Item 1A. Risk Factors.
Cautionary Statement Regarding Forward-Looking
Information
Certain statements contained in this Annual Report
on Form 10-K, and in other statements that we make from time to time in filings by the Company with the SEC, in press releases, and in
oral and written statements made by or with the approval of the Company which are not statements of historical fact constitute forward-looking
statements within the meaning of Section 27A of the Securities Act, Section 21E of the Exchange Act, and the Private Securities Litigation
Reform Act of 1995. Examples of forward-looking statements include: (a) projections of income or expense, earnings per share, the payment
or non-payment of dividends, capital structure and other financial items; (b) statements of plans and objectives of the Company or our
Board of Directors or management, including those relating to products and services; (c) statements of future economic performance; (d)
statements of future customer attraction or retention; and (e) statements of assumptions underlying these statements. Forward-looking
statements reflect our expectations, estimates or projections concerning future results or events. These statements are generally identified
by the use of forward-looking words or phrases such as “anticipates”, “believes”, “estimates”, “expects”,
“intends”, “may”, “plans”, “projects”, “should”, “will allow”,
“will continue”, “will likely result”, “will remain”, “would be”, or similar expressions.
The Private Securities Litigation Reform Act of
1995 provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information so
long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important
factors that could cause actual results to differ materially from those discussed in the forward-looking statements. We desire to take
advantage of the “safe harbor” provisions of the Act.
Forward-looking statements involve risks and uncertainties.
Actual results may differ materially from those predicted by the forward-looking statements because of various factors and possible events,
including those factors discussed in the Risk Factors below. There is also the risk that the Company’s management or Board of Directors
incorrectly analyzes these risks and forces, or that the strategies the Company develops to address them are unsuccessful.
Forward-looking statements speak only as of that
date on which they are made. Except as may be required by law, the Company undertakes no obligation to update any forward-looking statement
to reflect events or circumstances after the date on which the statement is made. All forward-looking statements attributable to the Company
or any person acting on our behalf are qualified in their entirety by the following cautionary statements.
Risk Factors
The following sets forth certain risk factors
that we are believe are relevant to the Company and its business. These risk factors are not presented in any particular order and do
not constitute all of the risks that may affect our business. Additional risks that are not presently known or that we currently deem
to be immaterial could also have a material adverse impact on our business, financial condition, or results of operations.
Economic, Market and Political Risks:
Changes in economic and political conditions
could adversely affect our earnings through declines in deposits, loan demand, the ability of our customers to repay loans and the value
of collateral securing our loans.
Our success depends to a large extent upon
local and national economic conditions, as well as governmental fiscal and monetary policies. Conditions such as inflation,
recession, unemployment, changes in interest rates, fiscal and monetary policy, an increasing federal government budget deficit, the
failure of the federal government to raise the federal debt ceiling and/or possible future U.S. government shutdowns over budget
disagreements, slowing gross domestic product, tariffs, a U.S. withdrawal from or significant renegotiation of trade agreements,
trade wars, and other factors beyond our control may adversely affect our deposit levels and composition, the quality of investment
securities available for purchase, demand for loans, the ability of our borrowers to repay their loans, and the value of the
collateral securing loans made by us. Disruptions in U.S. and global financial markets, and changes in oil production in the Middle
East also affect the economy and stock prices in the U.S., which can affect our earnings capital, as well as the ability of our
customers to repay loans. Because we have a significant amount of real estate loans, decreases in real estate values could adversely
affect the value of property used as collateral and our ability to sell the collateral upon foreclosure. Adverse changes in the
economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have
an adverse impact on our earnings and cash flows. In addition, our lending and deposit gathering activities are concentrated
primarily in Northwest Ohio. As a result, our success depends in large part on the general economic conditions of these areas,
particularly given that a significant portion of our lending relates to real estate located in this region. Therefore, adverse
changes in the economic conditions in these areas could adversely impact our earnings and cash flows.
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Instability in global economic conditions and
geopolitical matters, as well as volatility in financial markets, could have a material adverse effect on our results of operations and
financial condition.
The macroeconomic environment in the U.S. is susceptible
to global events and volatility in financial markets. In addition, trade negotiations between the U.S. and other nations remain uncertain
and could adversely impact economic and market conditions for the Company and our clients and counterparties. Instability in global economic
conditions and geopolitical matters, such as military conflicts in Ukraine and the Middle East, as well as volatility in financial markets,
could have a material adverse effect on our results of operations and financial condition. For example, on February 24, 2022, Russian
military forces invaded Ukraine, and sustained conflict and disruption in the region have occurred and remains likely to continue. In
addition, the October 7, 2023, attack by Hamas in Israel has resulted in prolonged conflict and disruption in the Middle East. Although
the length, impact and outcome of the ongoing war in Ukraine and the conflict in the Middle East are highly unpredictable, these conflicts
have resulted, and could continue to result, in significant market and other disruptions, including significant volatility in commodity
prices and supply of energy resources, instability in financial markets, supply chain interruptions, political and social instability,
changes in consumer or purchaser preferences, as well as increases in cyberattacks and espionage. The extent and duration of the military
action, sanctions and resulting market disruptions could be significant and could potentially have substantial impact on the global economy
and the Company’s business for an unknown period of time. Any of the above-mentioned events or disruptions could affect our business,
financial condition and operating results, and may also magnify the impact of other risks described in this Form 10-K.
We may be unable to manage interest rate risks,
which could reduce our net interest income.
Our results of operations are affected principally
by net interest income, which is the difference between interest earned on loans and investments and interest expense paid on deposits
and other borrowings. The spread between the yield on our interest-earning assets and our overall cost of funds may be compressed, and
our net interest income may continue to be adversely impacted by changing rates. We cannot predict or control changes in interest rates.
National, regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the FRB, affect
the movement of interest rates and our interest income and interest expense. If the interest rates paid on deposits and other borrowed
funds increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore
earnings, could be adversely affected. Earnings could also be adversely affected in a declining rate environment if the interest paid
for deposits decrease more slowly than the interest rates received on loans and other investments.
In addition, certain assets and liabilities may
react in different degrees to changes in market interest rates. For example, interest rates on some types of assets and liabilities may
fluctuate prior to changes in broader market interest rates, while interest rates on other types may lag behind. While the bulk of our
variable rate commercial assets have interest rate floors, some of our assets, such as adjustable rate mortgages, have features that restrict
changes in their interest rates, including rate caps.
We believe that the impact on our cost of funds
will depend on a number of factors, including but not limited to, the competitive environment in the banking sector for deposit pricing,
opportunities for clients to invest in other markets such as fixed income and equity markets, and the propensity of customers to invest
in their businesses. The effect on our net interest income from a change in interest rates will ultimately depend on the extent to which
the aggregate impact of loan re-pricings exceeds the impact of increases in our cost of funds.
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Changes in interest rates may affect the level
of voluntary prepayments on our loans and may also affect the level of financing or refinancing by customers. Changes in interest rates
may also negatively affect the ability of the Company’s borrowers to repay their loans, particularly as interest rates rise and
adjustable rate loans become more expensive.
Interest rates are highly sensitive to many factors
that are beyond our control. Some of these factors include: inflation, recession, unemployment, money supply, international disorders,
and instability in domestic and foreign financial markets. The Company’s management uses various measures to monitor interest rate
risk and believes it has implemented effective asset and liability management strategies to reduce the potential adverse effects of changes
in interest rates on the Company’s financial condition and results of operations. Management also periodically adjusts the mix of
assets and liabilities to manage interest rate risk. However, any significant, unexpected, prolonged change in market interest rates could
have a material adverse effect on our financial condition and results of operations.
Risks Related to Our Business Operations:
If our actual credit losses exceed our allowance
for credit losses, our net income will decrease.
Our loan customers may not repay their loans according
to their terms, and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. We may experience
significant credit losses, which could have a material adverse effect on our operating results. In accordance with accounting principles
generally accepted in the United States, we maintain an ACL to provide for loan defaults and
non-performance, which when combined, we refer to as the ACL. Our ACL may not be adequate
to cover actual credit losses, and future provisions for credit losses could have a material adverse effect on our operating results.
Our ACL is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount
of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be
beyond our control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination
process, review our loans and ACL. We cannot guarantee that we will not further increase the ACL or that regulators will not require us to increase this allowance. Either of these occurrences could have a material adverse effect
on our financial condition and results of operations.
Moreover, the Financial Accounting Standards Board
(the “FASB”) has changed its requirements for establishing the ACL. On June 16, 2016, the FASB issued
Accounting Standard Update (“ASU”) 2016-13 “Financial Instruments - Credit Losses”, which replaces the incurred loss
model with an expected loss model and is referred to as the CECL model. Under the incurred loss model, loans are recognized as impaired
when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. Under the
CECL model, financial institutions are required to use historical information, current conditions and reasonable forecasts to estimate
the expected loss over the life of the loan. The transition to the CECL model requires significantly greater data requirements and changes
to methodologies to accurately account for expected losses under the new parameters. If the methodologies and assumptions that we use
in the CECL model are proven to be incorrect or inadequate, the ACL may not be sufficient, resulting in the need
for additional ACL to be established, which could have a material adverse impact on our financial condition and
results of operations.
The new CECL accounting guidance is effective
for annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2019. However, the
FASB deferred the effective date for this ASU for smaller reporting companies, such as the Company, to annual reporting periods and interim
reporting periods within those annual periods, beginning after December 15, 2022. The Company recognized a one-time cumulative effect
adjustment (increase) to the ACL of $1.4 million upon adoption as of January 1, 2023. In addition, the Company
established a related reserve for unfunded commitments of $1.1 million as of January 1, 2023.
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If real
estate markets or the economy in general deteriorate, State Bank may experience increased delinquencies and credit losses. The ACL may not be sufficient to cover actual loan-related losses. Additionally, banking regulators may require State Bank to
increase its ACL in the future, which could have a negative effect on the Company’s financial condition
and results of operations. Additions to the ACL will result in a decrease in net earnings and capital and could
hinder our ability to grow our assets.
Any significant increase in our ACL or loan charge offs, including increases required by applicable regulatory authorities, might have a material adverse effect
on the Company’s financial condition and results of operations.
Our success depends upon our ability to attract
and retain key personnel.
Our success depends upon the continued service
of our senior management team and upon our ability to attract and retain qualified financial services personnel. Competition for qualified
employees is intense. We cannot guarantee that we will be able to retain our existing key personnel or attract additional qualified personnel.
If we lose the services of our key personnel, or are unable to attract additional qualified personnel, our business, financial condition
and results of operations could be adversely affected.
We depend upon the accuracy and completeness of information about
customers.
In deciding whether to extend credit or enter
into other transactions with customers, we may rely on information provided to us by customers, including financial statements and other
financial information. We may also rely on representations of customers as to the accuracy and completeness of that information and, with
respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to a business,
we may assume that the customer’s audited financial statements conform to generally accepted accounting principles and present fairly,
in all material respects, the financial condition, results of operations and cash flows of the customer, and we may also rely on the audit
report covering those financial statements. Our financial condition and results of operations could be negatively impacted to the extent
we rely on financial statements that do not comply with generally accepted accounting principles or that are materially misleading.
We may not be able to grow, and if we do, we
may have difficulty managing that growth.
Our business strategy is to continue to grow our
assets and expand our operations, including through potential strategic acquisitions. Our ability to grow depends, in part, upon our ability
to expand our market share, successfully attract core deposits, and to identify loan and investment opportunities as well as opportunities
to generate fee-based income. We can provide no assurance that we will be successful in increasing the volume of our loans and deposits
at acceptable levels and upon terms acceptable to us. We also can provide no assurance that we will be successful in expanding our operations
organically or through strategic acquisitions while managing the costs and implementation risks associated with this growth strategy.
We expect to continue to experience growth in
the number of our employees and customers and the scope of our operations, but we may not be able to sustain our historical rate of growth
or continue to grow our business at all. Our success will depend upon the ability of our officers and key employees to continue to implement
and improve our operational and other systems, to manage multiple, concurrent customer relationships, and to hire, train and manage our
employees. In the event that we are unable to perform all these tasks and meet these challenges effectively, including continuing to attract
core deposits, our operations, and consequently our earnings, could be adversely impacted.
Future acquisitions or other expansion may
adversely impact our financial condition and results of operations.
In the future, we may acquire other financial
institutions or branches or assets of other financial institutions. We may also open new branches, enter into new lines of business, or
offer new products or services. Any such acquisition or expansion of our business will involve a number of expenses and risks, which may
include some or all of the following:
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● any financing required in connection with an acquisition or expansion;
● the risk of loss of key employees and customers.
We may incur substantial costs to expand, and
we can give no assurance that such expansion will result in the levels of profits we expect. Neither can we assure that integration efforts
for any future acquisitions will be successful. We may issue equity securities in connection with acquisitions, which could dilute the
economic and voting interests of our existing shareholders.
We are exposed to a number of operational risks.
We are exposed to many types of operational risk,
including reputational risk, legal and compliance risk, cybersecurity risk, the risk of fraud or theft by employees or outsiders, unauthorized
transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled
computer or telecommunications systems.
We rely heavily on communications and information
systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions
in our customer relationship management, general ledger, deposit, loan and other systems.
Given the volume of transactions we process, certain
errors may be repeated or compounded before they are discovered and successfully rectified. Our necessary dependence upon automated systems
to record and process our transaction volume may further increase the risk that technical system flaws or employee tampering or manipulation
of those systems will result in losses that are difficult to detect. We may also be subject to disruptions of our operating systems arising
from events that are wholly or partially beyond our control (for example, cyberattacks or electrical or telecommunications outages), which
may give rise to disruption of service to customers and to financial loss or liability. We are further exposed to the risk that our external
vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by
their respective employees as we are) and to the risk that our (or our vendors’) consumer compliance, business continuity and data
security systems prove to be inadequate.
Negative public opinion can result from our actual
or alleged conduct in any number of activities, including lending practices, corporate governance, acquisitions, social media and other
marketing activities, and the implementation of environmental, social and governance (“ESG”) practices, and from actions taken by governmental
regulators and community organizations in response to any of the foregoing activities. Negative public opinion could adversely affect
our ability to attract and keep customers, could expose us to potential litigation and regulatory action, and could have a material adverse
effect on the price of our common shares or result in heightened volatility of our stock price.
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Recent and future bank failures may adversely
affect the Company’s business, earnings and financial condition.
The failure of other banks can have significant
impacts on the national, regional and local banking industry and the business environment in which the Company operates. The recent bank
failures of Silicon Valley Bank in California, Signature Bank in New York, and First Republic Bank in California during the first and
second quarters of 2023 have caused a degree of panic and uncertainty in the investor community and among bank customers generally. While
the Company does not believe that the circumstances of these three bank failures are indicators of broader issues with the banking system,
these and any future bank failures may reduce customer confidence, affect sources of funding and liquidity (for example, by increasing
the withdrawal or transfer of deposits by customers), increase regulatory requirements and costs, adversely affect financial markets and/or
have a negative reputational ramification for the banking industry as a whole. The Company will continue to monitor the ongoing events
concerning these three banks, as well as any future potential bank failures and/or volatility within the banking industry in general,
along with any responsive measures taken by the banking regulators to mitigate or manage potential turmoil in the banking industry.
We could experience an unexpected inability
to obtain needed liquidity which could adversely affect our business, profitability, and viability a going concern.
Liquidity measures the ability to meet current
and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to
accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities and is essential to a financial
institution’s business. The ability of a financial institution to meet its current financial obligations is a function of its balance
sheet structure, its ability to liquidate assets, and its access to alternative sources of funds. The bank failures in 2023 exemplify
the potential serious results of the unexpected inability of insured depository institutions to obtain needed liquidity to satisfy deposit
withdrawal requests, including how quickly such requests can accelerate once uninsured depositors lose confidence in an institution’s
ability to satisfy its obligations to depositors. We seek to ensure our funding needs are met by maintaining a level of liquidity through
asset and liability management. If we become unable to obtain funds when needed, it could have a material adverse effect on our business,
financial condition, and results of operations.
Our information systems may experience an interruption
or security breach.
We rely heavily on communications and information
systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions
in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed
to prevent or limit the effect of the possible failure, interruption or security breach of our information systems, there can be no assurance
that any such failure, interruption or security breach will not occur or, if they do occur, that they will be adequately addressed. The
occurrence of any failure, interruption or security breach of our information systems could damage our reputation, result in a loss of
customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability.
Unauthorized disclosure of sensitive or confidential
client information, or breaches in security of our systems, could severely harm our business.
We collect, process and store sensitive consumer
data by utilizing computer systems and telecommunications networks operated by both third-party service providers and us. State Bank’s
necessary dependence upon automated systems to record and process State Bank’s transactions poses the risk that technical system
flaws, employee errors, tampering or manipulation of those systems, or attacks by third parties will result in losses and may be difficult
to detect. We have security and backup and recovery systems in place, as well as a business continuity plan, to ensure the computer systems
will not be inoperable, to the extent possible. We also routinely review documentation of such controls and backups related to third party
service providers. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness
and efficiency of our business operations. In recent years, some banks have experienced cyberattacks with the goal and effect of disrupting
the ability of the bank to process transactions. Other businesses have been victims of ransomware attacks in which the business becomes
unable to access its own information and is presented with a demand to pay a ransom in order to once again have access to its information.
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We could be adversely affected if one of our employees
or a third-party service provider causes a significant operational breakdown or failure, either as a result of human error or where an
individual purposefully sabotages or fraudulently manipulates our operations or systems. State Bank is further exposed to the risk that
the third-party service providers may be unable to fulfill their contractual obligations (or will be subject to the same risks as we are).
These disruptions may interfere with service to our customers, cause additional regulatory scrutiny and result in a financial loss or
liability. We are also at risk of the impact of natural disasters, terrorism and international hostilities on our systems or for the effects
of outages or other failures involving power or communications systems operated by others.
Misconduct by employees could include fraudulent,
improper or unauthorized activities on behalf of clients or improper use of confidential information. We may not be able to prevent employee
errors or misconduct, and the precautions we take to detect this type of activity might not be effective in all cases. Employee errors
or misconduct could subject us to civil claims for negligence or regulatory enforcement actions, including fines and restrictions on our
business.
In addition, there have been instances where financial
institutions have been victims of fraudulent activity in which criminals pose as customers to initiate wire and automated clearinghouse
transactions out of customer accounts. Although we have policies and procedures in place to verify the authenticity of our customers,
we cannot assure that such policies and procedures will prevent all fraudulent transfers.
We have implemented security controls to prevent
unauthorized access to our computer systems, and we require that our third-party service providers maintain similar controls. However,
the Company’s management cannot be certain that these measures will be successful. A security breach of the computer systems and
loss of confidential information, such as customer account numbers and related information, could result in a loss of customers’
confidence and, thus, loss of business. We could also lose revenue if competitors gain access to confidential information about our business
operations and use it to compete with us. While we maintain specific “cyber” insurance coverage, which would apply in the
event of various breach scenarios, the amount of coverage may not be adequate in any particular case. Furthermore, because cyber threat
scenarios are inherently difficult to predict and can take many forms, some breaches may not be covered under our cyber insurance coverage.
Further, we may be affected by data breaches at
retailers and other third parties who participate in data interchanges with us and our customers that involve the theft of customer credit
and debit card data, which may include the theft of our debit card PIN numbers and commercial card information used to make purchases
at such retailers and other third parties. Such data breaches could result in us incurring significant expenses to reissue debit cards
and cover losses, which could result in a material adverse effect on our results of operations.
There can be no assurance that we will not suffer
such cyber-attacks or other information security breaches (or attempted breaches) or incur resulting losses in the future. Our risk and
exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, and our plans to continue
to implement internet and mobile banking capabilities to meet customer demand. As cyber and other data security threats continue to evolve,
we may be required to expend significant additional resources to continue to modify and enhance protective measures or to investigate
and remediate any security vulnerabilities.
All of the types of cybersecurity incidents discussed
above could result in damage to the Company’s reputation, loss of customer business, litigation, increased regulatory scrutiny and
potential enforcement actions, repairs of system damage, increased investments in cybersecurity (such as obtaining additional technology,
making organizational changes, deploying additional personnel, training personnel and engaging consultants), increased insurance premiums,
and loss of investor confidence and a reduction in the price of our common shares, all of which could result in financial loss and material
adverse effects on the Company’s results of operations and financial condition.
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Our business could be adversely affected through
third parties who perform significant operational services on our behalf.
The third parties performing operational services
for the Company are subject to risks similar to those faced by the Company relating to cybersecurity, breakdowns or failures of their
own systems, or misconduct of their employees. Like many other community banks, State Bank also relies, in significant part, on a single
vendor for the systems which allow State Bank to provide banking services to State Bank’s customers.
One or more of the third parties utilized by us
may experience a cybersecurity event or operational disruption and, if any such event does occur, it may not be adequately addressed,
either operationally or financially, by such third party. Certain of these third parties may have limited indemnification obligations
to us in the event of a cybersecurity event or operational disruption or may not have the financial capacity to satisfy their indemnification
obligations.
Financial or operational difficulties of a third-party
provider could also impair our operations if those difficulties interfere with such third party’s ability to serve the Company.
If a critical third-party provider is unable to meet the needs of the Company in a timely manner, or if the services or products provided
by such third party are terminated or otherwise delayed and if the Company is not able to develop alternative sources for these services
and products quickly and cost-effectively, our business could be materially adversely affected.
Additionally, regulatory guidance adopted by federal
banking regulators addressing how banks select, engage and manage their third-party relationships, affects the circumstances and conditions
under which we work with third parties and the cost of managing such relationships.
Strong competition within our market area may
reduce our ability to attract and retain deposits and originate loans.
We face competition both in originating loans
and in attracting deposits within our market area. We compete for clients by offering personal service and competitive rates on our loans
and deposit products. The type of institutions we compete with include large regional financial institutions, community banks, thrifts
and credit unions operating within our market areas. Nontraditional sources of competition for loan and deposit dollars come from captive
auto finance companies, mortgage banking companies, internet banks, brokerage companies, insurance companies, fintechs and direct mutual
funds. As a result of their size and ability to achieve economies of scale, certain of our competitors offer a broader range of products
and services than we offer. We expect competition to remain intense in the future due to legislative, regulatory and technological changes
and the continuing trend of consolidation in the financial services industry. In addition, to stay competitive in our markets we may need
to adjust the interest rates on our products to match the rates offered by our competitors, which could adversely affect our net interest
margin. As a result, our profitability depends upon our continued ability to successfully compete in our market areas while achieving
our investment objectives.
We may be required to repurchase loans we have
sold or indemnify loan purchasers under the terms of the sale agreements, which could adversely affect our liquidity, results of operations
and financial statements.
When State Bank sells a mortgage loan, it agrees
to repurchase or substitute a mortgage loan if it is later found to have breached any representation or warranty State Bank made about
the loan or if the borrower is later found to have committed fraud in connection with the origination of the loan. While we have underwriting
policies and procedures designed to avoid breaches of representations and warranties as well as borrower fraud, there can be no assurance
that no breach or fraud will ever occur. Required repurchases, substitutions or indemnifications could have an adverse impact on our liquidity,
results of operations and financial statements.
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We are subject to environmental liability risk associated with lending
activities.
A significant portion of our loan portfolio is
secured by real property. During the ordinary course of business, we foreclose on and take title to properties securing certain loans.
In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are
found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws and evolving regulation
may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use
or sell the affected property. In addition, future laws and regulations or more stringent interpretations or enforcement policies with
respect to existing laws or regulations may increase our exposure to environmental liability. Environmental reviews of real property before
initiating foreclosure actions may not be sufficient to detect all potential environmental hazards. The remediation costs and any other
financial liabilities associated with an environmental hazard could have a material adverse effect on our business, financial condition
and results of operations.
Legislative, Legal and Regulatory Risks:
FDIC insurance premiums may increase materially,
which could negatively affect our profitability.
The FDIC insures deposits at FDIC insured financial
institutions, including State Bank. The FDIC charges the insured financial institutions premiums to maintain the DIF at a certain level.
During 2008 and 2009, there were higher levels of bank failures which dramatically increased resolution costs of the FDIC and depleted
the deposit insurance fund. The FDIC collected a special assessment in 2009 to replenish the DIF and also required a prepayment of an
estimated amount of future deposit insurance premiums. In October 2022, the FDIC adopted a final rule increasing the assessment rate
from three basis points to five basis points beginning with the first quarterly assessment period of 2023. The FDIC recently adopted
rules revising the assessments in a manner benefiting banks with assets totaling less than $10 billion. There can be no assurance, however,
that assessments will not be changed in the future.
We operate in a highly regulated industry,
and the laws and regulations that govern our operations, corporate governance, executive compensation and financial accounting, or reporting,
including changes in, or failure to comply with the same, may adversely affect the Company.
The banking industry is highly regulated. We
are subject to supervision, regulation and examination by various federal and state regulators, including the FRB, the SEC, the CFPB,
the FDIC, Financial Industry Regulatory Authority, Inc. (“FINRA”), and various state regulatory agencies. The statutory and
regulatory framework that governs the Company is generally designed to protect depositors and customers, the DIF, the U.S. banking and
financial system, and financial markets as a whole and not to protect shareholders. These laws and regulations, among other matters,
prescribe minimum capital requirements, impose limitations on our business activities (including foreclosure and collection practices),
limit the dividends or distributions that we can pay, and impose certain specific accounting requirements that may be more restrictive
and may result in greater or earlier charges to earnings or reductions in capital than would otherwise be required under generally accepted
accounting principles in the United States of America. Compliance with laws and regulations can be difficult and costly, and changes
to laws and regulations often impose additional compliance costs. Both the scope of the laws and regulations and the intensity of the
supervision to which we are subject have increased in recent years in response to the perceived state of the financial services industry,
as well as other factors such as technological and market changes. Such regulation and supervision may increase our costs and limit our
ability to pursue business opportunities. Further, our failure to comply with these laws and regulations, even if the failure was inadvertent
or reflects a difference in interpretation, could subject the Company to restrictions on business activities, fines, and other penalties,
any of which could adversely affect results of operations, the capital base, and the price of our common shares. Further, any new laws,
rules, or regulations could make compliance more difficult or expensive or otherwise adversely affect our business and financial condition.
Legislative or regulatory changes or actions
could adversely impact our business.
The financial services industry is extensively
regulated. We are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our
operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors,
borrowers, the DIF and the banking system as a whole, and not to benefit our shareholders.
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Regulations affecting banks and financial services
businesses are undergoing continuous change, and management cannot predict the effect of these changes. While such changes are generally
intended to lessen the regulatory burden on financial institutions, the impact of any changes to laws and regulations or other actions
by regulatory agencies may negatively impact us or our ability to increase the value of our business. Regulatory authorities have extensive
discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation
of a financial institution, the classification of assets held by a financial institution, the adequacy of a financial institution’s
ACL and the ability to complete acquisitions. Additionally, actions by regulatory agencies against us could cause
us to devote significant time and resources to defending our business and may lead to penalties that materially affect us and our shareholders.
Even the reduction of regulatory restrictions could have an adverse effect on us and our shareholders if such lessening of restrictions
increases competition within our industry or our market area.
Changes in accounting standards could influence
our results of operations.
The accounting standard setters, including the
FASB, the SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation
of our consolidated financial statements. These changes can be difficult to predict and can materially affect how we record and report
our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively,
which would result in the restatement of our financial statements for prior periods.
The preparation of consolidated financial statements
in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) requires management to make significant estimates
that affect the financial statements. Due to the inherent nature of these estimates, actual results may vary materially from management’s
estimates.
Noncompliance with the Bank Secrecy Act (BSA)
and other anti-money laundering statutes and regulations could cause a material financial loss.
The BSA and the Patriot Act contain anti-money
laundering and financial transparency provisions intended to detect and prevent the use of the U.S. financial system for money laundering
and terrorist financing activities. The BSA, as amended by the Patriot Act, requires depository institutions and their holding companies
to undertake activities including maintaining an anti-money laundering program, verifying the identity of clients, monitoring for and
reporting suspicious transactions, reporting on cash transactions exceeding specified thresholds, and responding to requests for information
by regulatory authorities and law enforcement agencies. The Financial Crimes Enforcement Network (“FinCEN”), a unit of the
U.S. Department of the Treasury that administers the BSA, is authorized to impose significant civil money penalties for violations of
those requirements and has recently engaged in coordinated enforcement efforts with the federal bank regulatory agencies, as well as
the U.S. Department of Justice, Drug Enforcement Administration, and Internal Revenue Service. The AMLA is intended to be a comprehensive
reform and modernization to U.S. bank secrecy and anti-money laundering laws, which includes a codified risk-based approach to anti-money
laundering compliance for financial institutions; requires the development of standards for evaluating technology and internal processes
for BSA compliance; expands enforcement-related and investigation-related authority, including increasing available sanctions for certain
BSA violations and instituting BSA whistleblower incentives and protections.
There is also increased scrutiny of compliance
with the rules enforced by the Office of Foreign Assets Control (“OFAC”). If the Company’s policies, procedures, and
systems are deemed deficient, or if the policies, procedures, and systems of the financial institutions that the Company has already
acquired or may acquire in the future are deficient, the Company may be subject to liability, including fines and regulatory actions
such as restrictions on State Bank’s ability to pay dividends and the necessity to obtain regulatory approvals to proceed with
certain planned business activities, including acquisition plans, which could negatively impact our business, financial condition, and
results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also
have serious reputational consequences for the Company.
23
We may be the subject of litigation, which
could result in legal liability and damage to our business and reputation.
From time to time, we may be subject to claims
or legal action from customers, employees or others. Financial institutions like the Company and State Bank are facing a growing number
of significant class actions, including those based on the manner of calculation of interest on loans and the assessment of overdraft
fees. Future litigation could include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts
of damages. We are also involved from time to time in other reviews, investigations and proceedings (both formal and informal) by governmental
and other agencies regarding our business. These matters also could result in adverse judgments, settlements, fines, penalties, injunctions
or other relief. Like other large financial institutions, we are also subject to risk from potential employee misconduct, including non-compliance
with policies and improper use or disclosure of confidential information.
Our insurance may not cover all claims that may
be asserted against us, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Should
the ultimate judgments or settlements in any litigation exceed our insurance coverage, they could have a material adverse effect on our
financial condition and results of operations. In addition, we may not be able to obtain appropriate types or levels of insurance in
the future, nor may we be able to obtain adequate replacement policies with acceptable terms, if at all.
We could face legal and regulatory risk arising
out of our residential mortgage business.
Numerous federal and state governmental, legislative
and regulatory authorities are investigating practices in the business of mortgage and home equity lending and servicing and in the mortgage-related
insurance and reinsurance industries. We could face the risk of class actions, other litigation and claims from: the owners of or purchasers
of such loans originated or serviced by us, homeowners involved in foreclosure proceedings or various mortgage-related insurance programs,
downstream purchasers of homes sold after foreclosure, title insurers, and other potential claimants. Included among these claims are
claims from purchasers of mortgage and home equity loans seeking the repurchase of loans where the loans allegedly breached origination
covenants, representations, and warranties made to the purchasers in the purchase and sale agreements. The CFPB has issued new rules
for mortgage origination and mortgage servicing. Both the origination and servicing rules create new private rights of action for consumers
against lenders and servicers in the event of certain violations.
Risks Related to Our Capital and Common
Shares:
Our ability to pay cash dividends is limited,
and we may be unable to pay cash dividends in the future even if we elect to do so.
We are dependent primarily upon the earnings
of our operating subsidiaries for funds to pay dividends on our common shares. The payment of dividends by us is also subject to regulatory
restrictions. As a result, any payment of dividends in the future will be dependent, in large part, on our ability to satisfy these regulatory
restrictions and our subsidiaries’ earnings, capital requirements, financial condition and other factors. There can be no assurance
as to if or when the Company may pay dividends or as to the amount of any dividends which may be declared and paid to shareholders in
future periods. Failure to pay dividends on our shares could have a material adverse effect on the market price of our shares.
A limited trading market exists for our common
shares, which could lead to price volatility.
The ability to sell our common shares depends
upon the existence of an active trading market for those shares. While our shares are listed for trading on the NASDAQ Capital Market,
there is moderate trading volume in these shares. As a result, shareholders may be unable to sell our shares at the volume, price and
time desired. The limited trading market for our shares may cause fluctuations in the market value of our shares to be exaggerated, leading
to price volatility in excess of that which would occur in a more active trading market. In addition, even if a more active market of
our shares should develop, we cannot guarantee that such a market will continue.
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The market price of our common shares may
be subject to fluctuations and volatility.
The market price of our common shares may fluctuate
significantly due to, among other things, changes in market sentiment regarding our operations, financial results or business prospects,
the banking industry generally or the macroeconomic outlook. Certain events or changes in the market or banking industry generally are
beyond our control. In addition to the other risk factors contained or incorporated by reference herein, factors that could affect our
trading price:
● failure to declare dividends on our common shares from time to time;
● any future offerings by us of our common shares;
● proposed or final regulatory changes or developments;
Equity markets in general and our shares have
experienced volatility over the past few years. The market price of our shares may continue to be subject to volatility unrelated to
our operating performance or business prospects, which could result in a decline in the market price of our shares.
Investors could become subject to regulatory
restrictions upon ownership of our common shares.
Under the Federal
Change in Bank Control Act, a person may be required to obtain prior approval from the Federal Reserve Board before acquiring 10 percent
or more of our common shares or the power to directly or indirectly control our management, operations, or policies.
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We have implemented anti-takeover devices
that could make it more difficult for another company to purchase us, even though such a purchase may increase shareholder value.
In many cases, shareholders may receive a premium
for their shares if we were purchased by another company. Ohio law and our Amended Articles of Incorporation, as amended (“Articles”),
and Amended and Restated Regulations, as amended (“Regulations”), make it difficult for anyone to purchase us without the
approval of our Board of Directors. Consequently, a takeover attempt may prove difficult, and shareholders may not realize the highest
possible price for their securities.
We may be compelled to seek additional capital
in the future, but capital may not be available when needed.
We are required by federal and state regulatory
authorities to maintain adequate levels of capital to support our operations. In addition, federal banking agencies have proposed extensive
changes to their capital requirements; including raising required amounts and eliminating the inclusion of certain instruments from the
calculation of capital. In addition, we may elect to raise additional capital to support our business or to finance acquisitions, if
any, or we may otherwise elect to raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions
in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial
performance. Accordingly, we cannot be assured of our ability to raise additional capital if needed or on terms acceptable to us. If
we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations
and prospects.
General Risk Factors:
Our earnings are significantly affected by
the fiscal and monetary policies of the federal government and its agencies.
The policies of the FRB impact us significantly.
The FRB regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest
earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments we hold.
Those policies determine to a significant extent our cost of funds for lending and investing. Changes in those policies are beyond our
control and are difficult to predict. FRB policies can also affect our borrowers, potentially increasing the risk that they may fail
to repay their loans. For example, a tightening of the money supply by the FRB could reduce the demand for a borrower’s products
and services. This could adversely affect the borrower’s earnings and ability to repay its loan, which could have a material adverse
effect on our financial condition and results of operations.
Changes in tax laws could adversely affect
our performance.
We are subject to extensive federal, state and
local taxes, including income, excise, sales/use, payroll, franchise, withholding and ad valorem taxes. Changes to tax laws could have
a material adverse effect on our results of operations; fair values of net deferred tax assets and obligations of state and political
subdivisions held in our investment securities portfolio. In addition, our customers are subject to a wide variety of federal, state
and local taxes. Changes in taxes paid by our customers may adversely affect their ability to purchase homes or consumer products, which
could adversely affect their demand for our loans and deposit products. In addition, such negative effects on our customers could result
in defaults on the loans we have made.
The preparation of our financial statements
requires the use of estimates that may vary from actual results.
The preparation of consolidated financial statements
in conformity with accounting principles generally accepted in the U.S. requires management to make significant estimates that affect
the financial statements. Two of our most critical estimates are the level of the ACL and the accounting for
goodwill and other intangibles. Because of the inherent nature of these estimates, we cannot provide complete assurance that we will
not be required to adjust earnings for significant unexpected loan losses, nor that we will not recognize a material provision for impairment
of our goodwill. For additional information regarding these critical estimates, see Item 7. Management’s Discussion and Analysis
of Financial Condition and Results of Operations beginning on page 32 of this Annual Report on Form 10-K.
26
We may experience increasing scrutiny and
evolving expectations from customers, regulators, investors, and other stakeholders with respect to the Company’s environmental,
social and governance practices.
Financial institutions are facing increasing
scrutiny from customers, regulators, investors, and other stakeholders related to their ESG
practices and disclosure. Investor advocacy groups, investment funds, and influential investors are also increasingly focused on these
practices, especially as they relate to the environment, health and safety, diversity, labor conditions, and human rights. Increased
ESG-related compliance costs for the Company as well as among our suppliers, vendors and various other parties within our supply chain
could result in increases to our overall operational costs. Failure to adapt to or comply with regulatory requirements or investor or
stakeholder expectations and standards could negatively impact our reputation, ability to do business with certain partners, access to
capital, and the price of our common shares. New government regulations could also result in new or more stringent forms of ESG oversight
and expanding mandatory and voluntary reporting, diligence, and disclosure.
We need to constantly update our technology
in order to compete and meet customer demands.
The financial services market, including banking
services, is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition
to better serving customers, the effective use of technology increases efficiency and may enable us to reduce costs. Our future success
will depend, in part, on our ability to use technology to provide products and services that provide convenience to customers and to
create additional efficiencies in our operations. Some of our competitors have substantially greater resources to invest in technological
improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these
products and services to our customers. Failure to successfully keep pace with technological changes affecting the financial services
industry could negatively affect our growth, revenue and profit.
Climate change, severe weather, natural disasters,
acts of war or terrorism and other external events could significantly impact our business.
Natural disasters, including severe weather events
of increasing strength and frequency due to climate change, acts of war or terrorism, and other adverse external events could have a
significant impact on our ability to conduct business or upon third parties who perform operational services for us or our customers.
Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value
of collateral securing loans, cause significant property damage, result in lost revenue or cause us to incur additional expenses.
Item 1B. Unresolved Staff Comments
None.
Item 1C. Cybersecurity
The Company regularly assesses risks from cybersecurity
threats, monitors its information systems for potential vulnerabilities, and tests those systems pursuant to the Company’s cybersecurity
policies, standards, processes, and practices, which are integrated into the Company’s overall risk management program. We have
adopted aspects of the NIST cybersecurity framework, to which risk management in relation to our information systems is aligned. We categorize
our information systems as either Tier 1 (critical) or Tier 2 or Tier 3 (essential), depending on business value and/or risk of financial
or compliance impact of cybersecurity incidents. Our information security team uses a multifaceted approach to monitor, assess, identify,
and manage material risks to the Company from cybersecurity threats, including testing of the effectiveness of our cybersecurity incident
prevention and response systems; conducting routine vulnerability scanning of information systems assets; network/endpoint detection
and response coupled with advanced identification-enhanced logging capabilities powered by artificial intelligence software; discovery
through collaboration with the Company’s internal audit team; monitoring of threat intelligence feeds provided by industry associations/groups,
service providers, and federal/state authorities; and professional service engagements, such as retaining the services of an external
24/7 security operations center and partnering with third parties in testing our information systems for vulnerabilities from external,
internal, and social engineering perspectives and assessing the effectiveness of our cybersecurity controls.
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The Company partners with third-party service
providers and employs processes to assess, identify, and manage material risks from cybersecurity threats arising from the use of such
third-party service providers. Our latest assessment attempted to identify vulnerabilities in our network and systems from external,
internal, and social engineering perspectives. Our cybersecurity practices (including with respect to third-party service providers)
have been assessed to represent a level of maturity consistent with industry best practices.
Risks from cybersecurity threats, including as
a result of any previous cybersecurity incidents, have not materially affected the Company, including its business strategy, results