UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
For
fiscal year ended December 31, 2022
OR
For
transition period from __________ to ___________
Commission
File Number 0-33203
LANDMARK
BANCORP, INC.
(Exact
name of Registrant as specified in its charter)
701 Poyntz Avenue, Manhattan, Kansas 66502
(Address of principal executive offices) (Zip Code)
(785)565-2000
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share LARK Nasdaq Global 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 such 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 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, a smaller reporting
company, or an emerging growth company. See the definitions of “large accelerated filer,” “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 provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness
of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered
public accounting firm that prepared or issued its audit report. ☐
If
securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant
included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate
by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation
received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes
☐ No ☒
The
aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the last sales price
of $24.13 quoted on the Nasdaq Global Market on the last business day of the registrant’s most recently completed second fiscal
quarter, was approximately $92.7 million. On March 29, 2023, the total number of shares of common stock outstanding was 5,213,582.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the Proxy Statement for the Annual Meeting of Stockholders of the registrant to be held on May 24, 2023, are incorporated by reference
in Part III hereof, to the extent indicated herein.
LANDMARK
BANCORP, INC.
2022
Form 10-K Annual Report
Table
of Contents
ITEM 1. BUSINESS 3
ITEM 1A. RISK FACTORS 24
ITEM 1B. UNRESOLVED STAFF COMMENTS 37
ITEM 2. PROPERTIES 37
ITEM 3. LEGAL PROCEEDINGS 37
ITEM 4. MINE SAFETY DISCLOSURES 37
ITEM 6. [RESERVED] 38
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 48
ITEM 9A. CONTROLS AND PROCEDURES 90
ITEM 9B. OTHER INFORMATION 90
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS 90
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 91
ITEM 11. EXECUTIVE COMPENSATION 91
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 92
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 93
SIGNATURES 95
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, 2022, the Company had $1.5 billion in consolidated
total assets.
The
Company is headquartered in Manhattan, Kansas, and has expanded its geographic presence through opening new branches and acquisitions.
On October 1, 2022, the Company completed its acquisition of Freedom Bancshares, Inc. (“Freedom”), the holding company of
Freedom Bank. Freedom Bank was founded in 2006 and operated out of a single location in Overland Park, Kansas. As of September 30, 2022,
Freedom Bank reported total assets of $202.0 million, gross loans of $118.0 million, and total deposits of $150.4 million. The acquisition
was accounted for as a business combination under ASC 805. 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 31 branch offices in 24 communities
across the state of Kansas.
Landmark
Risk Management, Inc., which was formed and began operations in 2017, is a Nevada-based captive insurance company which 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 current 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.
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
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 became fully operational in May 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 acquisition
of Freedom bank in 2022 expanded the Bank’s presence in Overland Park and contributed to the 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.
Human
Capital Resources
Employees.
At December 31, 2022, the Bank had a total of 286 employees (276 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.
Diversity,
Equity and Inclusion. The Company believes that a diverse workforce is critical to achieving its strategic goals. The Company
strives to foster a strong and inclusive culture that is committed to delivering extraordinary service to our clients and communities
by meeting the financial needs of families and businesses across Kansas.
Talent
development and retention. The Company utilizes various processes to recruit employees with values that align with the Company’s
vision that Everyone Starts as a Customer and Leaves as a Friend. The long-term success of the Company revolves around the ability
to continue to develop and retain these employees.
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 Chief Credit Officer, 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, 2022 compared to December 31,
2021 primarily due to increasing mortgage rates, which increased demand for the Bank’s 7/1 ARM loans. These loans are retained
in portfolio and were the primary factor for the increase in balances during 2022. While the Bank retains some of the new fixed rate
mortgage loan originations, most of the new fixed rate mortgage 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 decreased as of December 31, 2022 compared to December 31, 2021 primarily due to lower demand from the Bank’s
loan customers for these types of loans.
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.
Additionally, the acquisition of Freedom Bank increased the Bank’s commercial real estate loans.
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 balances of commercial loans
increased during 2022, due to the acquisition of Freedom Bank and organic growth.
Paycheck
Protection Program Lending. Starting in 2020, the Bank participated 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. Through the first and second rounds of PPP lending, the Bank funded 2,195 loans totaling approximately $186.0 million. The
Bank received 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 majority of the Bank’s PPP loans were forgiven in 2020, 2021 and 2022, leaving one loan
totaling $21,000 remaining at December 31, 2022.
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 decrease in these loan
balances as of December 31, 2022 compared to December 31, 2021.
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.
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.
Total gross loans increased during 2022 as a result of the acquisition of Freedom Bank and loan growth in the Bank’s other markets.
The Bank was able to generate loan growth across the geographic markets that it serves, primarily in commercial, commercial real estate
and one-to-four residential real estate loans.
Deposits
The
Bank has a diversified deposit base. The deposit base consists of retail, commercial and public fund customers located in the
markets in which the Bank operates. The Bank is to is to provide a diverse financial suite of products to its deposit customers and
seeks to be the primary financial service provider for these customers. The Bank considers these deposit relationships to be its
core deposit base. If the Bank requires funding that exceeds these customer’s deposit balances, non-core or brokered deposits
may be utilized. The balance of non-core or brokered deposits at December 31, 2022 was $10.3 million, or 0.8% of total deposits.
In
order for the Bank to attract and retain stable deposit relationships, the Bank offers business cash management solution services to
help local companies better manage their cash flow. The expertise and experience of the Bank’s management coupled with the latest
technology accessed through third party providers enables the Bank to maximize the growth of business-related deposits.
As
for consumers, deposit growth is driven by a variety of factors including, but not limited to, population growth, bank and non-bank competition,
local bank mergers and consolidations, increases in household income, interest rates, accessibility of location and the sales efforts
of Bank personnel. Time deposits can be attracted and increased by paying an interest rate higher than that offered by competitors, but
are the costliest type of deposit. The most profitable type of deposits are non-interest bearing demand (checking) accounts, which can
be attracted by offering free checking. However, both high interest rates and free checking accounts generate certain expenses for a
bank and the desire to increase deposits must be balanced with the need to be profitable and the extent of banking relationships with
the customers. The deposit services of the Bank are generally comprised of demand deposits, savings deposits, money market deposits,
time deposits and individual retirement accounts.
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. The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (“Regulatory Relief
Act”) 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. These reforms have been 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. 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.
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.
Although 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.
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. The United States bank regulatory agencies adopted the Basel III regulatory capital reforms, and, at the same
time, effected changes required by the Dodd-Frank Act, in regulations that were effective (with certain phase-ins) in 2015. Basel III,
or the “Basel III Rule”, established capital standards for banks and bank holding companies that are meaningfully more stringent
than those in place previously: it increased the required quantity and quality of capital; and it required 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 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 Common Equity Tier 1 Capital equal to 4.5% of risk-weighted assets;
● A ratio of 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.
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, 2022: (i) the Bank was not subject to a directive from the OCC to increase its capital and (ii) the Bank was well-capitalized,
as defined by OCC regulations. As of December 31, 2022, 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%. We may elect the CBLR framework
at any time but have not currently determined to do so.
Supervision
and Regulation 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 is 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 more than 5% of the voting shares of any
company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing
services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows
bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve prior
to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit
the Company to engage in a variety of banking-related businesses, including the ownership and operation of a savings association, or
any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development)
and mortgage banking and brokerage 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, as long as the activity 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 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. 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.
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.
Supervision
and Regulation 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 DIF balance divided by estimated insured deposits. In response to the global financial crisis, the Dodd-Frank Act
increased the minimum reserve ratio from 1.15% to 1.35% of the estimated amount of total insured deposits. Prior to the COVID-19 pandemic,
the reserve ratio briefly exceeded the statutory threshold, but, because of extraordinary insured deposit growth caused by an unprecedented
inflow of deposits during the pandemic, the reserve ratio fell below 1.35% and continues to be below the threshold. The FDIC staff closely
monitors the factors that affect the reserve ratio, and, in order to raise the reserve ratio to 1.35% by September 30, 2028, the FDIC
increased the initial deposit insurance rates by two basis points, beginning with the first quarterly assessment period of the 2023 assessment.
As a result of this change, the Bank’s FDIC insurance assessment will increase beginning in 2023.
The
DIF balance was approximately $125.5 billion on September 30, 2022, up $1.0 billion from the end of the second quarter. The reserve ratio
remained at 1.26%, as growth in the fund balance kept pace with growth in insured deposits. The FDIC staff continues to closely monitor
the factors that affect the reserve ratio, and any change could impact FDIC assessments.
Given the recent actions of the
FDIC to apply increased insurance limits for all depositors of Silicon Valley Bank in California and Signature Bank in New York as a result
of their respective failures for reasons cited primarily as liquidity issues, it is possible that an overhaul of the deposit insurance
limits and an increase in premiums applied to FDIC-insured institutions may occur.
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, 2022, the Bank paid supervisory assessments to the OCC totaling $238,000.
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