ITEM 1A. RISK FACTORS 26
ITEM 1B. UNRESOLVED STAFF COMMENTS 41
ITEM 2. PROPERTIES 41
ITEM 3. LEGAL PROCEEDINGS 41
ITEM 4. MINE SAFETY DISCLOSURES 41
ITEM 6. SELECTED FINANCIAL DATA 43
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 55
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 57
ITEM 9A. CONTROLS AND PROCEDURES 97
ITEM 9B. OTHER INFORMATION 97
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 98
ITEM 11. EXECUTIVE COMPENSATION 98
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 99
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 100
PART
I.
ITEM
1. BUSINESS
The
Company
Landmark
Bancorp, Inc. (the “Company”) is a financial holding company that was incorporated under the laws of the State of
Delaware in 2001. Currently, the Company’s business consists of the ownership of Landmark National Bank (the “Bank”)
and Landmark Risk Management, Inc., which are wholly-owned subsidiaries of the Company. As of December 31, 2020, the Company had
$1.2 billion in consolidated total assets.
The
Company is headquartered in Manhattan, Kansas, and has expanded its geographic presence through opening new branches and past
acquisitions. In May 2019, the Bank opened a loan production office in Prairie Village, Kansas. During the third quarter of 2019,
the loan production office was converted into a branch office. The Company continues to explore opportunities to expand its banking
markets through mergers and acquisitions, as well as branching opportunities.
The
Bank has continued to focus on increasing its originations of commercial, commercial real estate and agricultural loans, which
management believes will be more profitable and provide more growth for the Bank than traditional one-to-four family residential
real estate lending. Additionally, greater emphasis has been placed on diversification of the deposit mix through the expansion
of core deposit accounts such as checking, savings, and money market accounts. The Bank has also diversified its geographical
markets as a result of its acquisitions and branching opportunities. The Company’s main office is in Manhattan, Kansas.
The Company has 30 branch offices in 24 communities across the state of Kansas.
Landmark
Risk Management, Inc., which was formed and began operations on May 31, 2017, is a Nevada-based captive insurance company that
provides property and casualty insurance coverage to the Company and the Bank for which insurance may not be currently available
or economically feasible in the insurance marketplace. Landmark Risk Management, Inc. is subject to the regulations of the State
of Nevada and undergoes periodic examinations by the Nevada Division of Insurance. As of May 31, 2019, Landmark Risk Management,
Inc. exited the pool resources relationship of which it was previously a member. On October 1, 2020, Landmark Risk Management,
Inc. joined a new pool and resumed providing insurance to the Company and the Bank.
The
results of operations of the Bank and the Company are dependent primarily upon net interest income and, to a lesser extent, upon
other income derived from sales of one-to-four family residential mortgage loans, loan servicing fees and customer deposit services.
Additional expenses of the Bank include general and administrative expenses such as salaries, employee benefits, federal deposit
insurance premiums, data processing, occupancy and related expenses.
Deposits
of the Bank are insured by the Deposit Insurance Fund (the “DIF”) of the Federal Deposit Insurance Corporation (the
“FDIC”) up to the maximum amount allowable under applicable federal laws and regulations. The Bank is regulated by
the Office of the Comptroller of the Currency (the “OCC”), as the chartering authority for national banks, and the
FDIC, as the administrator of the DIF. The Bank is also subject to regulation by the Board of Governors of the Federal Reserve
System (the “Federal Reserve”) with respect to reserves required to be maintained against deposits and certain other
matters. The Bank is a member of the Federal Reserve Bank of Kansas City and the Federal Home Loan Bank (the “FHLB”)
of Topeka.
The
Company’s executive office and the Bank’s main office are located at 701 Poyntz Avenue, Manhattan, Kansas 66502. The
telephone number is (785) 565-2000.
Market
Areas
The
COVID-19 pandemic in the United States has had and continues to have a complex and significant adverse impact on the economy,
the banking industry and the Company, all subject to a high degree of uncertainty for future periods. The Bank’s products
and services are offered primarily in Kansas, where individual and governmental responses to the COVID-19 pandemic led to a broad
curtailment of economic activity beginning in March 2020 as a result of a stay-at-home order, which was lifted on May 3, 2020,
with economic and social gatherings reopening in a phased-in approach since then. The re-opening of the economy in Kansas initially
resulted in increased cases of COVID-19, and additional restrictions were put in place to slow the spread. While case numbers
have declined, these measures have had an impact on the economy of and customers located in Kansas. The Bank and its branches
have remained open during these orders because banks have been deemed essential businesses. The Bank is currently serving its
customers through its digital banking platforms and drive-thru services, with most branch lobbies re-opened to customers. The
Bank will continue to monitor the situation to protect the safety and well-being of our customers and associates.
The
Bank’s primary deposit gathering and lending markets are geographically diversified throughout central, eastern, southeast,
and southwest Kansas. The primary industries within these respective markets are also diverse and dependent upon a wide array
of industry and governmental activity for their economic base. A brief description of the four geographic areas and the communities
which the Bank serves is set forth below.
The
central region of the Bank’s market area consists of the Bank’s locations in Auburn, Junction City, Manhattan, Osage
City, Topeka and Wamego, Kansas and includes the counties of Riley, Geary, Osage, Pottawatomie and Shawnee. The economies are
significantly impacted by employment at Fort Riley Military Base in Junction City and Kansas State University, the second largest
university in Kansas, which is located in Manhattan. Topeka is the capital of Kansas and strongly influenced by the government
of the State of Kansas. Topeka and Manhattan are regional destinations for retail shopping as well as home to regional hospitals.
Manhattan was also selected as the site of a new National Bio and Agro-Defense Facility, which has had a significant impact on
the regional economy as the facility is being constructed, and that impact is expected to continue once the facility begins operations.
Construction of the facility began in 2013, and the facility is expected to be fully operational in December 2022. Additionally,
manufacturing and service industries play a key role within the central Kansas market.
The
Bank’s eastern Kansas branches are located in the communities of Lawrence, Lenexa, Louisburg, Osawatomie, Overland Park,
Paola, Prairie Village and Wellsville, Kansas. The Bank’s Lawrence locations are located in Douglas County and are significantly
impacted by the University of Kansas, the largest university in Kansas. The eastern region is strongly influenced by the Kansas
City metropolitan market, which is the highest growth area in the State of Kansas. The region is influenced by public and private
industries and businesses of all sizes. In addition, housing growth and commercial real estate are major drivers of the region’s
economy. The Bank added commercial lenders in this market and opened a new branch in Prairie Village during 2019. These additions
have significantly contributed to the Bank’s growth in loans and deposits.
The
southeast region of the Bank’s market area consists of the Bank’s locations in Fort Scott, Iola, Kincaid, Mound City
and Pittsburg, Kansas. Agriculture, oil, and gas are the predominant industries in the southeast Kansas region. Both Fort Scott
and Pittsburg are recognized as regional commercial centers within the southeast region of the state, which attracts small retail
businesses to the region. Additionally, Pittsburg State University and Fort Scott Community College attract a number of individuals
from the surrounding area to live within the communities to participate in educational programs and pursue a degree. Additionally,
manufacturing and service industries play a key role within the southeast Kansas market.
The
Bank’s southwest Kansas branches are located in the communities of Dodge City, Garden City, Great Bend, Hoisington and LaCrosse,
Kansas. Agriculture, oil, and gas are the predominant industries in the southwest Kansas region. Predominant activities involve
crop production, feed lot operations, and food processing. Dodge City is known as the “Cowboy Capital of the World”
and maintains a significant tourism industry. Both Dodge City and Garden City are recognized as regional commercial centers within
the state with small businesses, manufacturing, retail, and service industries having a significant influence upon the local economies.
Additionally, the Dodge City, Garden City and Great Bend communities each have a community college that attracts individuals from
the surrounding areas.
Competition
The
Company faces strong competition both in attracting deposits and making real estate, commercial and other loans. Its most direct
competition for deposits and loans comes from large national and regional banks, local community banks, savings and loan associations,
securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit
unions, financial technology (fintech) companies and other non-bank financial service providers located in its principal market
areas, including many larger financial institutions which have greater financial and marketing resources available to them. The
ability of the Company to attract and retain deposits generally depends on its ability to provide a rate of return, service levels,
liquidity and risk comparable to or better than those offered by competing investment opportunities. The Company competes for
loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers.
Employees
At
December 31, 2020, the Bank had a total of 292 employees (282 full time equivalent employees). The Company has no employees, although
the Company is a party to several employment agreements with executives of the Bank. Employees are provided with a comprehensive
benefits program, including basic and major medical insurance, life and disability insurance, sick leave, and a 401(k) profit
sharing plan. Employees are not represented by any union or collective bargaining group, and the Bank considers its employee relations
to be good.
Lending
Activities
General.
The Bank strives to provide a full range of financial products and services to small- and medium-sized businesses and to consumers
in each market area it serves. The Bank targets owner-operated businesses and utilizes Small Business Administration (SBA) lending
as a part of its product mix. The Bank has a loan committee for each of its markets, which has authority to approve credits within
established guidelines. Concentrations in excess of those guidelines must be approved by either a corporate loan committee comprised
of the Bank’s Chief Executive Officer, the Credit Risk Manager, and other senior commercial lenders or the Bank’s
board of directors. When lending to an entity, the Bank generally obtains a guaranty from the principals of the entity. The loan
mix is subject to the discretion of the Bank’s board of directors and the demands of the local marketplace.
The
following is a brief description of each major category of the Bank’s lending activity.
One-to-Four
Family Residential Real Estate Lending. The Bank originates one-to-four family residential real estate loans with both
fixed and variable rates. One-to-four family residential real estate loans are typically priced and originated following underwriting
standards that are consistent with guidelines established by the major buyers in the secondary market. Generally, residential
real estate loans retained in the Bank’s loan portfolio have fixed or variable rates with adjustment periods of seven years
or less and amortization periods of typically either 15 or 30 years. A significant portion of these loans prepay prior to maturity.
The Bank has no potential negative amortization loans. While the origination of fixed-rate, one-to-four family residential loans
continues to be a key component of our business, the majority of these loans are sold in the secondary market. One-to-four family
residential real estate loans that exceed 80% of the appraised value of the real estate generally are required, by policy, to
be supported by private mortgage insurance, although on occasion the Bank will retain non-conforming residential loans to known
customers at premium pricing. The balances of one-to-four family residential real estate loans increased as of December 31, 2020
compared to December 31, 2019 as the Bank decided to retain additional loans as an alternative to purchasing investment securities.
While the Bank retains some of the new loan originations, most of the new loans continue to be sold.
Construction
and Land Lending. Loans in this category include loans to facilitate the development of both residential and commercial
real estate. Construction and land loans generally have terms of less than 18 months, and the Bank will retain a security interest
in the borrower’s real estate. Construction loans are generally limited, by policy, to 80% of the appraised value of the
property. Land loans are generally limited, by policy, to 65% of the appraised value of the property. The origination of construction
and land loans has not been a primary strategy of the Bank over the past few years to reduce risk in the Bank’s loan portfolio.
The balances of construction and land loans increased as of December 31, 2020 compared to December 31, 2019 as a result of increased
loans to existing customers.
Commercial
Real Estate Lending. Commercial real estate loans, including multi-family loans, generally have amortization periods of
15 or 20 years. Commercial real estate and multi-family loans are generally limited, by policy, to 80% of the appraised value
of the property. Commercial real estate loans are also supported by an analysis demonstrating the borrower’s ability to
repay. The Bank continues to focus on generating additional commercial real estate loan relationships. The Bank’s loan growth
over the past few years has been driven in large part by commercial real estate loans. These loans are primarily made to customers
with owner-occupied properties.
Commercial
Lending. Commercial loans include loans to service, retail, wholesale and light manufacturing businesses. Commercial loans
are made based on the financial strength and repayment ability of the borrower, as well as the collateral securing the loans.
The Bank targets owner-operated businesses as its customers and makes lending decisions based upon a cash flow analysis of the
borrower as well as a collateral analysis. Accounts receivable loans and loans for inventory purchases are generally on a one-year
renewable term, and loans for equipment generally have a term of seven years or less. The Bank generally takes a blanket security
interest in all assets of the borrower. Equipment loans are generally limited to 75% of the cost or appraised value of the equipment.
Inventory loans are generally limited to 50% of the value of the inventory, and accounts receivable loans are generally limited
to 75% of a predetermined eligible base. The Bank continues to focus its organic growth on generating additional commercial loan
relationships, including SBA loans. The Bank has been able to increase its balances of commercial loans over the past few years
as a result of recruiting new customer relationships.
Paycheck
Protection Program Lending. Starting in 2020, the Bank participates as a lender in the SBA’s Paycheck Protection
Program (“PPP”). PPP is a loan program administered through the SBA to help businesses impacted by COVID-19, with
the loans guaranteed by the SBA. The Bank receives an origination fee from the SBA as part of the lending process. The loans have
an interest rate of 1.00% plus the amortization of the origination fee. The maturity date of these loans is two or five years
unless the borrower’s loan is forgiven, in which case the loan may be repaid sooner. The Bank’s ability to originate
PPP loans is dependent upon the extent to which the program is authorized by the federal government to continue in future periods.
Municipal
Lending. Loans to municipalities are generally related to equipment leasing or general fund loans. Terms are generally
limited to 5 years. Equipment leases are generally made for the purchase of municipal assets and are secured by the leased asset.
The Bank is generally not active in the origination of municipal loans and leases; however, the Bank may originate loans or leases
for municipalities in its market area.
Agriculture
Lending. Agricultural real estate loans generally have amortization periods of 20 years or less, during which time the
Bank generally retains a security interest in the borrower’s real estate. The Bank also provides short-term credit for operating
loans and intermediate-term loans for farm product, livestock and machinery purchases and other agricultural improvements. Farm
product loans generally have a one-year term, and machinery, equipment and breeding livestock loans generally have five to seven
year terms. Extension of credit is based upon the borrower’s ability to repay, as well as the existence of federal guarantees
and crop insurance coverage. These loans are generally secured by a blanket lien on livestock, equipment, feed, hay, grain and
growing crops. Equipment and breeding livestock loans are generally limited to 75% of appraised value. The Bank continues to focus
on generating additional agriculture loan relationships in each of its market areas. Improvements in the financial results of
the Bank’s agriculture customers contributed to the decline in these loan balances as of December 31, 2020 compared to December
31, 2019.
Consumer
and Other Lending. Loans classified as consumer and other loans include automobile, boat, home improvement and home equity
loans. With the exception of home improvement loans and home equity loans, the Bank generally takes a purchase money security
interest in collateral for which it provides the original financing. Home improvement loans and home equity loans are principally
secured through second mortgages. The terms of the loans typically range from one to five years, depending upon the use of the
proceeds, and generally range from 75% to 90% of the value of the collateral. The majority of these loans are installment loans
with fixed interest rates. Home improvement and home equity loans are generally secured by a second mortgage on the borrower’s
personal residence and, when combined with the first mortgage, limited to 80% of the value of the property unless further protected
by private mortgage insurance. Home improvement loans are generally made for terms of five to seven years with fixed interest
rates. Home equity loans are generally made for terms of ten years on a revolving basis with adjustable monthly interest rates
tied to the national prime interest rate. While the Bank primarily provides consumer loans to its existing customers, consumer
lending is not a category the Bank targets for organic growth.
Loan
Origination and Processing
Loan
originations are derived from a number of sources. Residential loan originations result from real estate broker referrals, direct
solicitation by the Bank’s loan officers, present depositors and borrowers, referrals from builders and attorneys, walk-in
customers and, in some instances, other lenders. Consumer and commercial real estate loan originations generally emanate from
many of the same sources.
Residential
loan applications are underwritten and closed based upon standards which generally meet secondary market guidelines. The loan
underwriting procedures followed by the Bank conform to regulatory specifications and are designed to assess both the borrower’s
ability to make principal and interest payments and the value of any assets or property serving as collateral for the loan. Generally,
as part of the process, a loan officer meets with each applicant to obtain the appropriate employment and financial information
as well as any other required loan information. The Bank then obtains reports with respect to the borrower’s credit record,
and on real estate loans, orders and reviews an appraisal of any collateral for the loan (prepared for the Bank by an independent
appraiser).
Loan
applicants are notified promptly of the decision of the Bank. Prior to closing any long-term loan, the borrower must provide proof
of fire and casualty insurance on the property serving as collateral, and such insurance must be maintained during the full term
of the loan. Title insurance is required on loans collateralized by real property.
The
Bank is focusing on the generation of commercial, commercial real estate and agriculture loans to grow and diversify the loan
portfolio. During 2020, the Bank was able to generate loan growth across the geographic markets that it serves, primarily in commercial
real estate and commercial loans. In addition, the Bank also generated significant loan growth by originating PPP loans to help
businesses impacted by COVID-19.
Supervision
and Regulation
General
FDIC-insured
institutions, like the Bank, their holding companies and their affiliates are extensively regulated under federal law. As a result,
our growth and earnings performance may be affected not only by management decisions and general economic conditions, but also
by the requirements of applicable statutes and by the regulations and policies of various bank regulatory agencies, including
our primary regulator, the Federal Reserve, and the Bank’s primary regulator, the OCC, as well as the FDIC, as the insurer
of our deposits, and the Consumer Financial Protection Bureau (“CFPB”), as the regulator of consumer financial services
and their providers. Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities, accounting
rules developed by the Financial Accounting Standards Board (“FASB”), securities laws administered by the Securities
and Exchange Commission (“SEC”) and state securities authorities, and anti-money laundering laws enforced by the U.S.
Department of the Treasury (“Treasury”) have an impact on our business. The effect of these statutes, regulations,
regulatory policies and accounting rules are significant to our operations and results.
Federal
and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of FDIC-insured
institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits
and depositors of banks, rather than shareholders. These laws, and the regulations of the bank regulatory agencies issued under
them, affect, among other things, the scope of our business, the kinds and amounts of investments we may make, required capital
levels relative to assets, the nature and amount of collateral for loans, the establishment of branches, our ability to merge,
consolidate and acquire, dealings with the Company’s and the Bank’s insiders and affiliates and our payment of dividends.
In reaction to the global financial crisis and particularly following passage of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the “Dodd-Frank Act”), we experienced heightened regulatory requirements and scrutiny. Although the
reforms primarily targeted systemically significant financial service providers, their influence filtered down in varying degrees
to community banks over time and caused our compliance and risk management processes, and the costs thereof, to increase. Then,
in May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (“Regulatory Relief Act”) was enacted
by Congress in part to provide regulatory relief for community banks and their holding companies. To that end, the law eliminated
questions about the applicability of certain Dodd-Frank Act reforms to community bank systems, including relieving us of any requirement
to engage in mandatory stress tests, maintain a risk committee or comply with the Volcker Rule’s complicated prohibitions
on proprietary trading and ownership of private funds. We believe these reforms are favorable to our operations.
The
supervisory framework for U.S. banking organizations subjects banks and bank holding companies to regular examination by their
respective regulatory agencies, which results in examination reports and ratings that are not publicly available and that can
impact the conduct and growth of their business. These examinations consider not only compliance with applicable laws and regulations,
but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors.
The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated
entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable
law or are otherwise inconsistent with laws and regulations.
The
following is a summary of the material elements of the supervisory and regulatory framework applicable to the Company and the
Bank, beginning with a discussion of the impact of the COVID-19 pandemic on the banking industry. It does not describe all of
the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described.
The descriptions are qualified in their entirety by reference to the particular statutory and regulatory provision.
COVID-19
Pandemic
The
federal bank regulatory agencies, along with their state counterparts, have issued a steady stream of guidance responding to the
COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact.
These include, without limitation: requiring banks to focus on business continuity and pandemic planning; adding pandemic scenarios
to stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting
extensions; reducing margin requirements on swaps; permitting certain otherwise prohibited investments in investment funds; issuing
guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit
under the Community Reinvestment Act (“CRA”) for certain pandemic-related loans, investments and public service. Because
of the need for social distancing measures, the agencies revamped the manner in which they conducted periodic examinations of
their regulated institutions, including making greater use of off-site reviews.
Moreover,
the Federal Reserve issued guidance encouraging banking institutions to utilize its discount window for loans and intraday credit
extended by its Reserve Banks to help households and businesses impacted by the pandemic and announced numerous funding facilities.
The FDIC also has acted to mitigate the deposit insurance assessment effects of participating in the PPP and the Federal Reserve’s
PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility.
Reference
is made to the sections “Item 1A. Risk Factors – COVID-19 Risks” and “Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of Operations – Impact of COVID-19” for information on the Coronavirus
Aid, Relief and Economic Security Act (“CARES Act”), PPP program and the Federal Reserve’s lending facilities
and for discussions of the economic impact of the COVID-19 pandemic. In addition, information as to selected topics, such as the
impact on capital requirements, dividend payments, reserves and CRA, is contained in the relevant sections of this Supervision
and Regulation discussion provided below.
The
Role of Capital
Regulatory
capital represents the net assets of a banking organization available to absorb losses. Because of the risks attendant to their
business, FDIC-insured institutions are generally required to hold more capital than other businesses, which directly affects
our earnings capabilities. While capital has historically been one of the key measures of the financial health of both bank holding
companies and banks, its role became fundamentally more important in the wake of the global financial crisis, as the banking regulators
recognized that the amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses during periods
of severe stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish capital standards for banks
and bank holding companies that are meaningfully more stringent than those in place previously.
Capital
Levels. Banks have been required to hold minimum levels of capital based on guidelines established by the bank regulatory
agencies since 1983. The minimums have been expressed in terms of ratios of “capital” divided by “total assets”.
The capital guidelines for U.S. banks beginning in 1989 have been based upon international capital accords (known as “Basel”
rules) adopted by the Basel Committee on Banking Supervision, a committee of central banks and bank supervisors that acts as the
primary global standard-setter for prudential regulation, as implemented by the U.S. bank regulatory agencies on an interagency
basis. The accords recognized that bank assets for the purpose of the capital ratio calculations needed to be risk weighted (the
theory being that riskier assets should require more capital) and that off-balance sheet exposures needed to be factored in the
calculations. Following the global financial crisis, the Group of Governors and Heads of Supervision, the oversight body of the
Basel Committee on Banking Supervision, announced agreement on a strengthened set of capital requirements for banking organizations
around the world, known as Basel III, to address deficiencies recognized in connection with the global financial crisis.
The
Basel III Rule. In July 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital
reforms in pertinent part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the
“Basel III Rule”). In contrast to capital requirements historically, which were in the form of guidelines, Basel III
was released in the form of binding regulations by each of the regulatory agencies. The Basel III Rule increased the required
quantity and quality of capital and required more detailed categories of risk weighting of riskier, more opaque assets. For nearly
every class of assets, the Basel III Rule requires a more complex, detailed and calibrated assessment of risk in the calculation
of risk weightings. The Basel III Rule is applicable to all banking organizations that are subject to minimum capital requirements,
including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies,
other than “small bank holding companies” (generally certain holding companies with consolidated assets of less than
$3 billion, which at this juncture does not include us) and certain qualifying banking organizations that may elect a simplified
framework (which we have not done). Thus, the Company and the Bank are each currently subject to the Basel III Rule as described
below.
Not
only did the Basel III Rule increase most of the required minimum capital ratios in effect prior to January 1, 2015, but, in requiring
that forms of capital be of higher quality to absorb loss, it introduced the concept of Common Equity Tier 1 Capital, which consists
primarily of common stock, related surplus (net of Treasury stock), retained earnings, and Common Equity Tier 1 minority interests
subject to certain regulatory adjustments. The Basel III Rule also changed the definition of capital by establishing more stringent
criteria that instruments must meet to be considered Additional Tier 1 Capital (primarily non-cumulative perpetual preferred stock
that meets certain requirements) and Tier 2 Capital (primarily other types of preferred stock and subordinated debt, subject to
limitations). The Basel III Rule also constrained the inclusion of minority interests, mortgage-servicing assets, and deferred
tax assets in capital and required deductions from Common Equity Tier 1 Capital in the event that such assets exceeded a percentage
of a banking institution’s Common Equity Tier 1 Capital.
The
Basel III Rule required minimum capital ratios as of January 1, 2015, as follows:
● A ratio of minimum Tier 1 Capital equal to 6% of risk-weighted assets;
In
addition, institutions that seek the freedom to make capital distributions (including for dividends and repurchases of stock)
and pay discretionary bonuses to executive officers without restriction must also maintain 2.5% in Common Equity Tier 1 Capital
attributable to a capital conservation buffer. The purpose of the conservation buffer is to ensure that banking institutions maintain
a buffer of capital that can be used to absorb losses during periods of financial and economic stress. Factoring in the conservation
buffer increases the minimum ratios depicted above to 7% for Common Equity Tier 1 Capital, 8.5% for Tier 1 Capital and 10.5% for
Total Capital. The federal bank regulators released a joint statement in response to the COVID-19 pandemic reminding the industry
that capital and liquidity buffers were meant to give banks the means to support the economy in adverse situations, and that the
agencies would support banks that use the buffers for that purpose if undertaken in a safe and sound manner.
Well-Capitalized
Requirements. The ratios described above are minimum standards in order for banking organizations to be considered “adequately
capitalized.” Bank regulatory agencies uniformly encourage banks to hold more capital and be “well-capitalized”
and, to that end, federal law and regulations provide various incentives for banking organizations to maintain regulatory capital
at levels in excess of minimum regulatory requirements. For example, a banking organization that is well-capitalized may: (i)
qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities; (ii)
qualify for expedited processing of other required notices or applications; and (iii) accept, roll-over or renew brokered deposits.
Higher capital levels could also be required if warranted by the particular circumstances or risk profiles of individual banking
organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required
to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional
activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth
would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all intangible
assets), well above the minimum levels.
Under
the capital regulations of the Federal Reserve for the Company and the OCC for the Bank, in order to be well-capitalized, we must
maintain:
● A Common Equity Tier 1 Capital ratio to risk-weighted assets of 6.5% or more;
● A ratio of Tier 1 Capital to total risk-weighted assets of 8% or more;
● A ratio of Total Capital to total risk-weighted assets of 10% or more; and
It
is possible under the Basel III Rule to be well-capitalized while remaining out of compliance with the capital conservation buffer
discussed above.
As
of December 31, 2020, the Bank was not subject to a directive from the OCC to increase its capital and the Bank was well-capitalized,
as defined by OCC regulations. As of December 31, 2020, the Company had regulatory capital in excess of the Federal Reserve’s
requirements and met the Basel III Rule requirements to be well-capitalized. We are also in compliance with the capital conservation
buffer.
Prompt
Corrective Action. The concept of being “well-capitalized” is part of a regulatory regime that provides the federal
banking regulators with broad power to take “prompt corrective action” to resolve the problems of undercapitalized
institutions based on the capital level of each particular institution. The extent of the regulators’ powers depends on
whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly
undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the
capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution
to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii)
requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv) restricting
transactions between the institution and its affiliates; (v) restricting the interest rate that the institution may pay on deposits;
(vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed;
(viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest
certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing
a receiver for the institution.
Community
Bank Capital Simplification. Community banks have long raised concerns with bank regulators about the regulatory burden, complexity,
and costs associated with certain provisions of the Basel III Rule. In response, Congress provided an “off-ramp” for
institutions, like us, with total consolidated assets of less than $10 billion. Section 201 of the Regulatory Relief Act instructed
the federal banking regulators to establish a single “Community Bank Leverage Ratio” (“CBLR”) of between
8 and 10%. Under the final rule, a community banking organization is eligible to elect the new framework if it has: less than
$10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a CBLR greater
than 9%. The bank regulatory agencies temporarily lowered the CBLR to 8% as a result of the COVID-19 pandemic. We may elect the
CBLR framework at any time, but have not currently determined to do so.
Regulation
and Supervision of the Company
General.
The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, we are registered
with, and subject to regulation, supervision and enforcement by, the Federal Reserve under the Bank Holding Company Act of 1956,
as amended (the “BHCA”). We are legally obligated to act as a source of financial and managerial strength to the Bank
and to commit resources to support the Bank in circumstances where we might not otherwise do so. Under the BHCA, we are subject
to periodic examination by the Federal Reserve and are required to file with the Federal Reserve periodic reports of our
operations and such additional information regarding the Company and the Bank as the Federal Reserve may require.
Acquisitions
and Activities. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires
the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding
company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established
by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States.
In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the
aggregate amount of deposits that may be held by the acquiring bank holding company and its FDIC-insured institution affiliates
in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state institutions
or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time
(not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the
Dodd-Frank Act, bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers or acquisitions.
For a discussion of the capital requirements, see “—The Role of Capital” above.
The
BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of 5% or more of the voting shares
of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks
or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal
exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the
Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.”
This authority would permit the Company to engage in a variety of banking-related businesses, including the ownership and operation
of a savings association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau
(including software development) and mortgage banking and brokerage services. The BHCA does not place territorial restrictions
on the domestic activities of nonbank subsidiaries of bank holding companies.
Additionally,
bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding
companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and
insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary
of the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that
the Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk
to the safety or soundness of FDIC-insured institutions or the financial system generally. We elected to operate as a financial
holding company in May 2017. In order to maintain our status as a financial holding company, both the Company and the Bank must
be well-capitalized, well-managed, and the Bank must have at least a satisfactory CRA rating. If the Federal Reserve determines
that either we or the Bank is not well-capitalized or well-managed, the Federal Reserve will provide a period of time in which
to achieve compliance, but during the period of noncompliance, the Federal Reserve may place any additional limitations on us
that it deems appropriate. Furthermore, if non-compliance is based on the failure of the Bank to achieve a satisfactory CRA rating,
we would not be able to commence any new financial activities or acquire a company that engages in such activities.
Change
in Control. Federal law prohibits any person or company from acquiring “control” of an FDIC-insured depository
institution or its holding company without prior notice to the appropriate federal bank regulator. “Control” is conclusively
presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company,
but may arise under certain circumstances between 10% and 24.99% ownership.
Capital
Requirements. We file consolidated capital reports with the Federal Reserve under the Basel III Rule. For a discussion of
capital requirements, see “—The Role of Capital” above.
Dividend
Payments. Our ability to pay dividends to shareholders may be affected by both general corporate law considerations and policies
of the Federal Reserve applicable to bank holding companies. As a Delaware corporation, we are subject to the limitations
of the Delaware General Corporation Law (the “DGCL”). The DGCL allows us to pay dividends only out of its surplus
(as defined and computed in accordance with the provisions of the DGCL) or if we have no such surplus, out of its net profits
for the fiscal year in which the dividend is declared and/or the preceding fiscal year.
As
a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should eliminate, defer
or significantly reduce dividends to shareholders if: (i) the company’s net income available to shareholders for the past
four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective
rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial
condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.
These factors have come into consideration in the industry as a result of the COVID-19 pandemic, however, the Company’s
net income and capital has allowed it to maintain its dividend policy. The Federal Reserve also possesses enforcement powers over
bank holding companies and their nonbank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices
or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends
by banks and bank holding companies. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends
have to maintain 2.5% in Common Equity Tier 1 Capital attributable to the capital conservation buffer. See “—The Role
of Capital” above.
Monetary
Policy. The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank
holding companies and their subsidiaries, and this is evidenced in its reaction to the COVID-19 pandemic. Among the tools available
to the Federal Reserve to affect the money supply are open market transactions in U.S. government securities and changes in the
discount rate on bank borrowings. These means are used in varying combinations to influence overall growth and distribution of
bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
Federal
Securities Regulation. Our common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities
Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, we are subject to the information, proxy solicitation,
insider trading and other restrictions and requirements of the SEC under the Exchange Act.
Corporate
Governance. The Dodd-Frank Act addressed many investor protection, corporate governance and executive compensation matters
that will affect most U.S. publicly traded companies. It increased stockholder influence over boards of directors by requiring
companies to give stockholders a nonbinding vote on executive compensation and so-called “golden parachute” payments,
and authorizing the SEC to promulgate rules that would allow stockholders to nominate and solicit voters for their own candidates
using a company’s proxy materials. The legislation also directed the Federal Reserve to promulgate rules prohibiting excessive
compensation paid to executives of bank holding companies, regardless of whether such companies are publicly traded.
Regulation
and Supervision of the Bank
General.
The Bank is a national bank, chartered by the OCC under the National Bank Act. The deposit accounts of the Bank are insured
by the DIF to the maximum extent provided under federal law and FDIC regulations, currently $250,000 per insured depositor category,
and the Bank is a member of the Federal Reserve System. As a national bank, the Bank is subject to the examination, supervision,
reporting and enforcement requirements of the OCC, the chartering authority for national banks. The Bank is subject to that authority
and is examined by the OCC. The FDIC, as administrator of the DIF, also has regulatory authority over the Bank.
Deposit
Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC.
The FDIC has adopted a risk-based assessment system whereby FDIC-insured institutions pay insurance premiums at rates based on
their risk classification. For institutions like the Bank that are not considered large and highly complex banking organizations,
assessments are now based on examination ratings and financial ratios. The total base assessment rates currently range from 1.5
basis points to 30 basis points. At least semi-annually, the FDIC updates its loss and income projections for the DIF and, if
needed, increases or decreases the assessment rates, following notice and comment on proposed rulemaking.
The
reserve ratio is the FDIC insurance fund balance divided by estimated insured deposits. The Dodd-Frank Act altered the minimum
reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits. The reserve
ratio reached 1.36% as of September 30, 2018, exceeding the statutory required minimum. As a result, the FDIC provided assessment
credits to insured depository institutions, like the Bank, with total consolidated assets of less than $10 billion for the portion
of their regular assessments that contributed to growth in the reserve ratio between 1.15% and 1.35%. The FDIC applied the small
bank credits for quarterly assessment periods beginning July 1, 2019. However, the reserve ratio then fell to 1.30% in 2020 as
a result of extraordinary insured deposit growth caused by an unprecedented inflow of more than $1 trillion in estimated insured
deposits in the first half of 2020, stemming mainly from the COVID-19 pandemic. Although the FDIC could have ceased the small
bank credits, it waived the requirement that the reserve ratio be at least 1.35% for full remittance of the remaining assessment
credits, and it refunded all small bank credits as of September 30, 2020.
Supervisory
Assessments. National banks are required to pay supervisory assessments to the OCC to fund the operations of the OCC. The
amount of the assessment is calculated using a formula that considers the bank’s size and its supervisory condition. During
the year ended December 31, 2020, the Bank paid supervisory assessments to the OCC totaling $201,000.
Capital
Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital
requirements, see “—The Role of Capital” above.
Liquidity
Requirements. Liquidity is a measure of the ability and ease with which bank assets may be converted to cash. Liquid assets
are those that can be converted to cash quickly if needed to meet financial obligations. To remain viable, FDIC-insured institutions
must have enough liquid assets to meet their near-term obligations, such as withdrawals by depositors. Because the global financial
crisis was in part a liquidity crisis, Basel III also includes a liquidity framework that requires FDIC-insured institutions to
measure their liquidity against specific liquidity tests. One test, referred to as the Liquidity Coverage Ratio, or LCR, is designed
to ensure that the banking entity has an adequate stock of unencumbered high-quality liquid assets that can be converted easily
and immediately in private markets into cash to meet liquidity needs for a 30-calendar day liquidity stress scenario. The other
test, known as the Net Stable Funding Ratio, or NSFR, is designed to promote more medium- and long-term funding of the assets
and activities of FDIC-insured institutions over a one-year horizon. These tests provide an incentive for banks and holding companies
to increase their holdings in Treasury securities and other sovereign debt as a component of assets, increase the use of long-term
debt as a funding source and rely on stable funding like core deposits (in lieu of brokered deposits).
In
addition to liquidity guidelines already in place, the federal bank regulatory agencies implemented the Basel III LCR in 2014
and have proposed the NSFR. While these rules do not, and will not, apply to the Bank, we continue to review our liquidity risk
management policies in light of developments.
Dividend
Payments. The primary source of funds for the Company is dividends from the Bank. Under the National Bank Act, a national
bank may pay dividends out of its undivided profits in such amounts and at such times as the bank’s board of directors deems
prudent. Without prior OCC approval, however, a national bank may not pay dividends in any calendar year that, in the aggregate,
exceed the bank’s year-to-date net income plus the bank’s retained net income for the two preceding years. The payment
of dividends by any FDIC-insured institution is affected by the requirement to maintain adequate capital pursuant to applicable
capital adequacy guidelines and regulations, and an FDIC-insured institution generally is prohibited from paying any dividends
if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its capital requirements
under applicable guidelines as of December 31, 2020. Notwithstanding the availability of funds for dividends, however, the OCC
may prohibit the payment of dividends by the Bank if it determines such payment would constitute an unsafe or unsound practice.
In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends have to maintain 2.5% in Common Equity
Tier 1 Capital attributable to the capital conservation buffer. See “—The Role of Capital” above.
Insider
Transactions. The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between
the Bank and its “affiliates.” The Company is an affiliate of the Bank for purposes of these restrictions, and covered
transactions subject to the restrictions include extensions of credit to the Company, investments in the stock or other securities
of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by the Bank. The
Dodd-Frank Act enhanced the requirements for certain transactions with affiliates, including an expansion of the definition of
“covered transactions” and an increase in the amount of time for which collateral requirements regarding covered transactions
must be maintained.
Certain
limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors
and officers of the Company and its subsidiaries, to principal shareholders of the Company and to “related interests”
of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which
any person who is a director or officer of the Company or the Bank, or a principal shareholder of the Company, may obtain credit
from banks with which the Bank maintains a correspondent relationship.
Safety
and Soundness Standards/Risk Management. FDIC-insured institutions are expected to operate in a safe and sound manner. The
federal banking agencies have adopted operational and managerial standards to promote the safety and soundness of such institutions
that address internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest
rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In
general, the safety and soundness standards prescribe the goals to be achieved in each area, and each institution is responsible
for establishing its own procedures to achieve those goals. If an institution fails to operate in a safe and sound manner, the
FDIC-insured institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining
compliance. If an FDIC-insured institution fails to submit an acceptable compliance plan, or fails in any material respect to
implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order
directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator
may restrict the FDIC-insured institution’s rate of growth, require the FDIC-insured institution to increase its capital,
restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate
under the circumstances. Operating in an unsafe or unsound manner will also constitute grounds for other enforcement action by
the federal bank regulatory agencies, including cease and desist orders and civil money penalty assessments.
During
the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and
strong internal controls when evaluating the activities of the FDIC-insured institutions they supervise. Properly managing risks
has been identified as critical to the conduct of safe and sound banking activities and has become even more important as new
technologies, product innovation, and the size and speed of financial transactions have changed the nature of banking markets.
The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity,
operational, legal and reputational risk. The OCC, in its 2021 supervisory plan, identified key risk themes for 2021 as: credit
risk management given projected weaker economic conditions and commercial and residential real estate concentration risk management.
The agency will also be monitoring banks for their transition away from LIBOR (London Interbank Offered Rate) as a reference rate,
compliance risk management related to COVID-19 pandemic-related activities, Bank Secrecy Act/anti-money laundering compliance,