 2020.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held June 17, 2020 are incorporated by reference into Part III of this Form 10-K.

 



 

 

 

 

TABLE OF CONTENTS

 

 

 

Page No.

PART I

 

1

Item 1.

Business

1

Item 1A.

Risk Factors

9

Item 1B.

Unresolved Staff Comments

17

Item 2.

Properties

17

Item 3.

Legal Proceedings

17

Item 4.

Mine Safety Disclosures

18

     

PART II

 

19

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

19

Item 6.

Selected Financial Data

21

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operation

22

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

47

Item 8.

Financial Statements and Supplementary Data

49

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

92

Item 9A.

Controls and Procedures

92

Item 9B.

Other Information

92

     

PART III

 

93

Item 10.

Directors, Executive Officers and Corporate Governance

93

Item 11.

Executive Compensation

93

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

93

Item 13.

Certain Relationships and Related Transactions, and Director Independence

93

Item 14.

Principal Accounting Fees and Services

93

     

PART IV

 

94

Item 15.

Exhibits. Financial Statement Schedules

94

Item 16.

Form 10-K Summary

94

 

Index to Exhibits

95

     

 

Signatures

97

 

 

 

 

 

PART I

 

Preliminary Note Concerning Forward-Looking Statements

 

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express the Company’s beliefs, assumptions and expectations of its future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

 

Forward-looking statements involve risks and uncertainties that may cause the Company’s actual results to differ materially from the expectations of future results management expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be beyond the Company’s control. Factors that could contribute to differences in the Company’s results include, but are not limited to deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses; changes in the interest rate environment, which may reduce the Company’s margins or impact the value of securities, loans, deposits and other financial instruments; changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments; general economic or business conditions, either nationally, regionally or locally in the communities the Bank serves, may be worse than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit; the results of regulatory examinations; any matter that would cause us to conclude that there was impairment of any asset, including intangible assets; the continued service of key management personnel; the Company’s ability to attract, motivate and retain qualified employees; factors that increase the competitive pressure among depository and other financial institutions, including product and pricing pressures; the ability of the Company’s competitors with greater financial resources to develop and introduce products and services that enable them to compete more successfully than us; inability to comply with regulatory capital requirements and to secure any required regulatory approvals for capital actions; legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry; future acquisitions; integrations and performance of acquired businesses; and fiscal and governmental policies of the United States federal government.

 

Other risks are detailed in Item 1A. “Risk Factors” of this Form 10-K all of which are difficult to predict and many of which are beyond the Company’s control.

 

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.

 

Item 1.

Business

 

As used in this report, references to “the Company,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Limestone Bancorp, Inc. and its wholly-owned subsidiary. The “Bank” refers to Limestone Bancorp, Inc.’s bank subsidiary, Limestone Bank, Inc.

 

The Company is a bank holding company headquartered in Louisville, Kentucky. The Company’s common stock is traded on Nasdaq’s Capital Market under the symbol LMST. The Company operates Limestone Bank (the Bank), its wholly owned subsidiary and the eighth largest bank domiciled in the Commonwealth of Kentucky based on total assets. The Bank operates banking offices in 14 counties in Kentucky. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Bullitt and Henry. The Bank serves south central, southern, and western Kentucky from banking centers in Barren, Butler, Daviess, Edmonson, Green, Hardin, Hart, Ohio, and Warren counties. The Bank also has banking centers in Lexington, Kentucky, the second largest city in the state, and Frankfort, Kentucky, the state capital. The Bank is a traditional community bank with a wide range of personal and business banking products and services. As of December 31, 2019, the Company had total assets of $1.25 billion, total loans of $926.3 million, total deposits of $1.03 billion and stockholders’ equity of $105.8 million.

 

Markets

 

The Bank operates in markets that include the four largest cities in Kentucky – Louisville, Lexington, Bowling Green and Owensboro – and in other communities along the I-65, Western Kentucky Parkway, and Natcher Parkway corridors.

 

 

Louisville/Jefferson, Bullitt and Henry Counties: The Company’s headquarters are in Louisville, the largest city in Kentucky. The Bank also has banking offices in Bullitt County, south of Louisville, and Henry County, east of Louisville. The Company’s banking offices in these counties also serve the contiguous counties of Spencer, Shelby and Oldham to the east and northeast of Louisville. The area’s major employers are diversified across many industries and include the air hub for United Parcel Service (“UPS”), two Ford assembly plants, Humana, Norton Healthcare, Brown-Forman, YUM! Brands, Papa John’s Pizza, and Texas Roadhouse.

 

1

 

 

Lexington/Fayette County: Lexington, located in Fayette County, is the second largest city in Kentucky. Lexington is the financial, educational, retail, healthcare and cultural hub for Central and Eastern Kentucky. It is known worldwide for its horse farms and Keeneland Race Track, and proudly boasts of itself as “The Horse Capital of the World”. It is also the home of the University of Kentucky and Transylvania University. The area’s major employers include Toyota, Lexmark, IBM Global Services and Valvoline.

 

 

Frankfort/Franklin County: Frankfort, located along Interstate 64 in Franklin County, is the capital of the Commonwealth of Kentucky and the seat of Franklin County. Frankfort is home to Kentucky’s General Assembly or Legislature which consists of the Kentucky Senate and the Kentucky House of Representatives.  Frankfort is also the home of the Kentucky State University and major employers including Montaplast of North America, Inc., Buffalo Trace Distillery, Topy Corporation, Beam, Inc., and Nashville Wire Products.

 

 

Southern Kentucky: This market includes Bowling Green, the third largest city in Kentucky, located about 120 miles south of Louisville and 60 miles north of Nashville, Tennessee. Bowling Green, located in Warren County, is the home of Western Kentucky University and is the economic hub of the area. This market also includes communities in the contiguous Barren County, including the city of Glasgow. Major employers in Barren and Warren Counties include General Motor’s Corvette plant, automotive supply chain manufacturers, and R.R. Donnelley’s regional printing facility.

 

 

Owensboro/Daviess County: Owensboro, located on the banks of the Ohio River, is Kentucky’s fourth largest city. The city is called a festival city, with over 20 annual community celebrations that attract visitors from around the world, including its world famous Bar-B-Q Festival which attracts over 80,000 visitors. It is an industrial, medical, retail and cultural hub for Western Kentucky and the area employers include Owensboro Medical System, US Bank Home Mortgage, Titan Contracting, Specialty Food Group, and Toyotetsu.

 

 

South Central Kentucky: South of the Louisville metropolitan area, the Bank has banking offices in Butler, Edmonson, Green, Hardin, Hart, and Ohio Counties. This region includes stable community markets comprised primarily of agricultural and service-based businesses. Each of the Company’s banking offices in these markets has a stable customer and core deposit base.

 

Products and Services 

 

The Bank meets its customers’ banking needs with a broad range of financial products and services. Its lending services include real estate, commercial, mortgage, agriculture, and consumer loans to those in its communities and to small to medium-sized businesses, the owners and employees of those businesses, as well as other executives and professionals. We complement the Company’s lending operations with an array of retail and commercial deposit products. In addition, the Company offers customers drive-through banking facilities, automatic teller machines, night depository, personalized checks, credit cards, debit cards, internet banking, mobile banking, treasury management services, remote deposit services, electronic funds transfers through ACH services, domestic and foreign wire transfers, cash management and vault services, and loan and deposit sweep accounts.

 

Employees

 

At December 31, 2019, the Company had 244 full-time equivalent employees, and a total of 251 employees. The Company’s employees are not subject to a collective bargaining agreement, and management considers the Company’s relationship with employees to be good.

 

Recent Acquisitions 

 

On November 15, 2019, the Bank completed the acquisition of four branch banking centers located in the Kentucky cities of Elizabethtown, Frankfort, and Owensboro. The purchase included approximately $126.8 million in performing loans and $1.5 million in premises and equipment, as well as approximately $131.8 million in customer deposits. This acquisition allows the Bank to further optimize its branch footprint regionally and solidifies its presence and ability to serve customers in Daviess, Hardin, and Franklin counties. For further information, see Note 23 – Acquisitions to the financial statements in Item 8 of this report.

 

2

 

Competition

 

The banking business is highly competitive, and the Bank experiences competition from many other financial institutions and non-bank financial competitors. Competition is based upon interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the services offered, the convenience of banking facilities, the availability of technology channels and, in the case of loans to commercial borrowers, relative lending limits. The Bank competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions that operate offices within the Company’s market area and beyond.

 

Supervision and Regulation

 

Bank and Holding Company Laws, Rules and Regulations. The following is a summary description of the relevant laws, rules and regulations governing banks and bank holding companies. The descriptions of, and references to, the statutes and regulations below are brief summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.

 

The Dodd-Frank Act. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) was signed into law. The Dodd-Frank Act imposed new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions.

 

The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States. There are a number of reform provisions that significantly impact the ways in which banks and bank holding companies, including the Company and the Bank, do business. For example, regulations issued under the Dodd-Frank Act changed the assessment base for federal deposit insurance premiums by modifying the assessment base calculation to be based on a depository institution’s consolidated assets less tangible capital instead of deposits, and permanently increased the standard maximum amount of deposit insurance per customer to $250,000. The Dodd-Frank Act also imposed more stringent capital requirements on bank holding companies by, among other things, imposing leverage ratios on bank holding companies and prohibiting new trust preferred security issuances from counting as Tier I capital. The Dodd-Frank Act also repealed the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. The Dodd-Frank Act codified and expanded the Federal Reserve’s source of strength doctrine, which requires that all bank holding companies serve as a source of financial strength for its subsidiary banks. Other provisions of the Dodd-Frank Act include, but are not limited to: (i) the creation of the Consumer Financial Protection Bureau with rulemaking authority with respect to consumer protection laws; (ii) enhanced regulation of financial markets, including derivatives and securitization markets; (iii) reform related to the regulation of credit rating agencies; (iv) the elimination of certain trading activities by banks; and (v) new disclosure and other requirements relating to executive compensation and corporate governance. The implementation of the Dodd-Frank Act has resulted in greater compliance costs and higher fees paid to regulators.

 

Economic Growth, Regulatory Relief, and Consumer Protection Act. The Economic Growth, Regulatory Relief and Consumer Protection Act was signed into law on May 25, 2018. This Act amended certain provisions of the Dodd-Frank Act and other banking laws. The amendments are designed to provide regulatory relief to banking organizations, primarily small, community banking organizations, by adjusting thresholds at which increased regulatory requirements begin to apply. As implemented through regulations, community banking organizations with assets of less than $10 billion are now subject to reduced reporting requirements and, effective January 1, 2020, an optional simplified capital adequacy measure is available to those that have a leverage ratio greater than 9%.

 

Limestone Bancorp. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As such, the Company must file with the Federal Reserve Board annual and quarterly reports and other information regarding the Company’s business operations and the business operations of the Company’s subsidiaries. The Company is also subject to examination by the Federal Reserve Board and to operational guidelines established by the Federal Reserve Board. The Company is subject to the Bank Holding Company Act and other federal laws on the types of activities in which we may engage, and to other supervisory requirements, including regulatory enforcement actions for violations of laws and regulations.

 

Acquisitions. A bank holding company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of more than 5% of the voting stock or all or substantially all of the assets of a bank, merging or consolidating with any other bank holding company and before engaging, or acquiring a company that is not a bank and is engaged in certain non-banking activities. Federal law also prohibits a person or group of persons from acquiring “control” of a bank holding company without notifying the Federal Reserve Board in advance, and then may only do so if the Federal Reserve Board does not object to the proposed transaction. The Federal Reserve Board has established a rebuttable presumptive standard that the acquisition of 10% or more of the voting stock of a bank holding company would constitute an acquisition of control of the bank holding company for purposes of the Change in Bank Control Act. In addition, approval of the Federal Reserve Board is required before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of a bank holding company’s voting securities, or otherwise obtaining control or a “controlling influence” over a bank holding company.

 

3

 

Permissible Activities. A bank holding company is generally permitted under the Bank Holding Company Act to engage in or acquire direct or indirect control of more than 5% of the voting shares of any bank, bank holding company or company engaged in any activity that the Federal Reserve Board determines to be so closely related to banking as to be a proper incident to the business of banking.

 

Under current federal law, a bank holding company may elect to become a financial holding company, which enables the holding company to conduct activities that are “financial in nature,” incidental to financial activity, or complementary to financial activity that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Activities that are “financial in nature” include securities underwriting, dealing and market making in securities; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve Board has determined to be closely related to banking. No prior regulatory approval or notice is required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. The Bank has not filed an election to become a financial holding company.

 

Dividends. Under Federal Reserve Board policy, bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not declare a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.

 

The Company is a legal entity separate and distinct from the Bank. Historically, the majority of the Company’s revenue has been from dividends paid to it by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. If, in the opinion of a federal regulatory agency, an institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the agency may require, after notice and hearing, that the institution cease such practice. The federal banking agencies have indicated that paying dividends that deplete an institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), an insured institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the Federal Reserve and the FDIC have issued policy statements providing that bank holding companies and banks should generally pay dividends only out of current operating earnings. A bank holding company may still declare and pay a dividend if it does not have current operating earnings if the bank holding company expects profits for the entire year and the bank holding company obtains the prior consent of the Federal Reserve.

 

Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. The KDFI must approve the declaration of dividends if the total dividends to be declared by a bank for any calendar year would exceed the bank’s total net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. Additionally, retained earnings must be positive. The Company is also subject to the Kentucky Business Corporation Act, which generally prohibits dividends to the extent they result in the insolvency of the corporation from a balance sheet perspective or if the corporation is unable to pay its debts as they come due. The Bank did not pay any dividends in 2019 or 2018. The Bank has negative retained earnings and, as such, cannot pay dividends without prior regulatory approval.

 

Source of Financial Strength. Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to, and to commit resources to support, its bank subsidiaries. This support may be required at times when, absent such a policy, the bank holding company may not be inclined to provide it. In addition, any capital loans by the bank holding company to its bank subsidiaries are subordinate in right of payment to deposits and to certain other indebtedness of the bank subsidiary. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of subsidiary banks will be assumed by the bankruptcy trustee and entitled to a priority of payment. The Federal Reserve’s “Source of Financial Strength” policy was codified in the Dodd-Frank Act.

 

Limestone Bank. The Bank, a Kentucky chartered commercial bank, is subject to regular bank examinations and other supervision and regulation by both the FDIC and the KDFI. Kentucky’s banking statutes contain a “super-parity” provision that permits a well-rated Kentucky banking corporation to engage in any banking activity which could be engaged in by a national bank operating in Kentucky; a state bank, a thrift or savings bank operating in any other state; or a federal chartered thrift or federal savings association meeting the qualified thrift lender test and operating in any state could engage, provided the Kentucky bank first obtains a legal opinion specifying the statutory or regulatory provisions that permit the activity.

 

4

 

Capital Adequacy Requirements. The Company and the Bank are required to comply with capital adequacy guidelines. Guidelines are established by the Federal Reserve Board for the Company and the FDIC for the Bank. Both the Federal Reserve Board and the FDIC have substantially similar risk based and leverage ratio guidelines for banking organizations, which are intended to ensure that banking organizations have adequate capital related to the risk levels of assets and off-balance sheet instruments. The capital adequacy guidelines are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.

 

In July 2013, the Federal Reserve Board and the FDIC approved final rules that substantially amended the regulatory risk-based capital rules applicable to the Company and Bank. The final rules implement the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”) and changes required by the Dodd-Frank Act, and became effective for the Company and Bank on January 1, 2015.

  

The Basel III minimum capital level requirements applicable to bank holding companies and banks subject to the rules are  a common equity Tier 1 capital ratio of 4.5%, a Tier 1 risk-based capital ratio of 6%, a total risk-based capital ratio of 8%, and a Tier 1 leverage ratio of 4% for all institutions. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios, which was fully phased in as of January 1, 2019. With the capital conservation buffer fully phased in, the required ratios area common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%.

  

An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

Under the Basel III capital rules, Tier 1 capital generally consists of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. Tier 2 capital may consist of subordinated debt, certain hybrid capital instruments, qualifying preferred stock and a limited amount of the allowance for loan losses. Proceeds of trust preferred securities are excluded from Tier 1 capital unless issued before 2010 by an institution with less than $15 billion of assets. Total capital is the sum of Tier 1 and Tier 2 capital.

 

Prompt Corrective Action. Pursuant to the Federal Deposit Insurance Act (“FDIA”), the FDIC must take prompt corrective action to resolve the problems of undercapitalized institutions. FDIC regulations define the levels at which an insured institution would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”. A bank is “undercapitalized” if it fails to meet any one of the ratios required to be adequately capitalized. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. The degree of regulatory scrutiny increases and the permissible activities of a bank decrease, as the bank moves downward through the capital categories. Depending on a bank’s level of capital, the FDIC’s corrective powers include:

 

 

requiring a capital restoration plan;

 

 

placing limits on asset growth and restriction on activities;

 

 

requiring the bank to issue additional voting or other capital stock or to be acquired;

 

 

placing restrictions on transactions with affiliates;

 

 

restricting the interest rate the bank may pay on deposits;

 

 

ordering a new election of the bank’s board of directors;

 

 

requiring that certain senior executive officers or directors be dismissed;

 

 

prohibiting the bank from accepting deposits from correspondent banks;

 

 

requiring the bank to divest certain subsidiaries;

 

5

 

 

prohibiting the payment of principal or interest on subordinated debt; and

 

 

ultimately, appointing a receiver for the bank.

 

If an institution is required to submit a capital restoration plan, the institution’s holding company must guarantee the subsidiary’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy. The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.

 

Deposit Insurance Assessments. The deposits of the Bank are insured by the Deposit Insurance Fund (“DIF”) of the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”). Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits.

 

The Dodd-Frank Act imposed additional assessments and costs with respect to deposits. Under the Dodd-Frank Act, the FDIC imposes deposit insurance assessments based on total assets rather than total deposits. Pursuant to the Dodd-Frank Act, the FDIC revised the deposit insurance assessment system and implemented a revised assessment rate process with the goal of differentiating insured depository institutions who pose greater risk to the DIF.

 

Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to these matters. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of FDIA. See “Prompt Corrective Actions” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.

 

Incentive Compensation. The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets, such as Limestone Bancorp and Limestone Bank, that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, but the regulations have not been finalized. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which the Company may structure compensation for its executives.

 

In June 2010, the Federal Reserve, OCC, and FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. These three principles are incorporated into the proposed joint compensation regulations under the Dodd-Frank Act, discussed above.

 

6

 

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Limestone Bancorp, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.

 

Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

 

Branching. Kentucky law permits Kentucky chartered banks to establish a banking office in any county in Kentucky. A Kentucky bank may also establish a banking office outside of Kentucky. Well capitalized Kentucky banks that have been in operation at least three years and satisfy certain criteria relating to, among other things, their composite and management ratings, may establish a banking office in Kentucky without the approval of the KDFI upon notice to the KDFI and any other state bank with its main office located in the county where the new banking office will be located. Otherwise, branching requires the approval of the KDFI, which must ascertain and determine that the public convenience and advantage will be served and promoted and that there is reasonable probability of the successful operation of the banking office. The transaction must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers.

 

Section 613 of the Dodd-Frank Act effectively eliminated the interstate branching restrictions set forth in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Banks located in any state may now de novo branch in any other state, including Kentucky. Such unlimited branching power may increase competition within the markets in which the Company and the Bank operate.

 

Insider Credit Transactions. The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured depository institutions and their subsidiaries. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests, which may not exceed the institution’s total unimpaired capital and surplus.

 

Consumer Protection Laws. The Bank is subject to federal consumer protection statues and regulations promulgated under those laws, including, but not limited to, the:

 

 

Truth-In-Lending Act and Regulation Z, governing disclosures of credit terms to consumer borrowers;

 

Home Mortgage Disclosure Act and Regulation C, requiring financial institutions to provide certain information about home mortgage and refinanced loans;

 

Real Estate Settlement Procedures Act (“RESPA”), requiring lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements and prohibiting certain abusive practices;

 

Secure and Fair Enforcement for Mortgage Licensing Act (“S.A.F.E. Act”), requiring residential loan originators who are employees of financial institutions to meet registration requirements;

 

Fair Credit Reporting Act and Regulation V, governing the provision of consumer information to credit reporting agencies and the use of consumer information;

 

Equal Credit Opportunity Act and Regulation B, prohibiting discrimination on the basis of race, religion or other prohibited factors in the extension of credit;

 

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

 

Truth in Savings Act, which requires disclosure of deposit terms to consumers;

 

Regulation CC, which relates to the availability of deposit funds to consumers;

 

Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

 

Automated Overdraft Payment Regulations and Regulation E, requiring financial institutions to provide customer notices, monitor overdraft payment programs, and prohibiting financial institutions from charging consumer fees for paying overdrafts on automated teller machine and one time debit card transactions unless a consumer consents, or opts in to the service for those types of transactions.

 

7

 

The Dodd-Frank Act created the Consumer Financial Protection Bureau, which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB, but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive acts or practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Economic Growth, Regulatory Relief and Consumer Protection Act created a qualified mortgage safe harbor for eligible loans that are originated and retained by a bank with total assets of less than $10 billion.

 

The Dodd-Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. Federal preemption of state consumer protection law requirements, traditionally an attribute of the federal savings association charter, has also been modified by the Dodd-Frank Act and now requires a case-by-case determination of preemption by the Office of the Comptroller of the Currency (“OCC”) and eliminates preemption for subsidiaries of a bank. Depending on the implementation of this revised federal preemption standard, the operations of the Bank could become subject to additional compliance burdens in the states in which it operates.

 

Loans to One Borrower. Under current limits, loans and extensions of credit outstanding at one time to a single borrower and not fully secured generally may not exceed 20% of an institution’s unimpaired capital and unimpaired surplus. Loans and extensions of credit fully secured by collateral may represent an additional 10% of unimpaired capital and unimpaired surplus.

 

Volcker Rule. On December 10, 2013, the final Volcker Rule under the Dodd-Frank Act was approved and implemented by the Federal Reserve Board, the FDIC, the Securities and Exchange Commission (“SEC”), and the Commodity Futures Trading Commission. The Volcker Rule places limits on the trading activity of insured depository institutions and entities affiliated with a depository institution, subject to certain exceptions, and restricts them from engaging in hedging activities that do not hedge a specific identified risk. On October 8, 2019, the Federal Reserve and Securities and SEC finalized changes to the Volcker Rule, under which the most stringent regulations will apply to banks with the most trading assets and liabilities, while banks with significantly less trading activity will have fewer rules to abide by. The rule goes into effect on January 1, 2020, with a compliance date of January 1, 2021. The Economic Growth Regulatory Relief and Consumer Protection Act exempted banks, like the Bank, which have less than $10 billion in assets and no material trading assets and liabilities from the Volcker Rule.

 

Privacy. Federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.

 

Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the FDIC to assess the Company’s record in meeting the credit needs of the communities the Bank serves, including low- and moderate-income neighborhoods and persons. The FDIC’s assessment of the Company’s record is made available to the public. The assessment also is part of the Federal Reserve Board’s consideration of applications to acquire, merge or consolidate with another banking institution or its holding company, to establish a new banking office or to relocate an office.

 

Bank Secrecy Act. The Bank Secrecy Act of 1970 (“BSA”) was enacted to deter money laundering, establish regulatory reporting standards for currency transactions and improve detection and investigation of criminal, tax and other regulatory violations. BSA and subsequent laws and regulations require us to take steps to prevent the use of the Bank in the flow of illegal or illicit money, including, without limitation, ensuring effective management oversight, establishing sound policies and procedures, developing effective monitoring and reporting capabilities, ensuring adequate training and establishing a comprehensive internal audit of BSA compliance activities. In recent years, federal regulators have increased the attention paid to compliance with the provisions of BSA and related laws, with particular attention paid to “Know Your Customer” practices. Banks have been encouraged by regulators to enhance their identification procedures prior to accepting new customers in order to deter criminal elements from using the banking system to move and hide illegal and illicit activities.

 

8

 

USA Patriot Act. The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism. This includes standards for verifying customer identification at account opening, as well as rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. It grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on the operations of financial institutions. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

 

Effect on Economic Environment. The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and bank subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations 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. Their use may affect interest rates charged on loans or paid for deposits.

 

Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the Company’s business and earnings and those of the Company’s subsidiaries cannot be predicted.

 

Legislative and Regulatory Initiatives. From time to time various laws, regulations and governmental programs affecting financial institutions and the financial industry are introduced in Congress or otherwise promulgated by regulatory agencies. Such measures may change the environment in which the Company and its subsidiaries operate in substantial and unpredictable ways. The nature and extent of future legislative, regulatory or other changes affecting financial institutions are unpredictable at this time. Future legislation, policies and the effects thereof might have a significant influence on overall growth and distribution of loans, investments and deposits. They also may affect interest rates charged on loans or paid on time and savings deposits. New legislation and policies 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.

 

Available Information

 

The Company files periodic reports with the SEC including its annual report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K and proxy statements. The Bank’s Internet address is http://www.limestonebank.com. The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8, and amendments to those reports are accessible at no cost on its web site at http://www.limestonebank.com, under the Investors Relations section of the About Us tab, once they have been electronically filed with or furnished to the SEC. A shareholder may also request a copy of the Annual Report on Form 10-K free of charge upon written request to: Chief Financial Officer, Limestone Bancorp, Inc., 2500 Eastpoint Parkway, Louisville, Kentucky 40223. The Internet address of the Company is http://www.snl.com/IRW/CorporateProfile/1022071.

 

Item 1A. Risk Factors

 

An investment in the Company’s common stock involves a number of risks. Realization of any of the risks described below could have a material adverse effect on the Company’s business, financial condition, results of operations, cash flow and/or future prospects.

 

The Company’s business may be adversely affected by conditions in the financial markets and by economic conditions generally.

 

Weakness in business and economic conditions generally or specifically in the Company’s markets may have one or more of the following adverse effects on the Company’s business:

 

 

A decrease in the demand for loans and other products and services the Bank offers;

 

A decrease in the value of collateral securing the Bank’s loans; and

 

An increase in the number of customers who become delinquent, file for protection under bankruptcy laws or default on their loans.

 

Adverse conditions in the general business environment have had an adverse effect on the Company’s business in the past. Although the general business environment has improved, management cannot predict how long such improvement can be sustained. In addition, the improvement of certain economic indicators, such as real estate asset values, rents, and unemployment, may vary between geographic markets and may continue to lag behind improvement in the overall economy. These economic indicators typically affect the real estate and financial services industries, in which the Bank has a significant number of customers, more significantly than other economic sectors. Furthermore, the Bank has a substantial lending business that depends upon the ability of borrowers to make debt service payments on loans. Should economic conditions worsen, the Company’s business, financial condition or results of operations could be adversely affected.

 

9

 

The Bank’s profitability depends significantly on local economic conditions.

 

Most of the Bank’s business activities are conducted in central Kentucky and most of its credit exposure is in that region. The Bank is at risk from adverse economic or business developments affecting this area, including declining regional and local business and employment activity, a downturn in real estate values and agricultural activities and natural disasters. To the extent the central Kentucky economy weakens, delinquency rates, foreclosures, bankruptcies and losses in the Bank’s loan portfolio will likely increase. Moreover, the value of real estate or other collateral that secures the loans could be adversely affected by the economic downturn or a localized natural disaster. Events that adversely affect business activity and real estate values in central Kentucky have had in the past and may in the future to have a negative impact on the Bank’s business, financial condition, results of operations and future prospects.

 

Small to medium-sized business portfolio may have fewer resources to weather a downturn in the economy.

 

The loan portfolio includes loans to small and medium-sized businesses and other commercial enterprises. Small and medium-sized businesses frequently have smaller market shares than their competitors, may be more vulnerable to economic downturns, often need additional capital to expand or compete and may experience variations in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small or medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay the loan. A continued economic downturn may have a more pronounced negative impact on the target market, causing the Bank to incur substantial credit losses that could materially harm operating results.

 

The Bank’s decisions regarding credit risk may not be accurate, and its allowance for loan losses may not be sufficient to cover actual losses, which could adversely affect its business, financial condition and results of operations.

 

The Bank maintains an allowance for loan losses at a level management believes is adequate to absorb probable incurred losses in the loan portfolio based on historical loan loss experience, economic and environmental factors, specific problem loans, value of underlying collateral and other relevant factors. If management’s assessment of these factors is ultimately inaccurate, the allowance may not be sufficient to cover actual future loan losses, which would adversely affect operating results. Management’s estimates are subjective, and their accuracy depends on the outcome of future events. Changes in economic, operating, and other conditions that are generally beyond the Bank’s control could cause actual loan losses to increase significantly. In addition, bank regulatory agencies, as an integral part of their supervisory functions, periodically review the adequacy of the allowance for loan losses. Regulatory agencies may require an increase in provision for loan losses or to recognize additional loan charge-offs when their judgment differs. Any of these events could have a material negative impact on operating results.

 

Levels of classified loans and non-performing assets may increase in the future if economic conditions cause borrowers to default. Furthermore, the value of the collateral underlying a given loan, and the realizable value of such collateral in a foreclosure sale, may decline, making it less likely to realize a full recovery if a borrower defaults on a loan. Any increases in the level of non-performing assets, loan charge-offs or provision for loan losses, or the inability to realize the estimated net value of underlying collateral in the event of a loan default, could negatively affect the Bank’s business, financial condition, results of operations and the trading price of the Company’s common shares.

 

If the Bank experiences greater credit losses than anticipated, its operating results would be adversely affected.

 

As a lender, the Bank is exposed to the risk that borrowers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse effect on operating results. Credit risk with respect to the real estate and construction loan portfolio will relate principally to the creditworthiness of borrowers and the value of the real estate serving as security for the repayment of loans. Credit risk with respect to the commercial and consumer loan portfolio will relate principally to the general creditworthiness of businesses and individuals within the local markets.

 

Management makes various assumptions and judgments about the collectability of its loan portfolio and provides an allowance for estimated loss losses based on a number of factors. Management believes the Bank’s allowance for loan losses is adequate. However, if assumptions or judgments are wrong, the allowance for loan losses may not be sufficient to cover actual loan losses. Management may have to increase the allowance in the future at the request of one of the Bank’s primary regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of the loan portfolio. The actual amount of future provisions for loan losses cannot be determined at this time and may vary from the amounts of past provisions.

 

10

 

A large percentage of the Bank’s loans are collateralized by real estate, and any prolonged weakness in the real estate market may result in losses and adversely affect profitability.

 

Approximately 75.3% of the Bank’s loan portfolio as of December 31, 2019, was comprised of commercial and residential loans collateralized by real estate. Adverse economic conditions could decrease demand for real estate and depress real estate values in the Company’s markets. Persistent weakness in the real estate market could significantly impair the value of loan collateral and the ability to sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it will become more likely that management would be required to increase the Bank’s allowance for loan losses. If during a period of depressed real estate values, management was required to liquidate the collateral securing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce the Bank’s profitability and adversely affect its financial condition.

 

The Bank offers real estate construction and development loans, which carry a higher degree of risk than other real estate loans. Weakness in the residential construction and commercial development real estate markets has in the past increased the non-performing assets in the Bank’s loan portfolio and its provision for loan loss expense. These impacts have had, and could have in the future, a material adverse effect on capital, financial condition and results of operations.

 

Approximately 7.0% of the Company’s loan portfolio as of December 31, 2019 consisted of real estate construction and development loans, down from 11.4% at December 31, 2018 and 8.1% at December 31, 2017. These loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and permanent financing or sale of the property. If the Bank is forced to foreclose on a project prior to its completion, it may not be able to recover the entire unpaid portion of the loan or it may be required to fund additional money to complete the project, or hold the property for an indeterminate period of time. Any of these outcomes may result in losses and adversely affect profitability and financial condition.

 

Residential construction and commercial development real estate activity in the Bank’s markets were affected by the challenging economic conditions that followed the financial crisis of 2008. Weakness in these sectors could lead to valuation adjustments to the loan portfolios and real estate owned. A weak real estate market could reduce demand for residential housing, which, in turn, could adversely affect real estate development and construction activities. Consequently, the longer challenging economic conditions persist, the more likely they are to adversely affect the ability of residential real estate development borrowers to repay loans and the value of property used as collateral for such loans.

 

The Bank may acquire or hold from time to time OREO properties, which could increase operating expenses and result in future losses to the Company.

 

In the past, the Bank has acquired and disposed of a significant amount of real estate as a result of foreclosure or by deed in lieu of foreclosure that is listed on the balance sheet as other real estate owned (“OREO”). An increase in the OREO portfolio increases the expenses incurred to manage and dispose of these properties, which sometimes includes funding construction required to facilitate sale.

 

Properties in the Company’s OREO portfolio are recorded at fair value, which represents the estimated sales price of the properties on the date acquired less estimated selling costs. Generally, in determining “fair value” an orderly disposition of the property is assumed, except where a different disposition strategy is expected. Significant judgment is required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current may change during periods of market volatility. Any decreases in market prices of real estate may lead to additional OREO write downs, with a corresponding expense in the statement of operations. Management evaluates OREO property values periodically and writes down the carrying value of the properties if and when the results of the Company’s analysis require it.

 

In response to market conditions and other economic factors, management may utilize alternative sale strategies other than orderly disposition as part of the Bank’s OREO disposition strategy, such as auctions or bulk sales. In this event, as a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from such sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of OREO properties. In addition, the disposition of OREO through alternative sales strategies could impact the fair value of comparable OREO properties remaining in the portfolio. Generally, state regulatory requirements limit the period a Bank is permitted to hold OREO to ten years. All OREO properties held by the Bank at December 31, 2019 are currently under contract for sale.

 

11

 

Profitability is vulnerable to fluctuations in interest rates.

 

Changes in interest rates could harm financial condition or results of operations. The results of operations depend substantially on net interest income, the difference between interest earned on interest-earning assets (such as investments and loans) and interest paid on interest-bearing liabilities (such as deposits and borrowings). Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic or international economic or political conditions. Factors beyond the Company’s control, such as inflation, recession, unemployment and money supply may also affect interest rates. If, as a result of decreasing interest rates, interest-earning assets mature or reprice more quickly than interest-bearing liabilities in a given period, net interest income may decrease. Likewise, net interest income may decrease if interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period as a result of increasing interest rates.

 

Fixed-rate loans increase the exposure to interest rate risk in a rising rate environment because interest-bearing liabilities may be subject to repricing before assets become subject to repricing. Fixed rate investment securities are subject to fair value declines as interest rates rise. Adjustable-rate loans decrease the risk associated with rising interest rates but involve other risks, such as the inability of borrowers to make higher payments in an increasing interest rate environment. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as the borrowers refinance their loans at lower interest rates, which could reduce net interest income and harm results of operations.

 

Changes to LIBOR may adversely impact the value of, and the return on, the Bank’s financial instruments that are indexed to LIBOR

 

On July 27, 2017, the U.K. Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR to the LIBOR administrator after 2021. The announcement also indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide LIBOR submissions to the LIBOR administrator or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable benchmark for certain financial instruments, what rate or rates may become accepted alternatives to LIBOR, or the effect of any such changes in views or alternatives on the values of the financial instruments, whose interest rates are tied to LIBOR. Uncertainty as to the nature of such potential changes, alternative reference rates, the elimination or replacement of LIBOR, or other reforms may adversely affect the value of, and the return on our financial instruments.

 

If the Bank cannot obtain adequate funding, it may not be able to meet the cash flow requirements of its depositors and borrowers, or meet the operating cash needs of the Company.

 

The Company’s liquidity policies and limits are established by the Board of Directors of the Bank, with operating limits managed and monitored by the Asset Liability Committee (“ALCO”), based upon analyses of the ratio of loans to deposits and the percentage of assets funded with non-core or wholesale funding. The ALCO regularly monitors the overall liquidity position of the Bank and the Company to ensure that various alternative strategies exist to meet unanticipated events that could affect liquidity. Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. If the Company’s liquidity policies and strategies do not work as well as intended, the Bank may be unable to make loans and repay deposit liabilities as they become due or are demanded by customers. The ALCO follows established board approved policies and monitors guidelines to diversify the Company’s wholesale funding sources to avoid concentrations in any one-market source. Wholesale funding sources include Federal funds purchased, securities sold under repurchase agreements, and Federal Home Loan Bank (“FHLB”) advances that are collateralized with mortgage-related assets.

 

The Bank maintains a portfolio of securities that can be used as a secondary source of liquidity. There are other available sources of liquidity, including additional collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or common shares in public or private transactions. If the Bank is unable to access any of these funding sources when needed, it might not be able to meet the needs of customers, which could adversely impact its financial condition, its results of operations, cash flows, and its level of regulatory-qualifying capital.

 

The Company may not be able to realize the value of its deferred tax assets.

 

Due to losses in prior years, the Company has a net operating loss carry-forward of $22.9 million, credit carry-forwards of $381,000, and other net deferred tax assets of $4.5 million. In order to realize the benefit of these tax losses, credits and deductions, the Company must generate substantial taxable income in future periods. Deferred tax assets are calculated using a federal corporate tax rate of 21%. Changes in tax laws and rates may affect deferred tax assets in the future. If lower federal corporate tax rates are enacted, net deferred tax assets would be reduced commensurate with the rate reduction. Additionally, should the Company need to raise additional capital by issuing new common shares or securities convertible into common shares, then depending on the number of common share equivalents issued, it could trigger a “change in control,” as defined by Section 382 of the Internal Revenue Code. Such an event could negatively impact or limit the ability to utilize net operating loss carry-forwards, credit loss carry-forwards, and other net deferred tax assets.

 

12

 

As a bank holding company, the Company depends on dividends and distributions paid to it by its banking subsidiary.

 

The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. The principal source of cash flow, from which we would fund any dividends paid to shareholders, has historically been dividends the Company receives from the Bank. Regulations of the FDIC and the KDFI govern the ability of the Bank to pay dividends and other distributions to the Company, and regulations of the Federal Reserve govern the ability to pay dividends or make other distributions to shareholders. Since the Bank will not be in a position to pay dividends to the Company without prior regulatory approval until retained earnings are positive, cash inflows for the Company are limited to proceeds from common stock, preferred stock, or debt issuances. See the “Item 1. Business” “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – Dividends.”

 

The Company’s senior debt is secured by the Bank’s common stock and contains financial covenants that must be maintained to avoid default.

 

The Company’s senior secured loan agreement is with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty.

 

The loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $2,500,000, (ii) the Company must maintain a total risk based capital ratio at least equal to 10% of risk-weighted assets, (iii) the Bank must maintain a total risk based capital ratio at least equal to 11% of risk-weighted assets, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of December 31, 2019.

 

Risk related to legal proceedings.

 

From time to time, the Company is involved in judicial, regulatory, and arbitration proceedings concerning matters arising from the Company’s business activities and fiduciary responsibilities. The Company establishes reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The Company may still incur legal costs for a matter even if a reserve has not been established. In addition, the actual cost of resolving a legal claim may be substantially higher than any amounts reserved for that matter. The ultimate resolution of a pending or future legal proceeding, depending on the remedy sought and granted, could materially adversely affect results of operations and financial condition.

 

Acquisitions may not produce revenue enhancements or cost savings at levels or within timeframes originally anticipated and may result in unforeseen integration difficulties.

 

The Company regularly explores opportunities to acquire banks, branches, financial institutions, or other financial services businesses or assets. The Company cannot predict the number, size or timing of acquisitions. Difficulty in integrating an acquired business or company may cause the Company not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of the Company’s business or the business of the acquired company, or otherwise adversely affect the Company’s ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also, the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected. The Company may also issue equity securities in connection with acquisitions, which could cause ownership and economic dilution to current shareholders.

 

The Company may sell capital stock in the future to raise additional capital or for additional liquidity. Future sales or other dilution of equity may adversely affect the market price of the Company’s common shares.

 

The issuance of additional common shares or securities convertible into common shares would dilute the ownership interest of the Company’s existing common shareholders. The market price of the Company’s common shares could decline as a result of such an offering as well as other sales of a large block of shares of common shares or similar securities in the market after such an offering, or the perception that such sales could occur. The Company’s common shares have traded from time-to-time at a price below book value per share. A sale of common shares at or below book value would be dilutive to current shareholders. The sale of shares at a price below market value could negatively impact the market price of the Company’s common shares.

 

13

 

FDIC deposit insurance premiums and assessments can impact non-interest expense.

 

The Bank’s deposits are insured by the FDIC up to legal limits and, accordingly, the Bank is subject to FDIC deposit insurance premiums and assessments. FDIC assessments for deposit insurance are based on the average total consolidated assets of the insured institution during the assessment period, less the average tangible equity of the institution during the assessment period. Any increase in assessment rates may adversely affect the Bank’s business, financial condition or results of operations.

 

The Bank faces strong competition from other financial institutions and financial service companies, which could adversely affect the results of operations and financial condition.

 

The Bank competes with other financial institutions in attracting deposits and making loans. The competition in attracting deposits comes principally from other commercial banks, credit unions, savings and loan associations, securities brokerage firms, insurance companies, money market funds, and other mutual funds. The competition in making loans comes principally from other commercial banks, credit unions, savings and loan associations, mortgage banking firms, and consumer finance companies. In addition, competition for business in the Louisville and Lexington metropolitan areas has grown in recent years as changes in banking law have allowed banks to enter those markets by establishing new branches.

 

Competition in the banking industry may also limit the ability to attract and retain banking clients. We maintain smaller staffs of associates and have fewer financial and other resources than larger institutions with which we compete. Financial institutions that have far greater resources and greater efficiencies than we do may have several marketplace advantages resulting from their ability to:

 

 

offer higher interest rates on deposits and lower interest rates on loans than we can;

 

offer a broader range of services than we do;

 

maintain more branch locations than we do; and

 

mount extensive promotional and advertising campaigns.

 

In addition, banks and other financial institutions with larger capitalization and other financial intermediaries may not be subject to the same regulatory restrictions and may have larger lending limits. Some of the Company’s current commercial banking clients may seek alternative banking sources as they develop needs for credit facilities larger than we can accommodate. If we are unable to attract and retain customers, we may not be able to maintain growth and the results of operations and financial condition may otherwise be negatively impacted.

 

The Company depends on its senior management team, and the unexpected loss of one or more of the senior executives could impair relationships with customers and adversely affect business and financial results.

 

Future success significantly depends on the continued services and performance of key management personnel. Future performance will depend on the ability to motivate and retain these and other key officers. The Dodd-Frank Act, and the policies of bank regulatory agencies have placed restrictions on executive compensation practices. Such restrictions and standards may further impact the ability to compete for talent with other businesses that are not subject to the same limitations. The loss of the services of members of senior management or other key officers or the inability to attract additional qualified personnel as needed could materially harm its business.

 

Reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates.

 

Accounting policies and assumptions are fundamental to the reported financial condition and results of operations. Management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner in which to report the financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in reporting materially different results than would have been reported under a different alternative.


Certain accounting policies are critical to presenting reported financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include the valuation of securities, allowance for loan losses, valuation of OREO and valuation of net deferred income tax asset. Because of the uncertainty of estimates involved in these matters, we may be required, among other things, to recognize other-than-temporary impairment on securities, significantly increase the allowance for credit losses, sustain credit losses that are higher than the reserve provided, recognize impairment on OREO, or permanently impair deferred tax assets.

 

14

 

While management continually monitors and improves the system of internal controls, data processing systems, and corporate wide processes and procedures, the Company may suffer losses from operational risk in the future.

 

Management maintains internal operational controls, and has invested in technology to help process large volumes of transactions. However, we may not be able to continue processing at the same or higher levels of transactions. If systems of internal controls should fail to work as expected, if systems were to be used in an unauthorized manner, or if employees were to subvert the system of internal controls, significant losses could occur.

 

The Company processes large volumes of transactions on a daily basis exposing it to numerous types of operational risk, which could cause us to incur substantial losses. Operational risk resulting from inadequate or failed internal processes, people, and systems includes the risk of fraud by employees or persons outside of the company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.

 

The Company establishes and maintains systems of internal operational controls that provide management with timely and accurate information about its level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost effective levels. We have also established procedures that are designed to ensure policies relating to conduct, ethics and business practices are followed. Nevertheless, we experience loss from operational risk from time to time, including the effects of operational errors, and these losses may be substantial.

 

Information systems may experience an interruption or security breach.

 

Failure in or breach of operational or security systems or infrastructure, or those of third party vendors and other service providers, including as a result of cyber-attacks, could disrupt the Bank’s businesses, result in the disclosure or misuse of confidential or proprietary information, damage its reputation, increase costs and cause losses. As a financial institution, the Bank depends on its ability to process, record and monitor a large number of customer transactions on a continuous basis. As customer, public and regulatory expectations regarding operational and information security have increased, operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Business, financial, accounting, data processing systems or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control. For example, there could be sudden increases in customer transaction volume, electrical or telecommunications outages, natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics, events arising from local or larger scale political or social matters, including terrorist acts, and, as described below, cyber-attacks. Although we have business continuity plans and other safeguards in place, our business operations may be adversely affected by significant and widespread disruption to our physical infrastructure or operating systems that support our businesses and customers.

 

Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. As noted above, our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks. In addition, to access our products and services, our customers may use personal smartphones, tablet PC’s, and other mobile devices that are beyond our control systems. Although we believe we have appropriate information security procedures and controls, our technologies, systems, networks, and our customers’ devices may become the target of cyber-attacks or information security breaches. These events could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our customers’ confidential, proprietary and other information or that of its customers, or otherwise disrupt the business operations of the Bank, its customers or other third parties.

 

Third parties with which the Bank does business or that facilitate our business activities, could also be sources of operational and information security risk to the Bank, including from breakdowns or failures of their own systems or capacity constraints. Although to date we have not experienced any material losses relating to cyber-attacks or other information security breaches, we can give no assurance that we will not suffer such losses in the future. Risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats and the prevalence of Internet and mobile banking. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and customers, or cyber-attacks or security breaches of the networks, systems or devices that the Bank’s customers use to access our products and services could result in customer attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our business, results of operations or financial condition.

 

15

 

The Company operates in a highly regulated environment and, as a result, is subject to extensive regulation and supervision that could adversely affect financial performance and ability to implement growth and operating strategies.

 

The Company is subject to examination, supervision and comprehensive regulation by federal and state regulatory agencies, as described under “Item 1 – Business-Supervision and Regulation.” Regulatory oversight of banks is primarily intended to protect depositors, the federal deposit insurance funds, and the banking system as a whole, and not shareholders. Compliance with these regulations is costly and may make it more difficult to operate profitably.

 

Federal and state banking laws and regulations govern numerous matters including the payment of dividends, the acquisition of other banks, and the establishment of new banking offices. We must also meet specific regulatory capital requirements. Failure to comply with these laws, regulations, and policies or to maintain required capital could affect the ability to pay dividends on common shares, the ability to grow through the development of new offices, make acquisitions, and remain independent. These limitations may prevent us from successfully implementing growth and operating strategies.

 

In addition, the laws and regulations applicable to banks could change at any time, which could significantly impact our business and profitability. For example, new legislation or regulation could limit the manner in which we may conduct our business, including our ability to attract deposits and make loans. Events that may not have a direct impact on us, such as the bankruptcy or insolvency of a prominent U.S. corporation, can cause legislators and banking regulators and other agencies such as the Consumer Financial Protection Bureau, the SEC, the Public Company Accounting Oversight Board and various taxing authorities to respond by adopting and or proposing substantive revisions to laws, regulations, rules, standards, policies, and interpretations. The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations may have a material impact on our business and results of operations. Changes in regulation may cause us to devote substantial additional financial resources and management time to compliance, which may negatively affect operating results.

 

Changes in banking laws could have a material adverse effect.

 

The Bank is subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and monetary policies. Management cannot predict whether any of these changes could adversely and materially affect us. The current regulatory environment for financial institutions entails significant potential increases in compliance requirements and associated costs. Federal and state banking regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on our activities that could have a material adverse effect on our business and profitability.

 

16

 

Item 1B.

Unresolved Staff Comments

 

Not applicable.

 

Item 2.

Properties

 

The Bank operates 20 banking offices in Kentucky. The following table shows the location, square footage and ownership of each property. Management believes that each of these locations is adequately insured. Support operations are located at the main office in Louisville and in Glasgow.

 

Markets

 

Square Footage

 

Owned/Leased

Frankfort/Franklin County

         

Frankfort Office: 100 Highway 676, Frankfort

    3,000  

Leased

           

Elizabethtown/Hardin County

         

Elizabethtown Office: 1690 Ring Road, Suite 100, Elizabethtown

    4,000  

Leased

           

Louisville/Jefferson, Bullitt and Henry Counties

         

Main Office: 2500 Eastpoint Parkway, Louisville

    30,000  

Owned

Eminence Office: 646 Elm Street, Eminence

    1,500  

Owned

Hillview Office: 6890 North Preston Highway, Hillview

    3,500  

Owned

Pleasureville Office: 5440 Castle Highway, Pleasureville

    10,000  

Owned

Conestoga Office: 155 Conestoga Parkway, Shepherdsville

    3,900  

Owned

           

Lexington/Fayette County

         

Lexington Office: 2424 Harrodsburg Road, Suite 100, Lexington

    8,500  

Leased

City Center Office: 130 West Main Street, Lexington

    2,400  

Leased

           

South Central Kentucky

         

Brownsville Office: 113 East Main Cross Street, Brownsville

    8,500  

Owned

Greensburg Office: 202 North Main Street, Greensburg

    11,000  

Owned

Horse Cave Office: 201 East Main Street, Horse Cave

    5,000  

Owned

Morgantown Office: 112 West G.L. Smith Street, Morgantown

    7,500  

Owned

Munfordville Office: 949 South Dixie Highway, Munfordville

    9,000  

Owned

Beaver Dam Office: 1300 North Main Street, Beaver Dam

    3,200  

Owned

           

Owensboro/Daviess County

         

Owensboro Office: 1819 Frederica Street, Owensboro

    3,000  

Owned

Owensboro Frederica Office: 3500 Frederica Street, Owensboro

    5,000  

Owned

Owensboro Villa Point: 3332 Villa Point Drive, Owensboro

    2,000  

Leased

           

Southern Kentucky

         

Campbell Lane Office: 751 Campbell Lane, Bowling Green

    7,500  

Owned

Glasgow Office: 1006 West Main Street, Glasgow

    12,000  

Owned

           

Other Properties

         

Office Building: 2708 North Jackson Highway, Canmer

    3,500  

Owned

           

Other Properties - Held for Sale

         

Office Building: 701 Columbia Avenue, Glasgow

    20,000  

Owned

 

Item 3.

Legal Proceedings

 

In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amount of damages. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur.

 

17

 

The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated.

 

The Company is not currently involved in any material litigation.

 

Item 4.

Mine Safety Disclosure

 

Not applicable.

 

18

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

The Company’s common shares are traded on the Nasdaq Capital Market under the ticker symbol “LMST”.

 

As of January 31, 2020, our common shares were held by approximately 1,417 shareholders, including 330 shareholders of record and approximately 1,087 beneficial owners whose shares are held in “street” name by securities broker-dealers or other nominees, and our non-voting common shares were held by two holders.

 

Dividends 

 

As a bank holding company, the Company’s ability to declare and pay dividends depends on various federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.

 

The principal source of revenue with which to pay dividends on common shares are dividends the Bank may declare and pay out of funds legally available for payment of dividends. Currently, the Bank must obtain the prior written consent of its primary regulators prior to declaring or paying any dividends until retained earnings are positive. A Kentucky chartered bank may declare a dividend of an amount of the bank’s net profits as the board deems appropriate. The approval of the KDFI is required if the total of all dividends declared by a bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt.

 

19

 

Purchase of Equity Securities by Issuer

 

During the fourth quarter of 2019, the Company did not repurchase any of its common shares, which is its only registered class of equity securities.

 

Equity Compensation Plan Information

 

The following table provides information about our equity compensation plans as of December 31, 2019:

 

Plan category

 

Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights

   

 

 

 

Weighted-average
exercise price of
outstanding options,
warrants and rights

   

Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in

column 1)

 
                         

Equity compensation plans approved by shareholders

                292,497  

Equity compensation plans not approved by shareholders

                 
                         

Total

                292,497  

 

At December 31, 2019, 292,497 common shares remain available for issuance under the Company’s 2018 Omnibus Equity Compensation Plan.

 

20

 

Item 6.

Selected Financial Data

 

The following table summarizes the Company’s selected historical consolidated financial data from 2015 to 2019. You should read this information in conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary Data.”

 

Selected Consolidated Financial Data 

 

   

As of and for the Years Ended December 31,

 

(Dollars in thousands except per share data)

 

2019

   

2018

   

2017

   

2016

   

2015

 

Income Statement Data:

                                       

Interest income

  $ 49,584     $ 43,461     $ 37,522     $ 35,602     $ 36,574  

Interest expense

    14,234       9,790       6,405       5,981       7,023  

Net interest income

    35,350       33,671       31,117       29,621       29,551  

Provision (negative provision) for loan losses

          (500

)

    (800

)

    (2,450

)

    (4,500

)

Non-interest income

    5,918       5,779       5,404       5,218       7,695  

Non-interest expense (1)

    30,270       29,126       30,767       40,021       44,959  

Income (loss) before income taxes

    10,998       10,824       6,554       (2,732

)

    (3,213

)

Income tax expense (benefit) (2)

    480       2,030       (31,899

)

    21        

Net income (loss)

    10,518       8,794       38,453       (2,753

)

    (3,213

)

Less:

                                       

Earnings (loss) allocated to participating securities

    106       144       967       (88

)

    (336

)

Net income (loss) attributable to common

  $ 10,412     $ 8,650     $ 37,486     $ (2,665

)

  $ (2,877

)

                                         

Common Share Data: (3)

                                       

Basic earnings (loss) per common share

  $ 1.41     $ 1.23     $ 6.15     $ (0.46

)

  $ (0.62

)

Diluted earnings (loss) per common share

    1.41       1.23       6.15       (0.46

)

    (0.62

)

Cash dividends declared per common share

                             

Book value per common share

    14.15       12.34       11.17       4.81       5.43  

Tangible book value per common share (4)

    12.98       12.34       11.17       4.79       5.33  
                                         

Balance Sheet Data (at period end): (1)

                                       

Total assets

  $ 1,245,779     $ 1,069,692     $ 970,801     $ 945,177     $ 948,722  

Debt obligations:

                                       

FHLB advances

    61,389       46,549       11,797       22,458       3,081  

Junior subordinated debentures

    21,000       21,000       21,000       21,000       21,000  

Subordinated capital note

    17,000             2,250       3,150       4,050  

Senior debt

    5,000       10,000       10,000              
                                         

Average Balance Data: (1)

                                       

Average assets

  $ 1,112,388     $ 1,026,310     $ 947,961     $ 929,140     $ 984,419  

Average loans

    801,813       743,352       667,474       621,275       635,948  

Average deposits

    936,243       860,825       864,278       852,717       907,785  

Average FHLB advances

    35,038       43,363       9,184       2,967       3,473  

Average junior subordinated debentures

    21,000       21,000       21,000       21,000       23,981  

Average subordinated capital note

    7,545       791       2,805       3,708       4,608  

Average senior debt

    7,781       10,000       5,068              

Average stockholders’ equity

    100,126       84,860       37,851       39,423       33,083  

 


(1)

On November 15, 2019, the Company completed a four branch acquisition. The purchase included $126.8 million in performing loans and $1.5 million in premises and equipment, as well as $131.8 million in customer deposits. Acquisition related costs totaled $775,000, or $0.08 per common share after taxes.

(2)

Income tax expense for 2019 benefitted $1.6 million, or $0.21 per basic and diluted share, from the establishment of a state net deferred tax asset related to the 2019 tax law enactments. Income tax expense for 2017 benefitted $54.0 million from the reversal of the deferred tax valuation allowance offset by $20.3 million of income tax expense related to the revaluation of the deferred tax asset to 21%.

(3)

On December 16, 2016, the Company completed a 1-for-5 reverse stock split of its issued and outstanding common and non-voting common shares. As a result of the reverse stock split, all share and per share data has been adjusted in the accompanying tables. Preferred shares were not impacted by the 1-for-5 reverse stock split.

 

21

 

(4)

Tangible book value per common share is a non-GAAP financial measure derived from GAAP based amounts. Tangible book value is calculated by excluding the balance of intangible assets from common stockholders’ equity. Tangible book value per common share is calculated by dividing tangible common equity by common shares outstanding, as compared to book value per common share, which is calculated by dividing common stockholders’ equity by common shares outstanding. Management believes this is consistent with bank regulatory agency treatment, which excludes tangible assets from the calculation of risk-based capital.

 

   

As of and for the Years Ended December 31,

 
   

2019

   

2018

   

2017

   

2016

   

2015

 

Tangible Book Value Per Share

 

(in thousands, except share and per share data)

 
                                         

Common stockholder’s equity

  $ 105,750     $ 92,097     $ 69,902     $ 29,962     $ 29,246  

Less: Goodwill

    6,252                          

Less: Intangible assets

    2,500                   140       532  

Tangible common equity

    96,998       92,097       69,902       29,822       28,714  
                                         

Shares outstanding

    7,471,975       7,462,720       6,259,864       6,224,533       5,389,507  

Tangible book value per common share

  $ 12.98     $ 12.34     $ 11.17     $ 4.81     $ 5.33  

Book value per common share

    14.15       12.34       11.17       4.79       5.43  

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

Management’s discussion and analysis of financial condition and results of operations analyzes the consolidated financial condition and results of operations of Limestone Bancorp, Inc. (the “Company”) and its wholly owned subsidiary, Limestone Bank, Inc. (the “Bank”). The Company is a Louisville, Kentucky-based bank holding company that operates banking offices in fourteen Kentucky counties. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Bullitt and Henry. The Bank serves south central, southern, and western Kentucky from banking offices in Barren, Butler, Daviess, Edmonson, Green, Hardin, Hart, Ohio, and Warren Counties. The Bank also has an office in Lexington, the second largest city in the state, and Frankfort, the state capital. The Bank is a traditional community bank with a wide range of personal and business banking products and services.

 

Historically, the Bank has focused on commercial and commercial real estate lending, both in markets where we have banking offices and other growing markets in our region. Commercial, commercial real estate and real estate construction loans accounted for 58.8% of our total loan portfolio as of December 31, 2019, and 60.9% as of December 31, 2018. Commercial lending generally produces higher yields than residential lending, but involves greater risk and requires more rigorous underwriting standards and credit quality monitoring.

 

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes and other schedules presented elsewhere in the report.

 

Overview

 

Net income before taxes was $11.0 million for the year ended December 31, 2019 compared to $10.8 million for the year ended December 31, 2018. Income tax expense was $480,000 for 2019 and $2.0 million for 2018.

 

For the year ended December 31, 2019, the Company reported net income of $10.5 million compared with net income of $8.8 million for the year ended December 31, 2018 and net income of $38.5 million for the year ended December 31, 2017, which includes the reversal of a deferred tax asset valuation allowance. Basic and diluted income per common share were $1.41 for the year ended December 31, 2019, compared with net income per common share of $1.23 for 2018, and net income per common share of $6.15 for 2017.

 

The following significant items are of note for the year ended December 31, 2019:

 

 

On November 15, 2019, the Bank completed the acquisition of four branch banking centers located in the Kentucky cities of Elizabethtown, Frankfort, and Owensboro. The purchase included approximately $126.8 million in performing loans and $1.5 million in premises and equipment, as well as approximately $131.8 million in customer deposits. This acquisition allows the Bank to further optimize its branch footprint regionally and solidifies its presence and ability to serve customers in Daviess, Hardin, and Franklin counties. Fourth quarter results were impacted by non-recurring acquisition related expenses of approximately $775,000, or $0.08 per common share after taxes.

 

22

 

 

During the first quarter of 2019, the Company benefited $341,000, or approximately $0.05 per basic and diluted share, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during the first quarter. The new law eliminates the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021. In addition, the Company has state net operating loss carryforwards (“NOLs”) of $31.8 million, which were previously subject to a full valuation allowance and will begin to expire in 2025. In April 2019, tax legislation was enacted which allowed for certain Kentucky NOLs to be utilized in a combined filing return. Therefore, the Company will begin filing a Kentucky combined filing in 2021 and, as a result, a state NOL tax benefit, net of federal impact, of $1.2 million, or approximately $0.16 per basic and diluted share, was recognized in the second quarter of 2019.

 

 

Average loans receivable increased approximately $58.5 million or 7.9% to $801.2 million for the year ended December 31, 2019, compared with $743.4 million for the year ended December 31, 2018. Loan interest income benefited from an increase in interest revenue volume of approximately $3.0 million and interest rate increases of $1.8 million for the year ended December 31, 2019, compared with the year ended December 31, 2018.

 

 

Net interest margin decreased 13 basis points to 3.40% for the year ended 2019 compared with 3.53% in the year ended December 31, 2018. The yield on earning assets increased to 4.76% in 2019, compared to 4.55% in 2018. The cost of interest-bearing liabilities increased to 1.66% in 2019 from 1.23% in 2018 as a result of Federal Reserve increases in short-term interest rates during 2018, which negatively affected certificate of deposit repricing in 2019.

 

 

The Company recorded no provision for loan losses expense in 2019, compared to a negative provision for loan losses expense of $500,000 for 2018. Historical loss experience, risk grade classification metrics, charge-off levels, and past due trends remain at historically strong levels and were generally stable between periods. Net loan charge-offs were $504,000 for 2019, compared to net loan recoveries of $1.2 million for 2018 and net loan recoveries of $35,000 for 2017.

 

 

Nonaccrual loans decreased $463,000 to $1.5 million at December 31, 2019, compared with $2.0 million at December 31, 2018. The decrease in nonaccrual loans was primarily due to $1.7 million in paydowns, $992,000 in charge-offs, $880,000 in loans returned to accrual status, offset by $3.1 million in loans placed on non-accrual.

 

 

The ratio of non-performing assets to total assets decreased to 0.42% at December 31, 2019, compared with 0.60% at December 31, 2018, and 1.14% at December 31, 2017.

 

 

Deposits were $1.03 billion at December 31, 2019, compared with $894.2 million at December 31, 2018. Non-interest bearing demand deposits increased $44.9 million or 31.5% during 2019 to $187.6 million compared with $142.6 million at December 31, 2018. Money market accounts decreased $11.1 million or 6.4% during 2019 to $160.8 million compared with $171.9 million at December 31, 2018. Savings accounts increased $21.5 million during 2019 to $56.0 million compared to $34.5 million at December 31, 2018. Certificate of deposit balances increased $25.6 million during 2019 to $476.5 million at December 31, 2019, from $450.9 million at December 31, 2018.

 

 

On July 23, 2019, the Company completed the issuance of a $17.0 million 10-year subordinated note. The note carries interest at a fixed rate of 5.75% for the first five years and qualifies as Tier 2 regulatory capital. The Company contributed $10.0 million of the proceeds to the Bank as Tier 1 capital, used $5.0 million to reduce senior debt, and retained the remaining proceeds for general corporate purposes.

 

These items are discussed in further detail throughout this Item 7.

 

Application of Critical Accounting Policies

 

The Company’s accounting and reporting policies comply with GAAP and conform to general practices within the banking industry. Management believes the following significant accounting policies may involve a higher degree of management assumptions and judgments that could result in materially different amounts to be reported if conditions or underlying circumstances were to change.

 

23

 

Allowance for Loan Losses – The Bank maintains an allowance for loan losses believed to be sufficient to absorb probable incurred credit losses existing in the loan portfolio. The Board of Directors evaluates the adequacy of the allowance for loan losses on a quarterly basis. Management evaluates the adequacy of the allowance using, among other things, historical loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral and current economic conditions and trends. The allowance may be allocated for specific loans or loan categories, but the entire allowance is available for any loan. The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated and measured for impairment. The general component is based on historical loss experience adjusted for qualitative environmental factors. Management develops allowance estimates based on actual loss experience adjusted for current economic conditions and trends. Allowance estimates are a prudent measurement of the risk in the loan portfolio applied to individual loans based on loan type. If the mix and amount of future charge-off percentages differ significantly from the assumptions used by management in making its determination, management may be required to materially increase its allowance for loan losses and provision for loan losses, which could adversely affect results.

 

Income Taxes – Income tax liabilities or assets are established for the amount of taxes payable or refundable for the current year. Deferred tax liabilities (“DTLs”) and assets (“DTAs”) are also established for the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. A DTL or DTA is recognized for the estimated future tax effects attributable to temporary differences and deductions that can be carried forward (used) in future years. The valuation of current and deferred income tax liabilities and assets is considered critical, as it requires management to make estimates based on provisions of the enacted tax laws. The assessment of tax liabilities and assets involves the use of estimates, assumptions, interpretations and judgments concerning certain accounting pronouncements and federal and state tax codes.

 

There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings. The Company believes its tax assets and liabilities are adequate and are properly recorded in the consolidated financial statements at December 31, 2019 and 2018.

 

Results of Operations 

 

The following table summarizes components of income and expense and the change in those components for 2019 compared with 2018:

 

   

For the

Years Ended December 31,

   

Change from Prior Period

 
   

2019

   

2018

   

Amount

   

Percent

 
   

(dollars in thousands)

 

Gross interest income

  $ 49,584     $ 43,461     $ 6,123       14.1

%

Gross interest expense

    14,234       9,790       4,444       45.4  

Net interest income

    35,350       33,671       1,679       5.0  

Provision (negative provision) for loan losses

          (500

)

    500       (100.0

)

Non-interest income

    5,923       5,785       138       2.4  

Gains on sale of securities, net

    (5

)

    (6

)

    1       (16.7

)

Non-interest expense

    30,270       29,126       1,144       3.9  

Net income before taxes

    10,998       10,824       174       1.6  

Income tax expense (benefit)

    480       2,030       (1,550

)

    (76.4

)

Net income

    10,518       8,794       1,724       19.6  

 

Net income of $10.5 million for the year ended December 31, 2019 increased by $1.7 million from net income of $8.8 million for 2018. Income tax expense for 2019 benefitted $1.6 million from the establishment of a state net deferred tax asset related to the 2019 tax law enactments. The new laws eliminate the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021. Based upon historically strong trends in asset quality and management’s assessment of risk within the portfolio, the Company recorded no provision for loan losses expense in 2019, compared to $500,000 negative provision for loan losses expense for 2018. Non-interest income increased $139,000 million during 2019. There was an increase of $607,000 in bank card interchange fees, partially offset by a decrease in other non-interest income of $468,000 related to the $150,000 one-time gain on the sale of the secondary market residential servicing rights portfolio in the third quarter of 2018 and a $632,000 gain on the sale of a subdivided lot at the Company’s headquarters offset by a $392,000 impairment charge associated with the transfer of the Bank’s former data processing center to Premises Held for Sale in the fourth quarter of 2018.

 

Non-interest expense increased $1.1 million during 2019 due primarily to $775,000 of expenses attributable to the branch acquisition. There was also an increase of $744,000 in salary and employee benefits, as the Bank added sales talent and customer facing associates during 2019, and branch staff added in connection with the branch purchase transaction. Deposit account related expense increased $401,000, which was offset by decreases in OREO expenses of $500,000, and FDIC insurance expense of $346,000.

 

24

 

The following table summarizes components of income and expense and the change in those components for 2018 compared with 2017:

 

   

For the

Years Ended December 31,

   

Change from Prior Period

 
   

2018

   

2017

   

Amount

   

Percent

 
   

(dollars in thousands)

 

Gross interest income

  $ 43,461     $ 37,522     $ 5,939       15.8

%

Gross interest expense

    9,790       6,405       3,385       52.8  

Net interest income

    33,671       31,117       2,554       8.2  

Provision (negative provision) for loan losses

    (500

)

    (800

)

    300       37.5  

Non-interest income

    5,785       5,116       669       13.1  

Gains on sale of securities, net

    (6

)

    288       (294

)

    (102.1

)

Non-interest expense

    29,126       30,767       (1,641

)

    (5.3

)

Net income (loss) before taxes

    10,824       6,554       4,270       65.2  

Income tax expense (benefit)

    2,030       (31,899

)

    33,929       NM  

Net income (loss)

    8,794       38,453       (29,659

)

    NM  

 

  NM: Not Meaningful

 

Net income of $8.8 million for the year ended December 31, 2018 decreased by $29.7 million from net income of $38.5 million for 2017. Net income for 2017 was impacted by the reversal of the Company’s deferred tax asset valuation allowance and the change in federal corporate tax rates in connection with the enactment of the Tax Cuts and Jobs Act of 2017. This resulted in an income tax benefit of $31.9 million for 2017. During 2018, improving trends in non-performing loans, past due loans, and loan risk categories continued. A negative provision for loan losses expense of $500,000 was recorded during 2018, compared to $800,000 negative provision for loan losses expense for 2017. Non-interest income increased $669,000 during 2018. There was an increase of $310,000 in bank card interchange fees, $232,000 in other non-interest income, and $102,000 in service charges on deposit accounts. Non-interest expense decreased $1.6 million during 2018 due primarily to decreases in OREO expense of $1.1 million and FDIC insurance of $855,000 offset by an increase in salaries and employee benefits of $399,000.

 

Net Interest Income – Net interest income was $35.4 million for the year ended December 31, 2019, an increase of $1.7 million, or 5.0%, compared with $33.7 million for the same period in 2018. Net interest spread and margin were 3.10% and 3.40%, respectively, for 2019, compared with 3.32% and 3.53%, respectively, for 2018.

 

Net interest margin for 2019 was under pressure as the Federal Reserve lowered its target rate by 25 basis points on July 31, 2019, September 18, 2019, and October 30, 2019. The Company’s interest rate risk profile is marginally asset sensitive as its assets generally reprice more quickly then its liabilities over a twelve-month horizon. In particular, the Federal Reserve’s actions served to lower rates on the short end of the yield curve impacting yields on fed funds, certain floating rate investment securities, and loans with variable rate pricing features. These rate decreases in 2019 followed four 25 basis point increases during 2018. As of December 31, 2019, time deposits comprise $476.5 million of the Company’s liabilities with $389.3 million, or 82%, set to reprice or mature within one year of which, $179.4 million with a current average rate of 2.19% reprice or mature within the first quarter of 2020.

 

Average interest-earning assets were $1.04 billion for 2019, compared with $957.5 million for 2018, a 8.9% increase, primarily attributable to higher average loans and average investment securities. Average loans were $801.8 million for 2019, compared with $743.4 million for 2018, a 7.9% increase due to loan growth, as well as the completion of the branch acquisition on November 15, 2019. This resulted in an increase in interest revenue of approximately $3.0 million and an increase of $1.8 million attributable to increasing interest rates for 2019 as compared to 2018. Average investment securities were $206.2 million for 2019, compared with $178.9 million for 2018, a 15.2% increase. Total interest income increased 14.1% to $49.6 million for 2019, compared with $43.5 million for 2018.

 

Average interest-bearing liabilities increased by 7.2% to $856.3 million for 2019, compared with $799.0 million for 2018 due to deposit growth, as well as the completion of the branch acquisition on November 15, 2019. Total interest expense increased by 45.4% to $14.2 million for 2019, compared with $9.8 million during 2018, due primarily to increases in rates paid on certificates of deposits and other time deposits in 2019 compared to 2018. Average volume of certificates of deposit increased 9.9% to $483.2 million for 2019, compared with $439.6 million for 2018. The average interest rate paid on certificates of deposit increased to 1.98% for 2019, compared with 1.35% for 2018. Average volume of interest checking and money market deposit accounts increased 6.5% to $265.7 million for 2019, compared with $249.4 million for 2018. The average interest rate paid on interest checking and money market deposit accounts increased to 0.76% for 2019, compared with 0.62% for 2018. The cost of interest-bearing liabilities for 2019 was also impacted by the subordinated debt issuance at a fixed rate of 5.75%.

 

25

 

Net interest income was $33.7 million for the year ended December 31, 2018, an increase of $2.6 million, or 8.2%, compared with $31.1 million for the same period in 2017. Net interest spread and margin were 3.32% and 3.53%, respectively, for 2018, compared with 3.35% and 3.48%, respectively, for 2017. Average nonaccrual loans were $3.5 million and $7.1 million in 2018 and 2017, respectively.

 

Average interest-earning assets were $957.5 million for 2018, compared with $904.1 million for 2017, a 5.9% increase, primarily attributable to higher average loans, partially offset by a decrease in average investment securities. Average loans were $743.4 million for 2018, compared with $667.5 million for 2017, an 11.4% increase. Average investment securities were $178.9 million for 2018, compared with $193.1 million for 2017, a 7.3% decrease. Average interest-bearing deposits with financial institutions and fed funds sold were $27.9 million in 2018, compared with $36.2 million in 2017, a 22.8% decrease. Total interest income increased 15.8% to $43.5 million for 2018, compared with $37.5 million for 2017.

 

Average interest-bearing liabilities increased by 3.3% to $799.0 million for 2018, compared with $773.2 million for 2017. Total interest expense increased by 52.8% to $9.8 million for 2018, compared with $6.4 million during 2017, due primarily to increases in rates paid on certificates of deposits and other time deposits as well as increases in average balances of FHLB advances in 2018 compared to 2017. Average volume of certificates of deposit decreased 2.8% to $439.6 million for 2018, compared with $452.4 million for 2017. The average interest rate paid on certificates of deposit increased to 1.35% for 2018, compared with 0.93% for 2017. Average volume of interest checking and money market deposit accounts increased 0.9% to $249.4 million for 2018, compared with $247.3 million for 2017. The average interest rate paid on interest checking and money market deposit accounts increased to 0.62% for 2018, compared with 0.38% for 2017. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2017 and 2018.

 

26

 

Average Balance Sheets

 

The following table sets forth the average daily balances, the interest earned or paid on such amounts, and the weighted average yield on interest-earning assets and weighted average cost of interest-bearing liabilities for the periods indicated. Dividing income or expense by the average daily balance of assets or liabilities, respectively, derives such yields and costs for the periods presented.

 

   

For the Years Ended December 31,

 
   

2019

   

2018

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loans receivables (1)(2)

                                               

Real estate

  $ 576,441     $ 30,139       5.23

%

  $ 548,877     $ 27,296       4.97

%

Commercial

    134,735       6,660       4.94       123,044       5,934       4.82  

Consumer

    51,001       2,863       5.61       32,049       1,765       5.51  

Agriculture

    39,116       2,480       6.34       38,796       2,334       6.02  

Other

    520       11       2.12       586       13       2.22  

U.S. Treasury and agencies

    23,263       558       2.40       23,732       549       2.31  

Mortgage-backed securities

    91,609       2,495       2.72       81,771       2,142       2.62  

Collateralized loan obligations

    49,881       2,015       4.04       32,163       1,177       3.66  

State and political subdivision securities (non-taxable) (3)

    11,759       326       3.51       14,189       383       3.42  

State and political subdivision securities (taxable)

    18,270       583       3.19       18,890       570       3.02  

Corporate bonds

    11,376       618       5.43       8,162       442       5.42  

FHLB stock

    6,691       348       5.20       7,280       429       5.89  

Federal funds sold

    182       4       2.20       1,152       22       1.91  

Interest-bearing deposits in other financial institutions

    27,809       484       1.74       26,763       405       1.51  

Total interest-earning assets

    1,042,653       49,584       4.76

%

    957,454       43,461       4.55

%

Less: Allowance for loan losses

    (8,786

)

                    (8,692

)

               

Non-interest-earning assets

    78,521                       77,548                  

Total assets

  $ 1,112,388                     $ 1,026,310                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities

                                               

Certificates of deposit and other time deposits

  $ 483,222     $ 9,564       1.98

%

  $ 439,597     $ 5,949       1.35

%

Interest checking and money market deposits

    265,687       2,026       0.76       249,415       1,543       0.62  

Savings accounts

    36,035       67       0.19       34,866       57       0.16  

FHLB advances

    35,038       810       2.31       43,363       867       2.00  

Junior subordinated debentures

    21,000       1,005       4.79       21,000       946       4.50  

Subordinated capital note

    7,545       433       5.74       791       39       4.93  

Senior debt

    7,781       329       4.23       10,000       389       3.89  

Total interest-bearing liabilities

    856,308       14,234       1.66

%

    799,032       9,790       1.23

%

Non-interest-bearing liabilities

                                               

Non-interest-bearing deposits

    151,299                       136,947                  

Other liabilities

    4,655                       5,471                  

Total liabilities

    1,012,262                       941,450                  

Stockholders’ equity

    100,126                       84,860                  

Total liabilities and stockholders’ equity

  $ 1,112,388                     $ 1,026,310                  
                                                 

Net interest income

          $ 35,350                     $ 33,671          
                                                 

Net interest spread

                    3.10

%

                    3.32

%

                                                 

Net interest margin

                    3.40

%

                    3.53

%

                                                 

Ratio of average interest-earning assets to average interest-bearing liabilities

                    121.76

%

                    119.83

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans of $2.2 million and $3.5 million in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 21% federal income tax rate for 2019 and 2018.

 

27

 

 

   

For the Years Ended December 31,

 
   

2018

   

2017

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loans receivables (1)(2)

                                               

Real estate

  $ 548,877     $ 27,296       4.97

%

  $ 509,133     $ 24,544       4.82

%

Commercial

    123,044       5,934       4.82       107,188       4,403       4.11  

Consumer

    32,049       1,765       5.51       10,790       843       7.81  

Agriculture

    38,796       2,334       6.02       39,839       2,047       5.14  

Other

    586       13       2.22       524       29       5.53  

U.S. Treasury and agencies

    23,732       549       2.31       31,440       694       2.21  

Mortgage-backed securities

    81,771       2,142       2.62       94,451       2,240       2.37  

Collateralized loan obligations

    32,163       1,177       3.66       20,242       541       2.67  

State and political subdivision securities (non-taxable) (3)

    14,189       383       3.42       19,617       571       4.48  

State and political subdivision securities (taxable)

    18,890       570       3.02       23,689       757       3.20  

Corporate bonds

    8,162       442       5.42       3,651       167       4.57  

FHLB stock

    7,280       429       5.89       7,323       366       5.00  

Federal funds sold

    1,152       22       1.91       960       10       1.04  

Interest-bearing deposits in other financial institutions

    26,763       405       1.51       35,222       310       0.88  

Total interest-earning assets

    957,454       43,461       4.55

%

    904,069       37,522       4.18

%

Less: Allowance for loan losses

    (8,692

)

                    (8,961

)

               

Non-interest-earning assets

    77,548                       52,853                  

Total assets

  $ 1,026,310                     $ 947,961                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities

                                               

Certificates of deposit and other time deposits

  $ 439,597     $ 5,949       1.35

%

  $ 452,443     $ 4,191       0.93

%

Interest checking and money market deposits

    249,415       1,543       0.62       247,261       940       0.38  

Savings accounts

    34,866       57       0.16       35,486       59       0.17  

FHLB advances

    43,363       867       2.00       9,184       120       1.31  

Junior subordinated debentures

    21,000       946       4.50       21,000       753       3.59  

Subordinated capital note

    791       39       4.93       2,805       148       5.28  

Senior debt

    10,000       389       3.89       5,068       194       3.83  

Total interest-bearing liabilities

    799,032       9,790       1.23

%

    773,247       6,405       0.83

%

Non-interest-bearing liabilities

                                               

Non-interest-bearing deposits

    136,947                       129,088                  

Other liabilities

    5,471                       7,775                  

Total liabilities

    941,450                       910,110                  

Stockholders’ equity

    84,860                       37,851                  

Total liabilities and stockholders’ equity

  $ 1,026,310                     $ 947,961                  
                                                 

Net interest income

          $ 33,671                     $ 31,117          
                                                 

Net interest spread

                    3.32

%

                    3.35

%

                                                 

Net interest margin

                    3.53

%

                    3.48

%

                                                 

Ratio of average interest-earning assets to average interest-bearing liabilities

                    119.83

%

                    116.92

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans of $3.5 million and $7.1 million in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 21% and 35% federal income tax rate for 2018 and 2017, respectively.

 

28

 

Rate/Volume Analysis

 

The table below sets forth information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

 

   

Year Ended December 31, 2019 vs. 2018

   

Year Ended December 31, 2018 vs. 2017

 
   

Increase (decrease)

due to change in

   

Increase (decrease)

due to change in

 
   

Rate

   

Volume

   

Net

Change

   

Rate

   

Volume

   

Net

Change

 
   

(in thousands)

 

Interest-earning assets:

                                               

Loan receivables

  $ 1,789     $ 3,022     $ 4,811     $ 1,723     $ 3,753     $ 5,476  

U.S. Treasury and agencies

    20       (11

)

    9       32       (177

)

    (145

)

Mortgage-backed securities

    87       266       353       220       (318

)

    (98

)

Collateralized loan obligations

    133       705       838       245       391       636  

State and political subdivision securities

    47       (91

)

    (44

)

    (76

)

    (299

)

    (375

)

Corporate bonds

    1       175       176       36       239       275  

FHLB stock

    (48

)

    (33

)

    (81

)

    65       (2

)

    63  

Federal funds sold

    3       (21

)

    (18

)

    9       3       12  

Interest-bearing deposits in other financial institutions

    63       16       79       182       (87

)

    95  

Total increase (decrease) in interest income

    2,095       4,028       6,123       2,436       3,503       5,939  
                                                 

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

    2,977       638       3,615       1,880       (122

)

    1,758  

Interest checking and money market accounts

    377       106       483       595       8       603  

Savings accounts

    8       2       10       (1

)

    (1

)

    (2

)

FHLB advances

    123       (180

)

    (57

)

    94       653       747  

Junior subordinated debentures

    59             59       193             193  

Subordinated capital note

    7       387       394       (9

)

    (100

)

    (109

)

Senior debt

    32       (92

)

    (60

)

    3       192       195  

Total increase (decrease) in interest expense

    3,583       861       4,444       2,755       630       3,385  

Increase (decrease) in net interest income

  $ (1,488 )   $ 3,167     $ 1,679     $ (319 )   $ 2,873     $ 2,554  

 

Non-interest Income – The following table presents for the periods indicated the major categories of non-interest income:

 

   

For the Years Ended

December 31,

 
   

2019

   

2018

   

2017

 
   

(in thousands)

 

Service charges on deposit accounts

  $ 2,381     $ 2,355     $ 2,253  

Bank card interchange fees

    2,438       1,831       1,521  

Income from bank owned life insurance

    410       437       412  

Net gain (loss) on sales and calls of securities

    (5

)

    (6

)

    288  

Other

    694       1,162       930  

Total non-interest income

  $ 5,918     $ 5,779     $ 5,404  

 

Non-interest income increased by $139,000 for 2019 to $5.9 million compared with $5.8 million for the year ended December 31, 2018. This increase was primarily due to growth in bank card interchange fees of $607,000 partially offset by a decrease in other non-interest income of $468,000 related to the $150,000 one-time gain on the sale of the secondary market residential servicing rights portfolio in the third quarter of 2018 and a $632,000 gain on the sale of a subdivided lot at the Company’s headquarters offset by a $392,000 impairment charge associated with the transfer of the Bank’s former data processing center to held for sale in the fourth quarter of 2018.

 

29

 

Non-interest income increased by $375,000 in 2018 to $5.8 million compared with $5.4 million for the year ended December 31, 2017. This increase was primarily attributable to a $310,000 increase in bank card interchange fees, a $232,000 increase in other non-interest income, and a $102,000 increase in service charges on deposit accounts partially offset by a $6,000 net loss on sale of securities for 2018 compared to a $288,000 net gain during 2017.

 

Non-interest Expense – The following table presents the major categories of non-interest expense:

 

   

For the Years Ended

December 31,

 
   

2019

   

2018

   

2017

 
   

(in thousands)

 

Salary and employee benefits

  $ 16,233     $ 15,489     $ 15,090  

Occupancy and equipment

    3,522       3,586       3,420  

FDIC insurance

    211       557       1,412  

Data processing expense

    1,259       1,192       1,256  

Marketing expense

    908       1,114       1,098  

State franchise and deposit tax

    1,210       1,118       956  

Deposit account related expense

    1,224       823       896  

Professional fees

    769       814       978  

Communications

    772       701       722  

Insurance expense

    444       478       540  

Postage and delivery

    544       364       395  

Litigation and loan collection expense

    189       245       179  

Other real estate owned expense

    368       868       1,973  

Acquisition costs

    775              

Other

    1,842       1,777       1,852  

Total non-interest expense

  $ 30,270     $ 29,126     $ 30,767  

 

Non-interest expense for the year ended December 31, 2019 of $30.3 million represented a 3.9% increase from $29.1 million for 2018. The increase in non-interest expense was attributable primarily to $775,000 of expenses related to the branch acquisition. There was also an increase of $744,000 in salary and employee benefits, as the Bank added sales talent and customer facing associates during 2019, and branch staff added in connection with the branch purchase transaction. Deposit account related expense increased $401,000, which correlated to growth in card interchange income, and was offset by decreases in OREO expenses of $500,000, and FDIC insurance expense of $346,000. As shown below, expenses related to OREO decreased due to lower valuation adjustment write-downs during 2019 compared to 2018.

 

   

2019

   

2018

 
   

(in thousands)

 

Net gain on sales

  $     $ (72

)

Valuation adjustment write-downs

    260       850  

Operating expense

    108       90  

Total

  $ 368     $ 868  

 

During the year ended December 31, 2019, fair value write-downs of $260,000 were recorded compared with $850,000 for the year ended December 31, 2018. The 2019 write-downs reflect declines in the fair value due to changes in marketing strategies. There were no OREO sales in 2019 compared to $876,000 during 2018.

 

30

 

Non-interest Expense Comparison – 2018 to 2017

 

Non-interest expense for the year ended December 31, 2018 of $29.1 million represented a 3.1% decrease from $30.8 million for 2017. The decrease in non-interest expense was attributable primarily to a decrease in OREO expense of $1.1 million. Non-interest expense also benefited from a $855,000 decrease in FDIC insurance as a result of the Bank’s improved risk profile, partially offset by a $399,000 increase in salaries and employee benefits. As shown below, expenses related to OREO decreased due to lower valuation adjustment write-downs during 2018 compared to 2017.

 

   

2018

   

2017

 
   

(in thousands)

 

Net gain on sales

  $ (72

)

  $ (74

)

Valuation adjustment write-downs

    850       1,963  

Operating expense

    90       84  

Total

  $ 868     $ 1,973  

 

During the year ended December 31, 2018, fair value write-downs of $850,000 were recorded compared with $2.0 million for the year ended December 31, 2017. The 2018 write-downs reflect declines in fair value due to changes in marketing strategies and new appraisals. OREO sales totaled $876,000 and $793,000 during 2018 and 2017, respectively.

 

Income Tax Expense and Benefit – Effective tax rates differ from the federal statutory rate applied to income (loss) before income taxes due to the following:

 

   

2019