UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
(Mark One)
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended
OR
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number:
LIMESTONE BANCORP, INC.
(Exact name of registrant as specified in its charter)
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(State or other jurisdiction of incorporation or organization) |
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(Address of principal executive offices) |
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(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
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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 ☐
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 ☐
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
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. Yes ☐ No ☐
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). 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 ☐ |
| Smaller reporting company |
Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. Yes ☐ No ☐
Indicate by check mark whether the registrant 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. Yes
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 Exchange Act). Yes
The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the close of business on June 30, 2022, was $
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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Changes in and Disagreements With Accountants on Accounting and Financial Disclosure |
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Disclosure Regarding Foreign Jurisdictions that Prevent Inspections |
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
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Certain Relationships and Related Transactions, and Director Independence |
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As used in this report, references to “the Company,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Limestone Bancorp, Inc. and its wholly-owned subsidiary, Limestone Bank, Inc., which is referred to in this report as “the Bank.”
Preliminary Note Concerning Forward-Looking Statements
This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express the Company’s beliefs, assumptions and expectations of its future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.
Forward-looking statements involve risks and uncertainties that may cause the Company’s actual results to differ materially from the expectations of future results management expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be beyond the Company’s control. Factors that could contribute to differences in the Company’s results include, but are not limited to:
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risks related to the Company’s pending merger with Peoples Bancorp Inc., including risks if the Company is unable to complete the Merger due to the failure to satisfy the conditions to completion of the Merger, including receipt of required regulatory and other approvals, the failure of the proposed merger to close for any other reason, the diversion of management’s attention from ongoing business operations and opportunities due to the merger transaction, and the effect of the announcement and pendency of the merger transaction on the Company’s customer and employee relationships and operating results; |
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the impact of the novel coronavirus disease 2019 (“COVID-19”) pandemic and the economic and financial disruptions and instabilities that have followed it; |
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deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses; |
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changes in inflation and efforts to control it; |
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changes in the interest rate environment, which may reduce the Company’s margins or impact the value of securities, loans, deposits and other financial instruments; |
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changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments; |
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general economic or business conditions, either nationally, regionally or locally in the communities the Bank serves, may be worse than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit; |
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the results of regulatory examinations; |
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any matter that would cause the Bank to conclude that there was impairment of any asset, including intangible assets; |
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the continued service of key management personnel, and the Company’s ability to attract, motivate and retain qualified employees; |
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factors that increase the competitive pressure among depository and other financial institutions, including product and pricing pressures; the ability of the Company’s competitors with greater financial resources to develop and introduce products and services that enable them to compete more successfully; |
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failure in or breach of operational or security systems or infrastructure, or those of third-party vendors and other service providers, including as a result of cyber-attacks; |
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legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry; and |
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fiscal and governmental policies of the United States federal government. |
Other risks are detailed in Item 1A. “Risk Factors” of this Form 10-K all of which are difficult to predict and many of which are beyond the Company’s control.
Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.
Organized in 1988, Limestone Bancorp, Inc. (the Company) is a bank holding company headquartered in Louisville, Kentucky. The Company’s common stock is traded on Nasdaq’s Capital Market under the symbol LMST. The Company operates Limestone Bank, Inc. (the Bank), the eleventh largest bank domiciled in the Commonwealth of Kentucky based on total assets. The Bank operates banking offices in 14 counties in Kentucky. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Bullitt and Henry. The Bank serves south central, southern, and western Kentucky from banking centers in Barren, Butler, Daviess, Edmonson, Green, Hardin, Hart, Ohio, and Warren counties. The Bank also has banking centers in Lexington, Kentucky, the second largest city in the state, and Frankfort, Kentucky, the state capital. The Bank is a traditional community bank with a wide range of personal and business banking products and services. As of December 31, 2022, the Company had total assets of $1.46 billion, total loans of $1.11 billion, total deposits of $1.20 billion and stockholders’ equity of $133.9 million.
Recent Developments
On October 24, 2022, Peoples Bancorp Inc., an Ohio corporation ("Peoples"), and the Company, entered into an Agreement and Plan of Merger (the "Merger Agreement") pursuant to which the Company agreed to merge with and into Peoples (the "Merger"). The Merger Agreement provides that the Company’s wholly-owned banking subsidiary, Limestone Bank, Inc., will be merged with and into Peoples' wholly-owned banking subsidiary, Peoples Bank (the “Bank Merger”), following the Merger. The Boards of Directors of both Peoples and the Company have approved the Merger, the Bank Merger, and the Merger Agreement. The Merger is expected to close during the second quarter of 2022, subject to customary regulatory approval and completion of other customary closing conditions.
Website Access to Reports
The Company files reports with the SEC including the Annual Report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K, and proxy statements, as well as any amendments to those reports. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are also accessible at no cost on the Company’s web site at http://www.limestonebank.com after they are electronically filed with the SEC. The information contained on our website is not included, a part of, or incorporated by reference into this Annual Report on Form 10-K.
Markets
The Bank operates in markets that include the four largest cities in Kentucky – Louisville, Lexington, Bowling Green and Owensboro – and in other communities along the I-65, Western Kentucky Parkway, and Natcher Parkway corridors.
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Louisville/Jefferson, Bullitt and Henry Counties: The Company’s headquarters are in Louisville, the largest city in Kentucky. The Bank also has banking offices in Bullitt County, south of Louisville, and Henry County, east of Louisville. The Company’s banking offices in these counties also serve the contiguous counties of Spencer, Shelby and Oldham to the east and northeast of Louisville. The area’s major employers are diversified across many industries and include the Worldport air hub for United Parcel Service (“UPS”), two Ford assembly plants, Humana, Norton Healthcare, the University of Louisville, Brown-Forman, Churchill Downs, YUM! Brands, and Texas Roadhouse. |
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Lexington/Fayette County: Lexington, located in Fayette County, is the second largest city in Kentucky. Lexington is the financial, educational, retail, healthcare and cultural hub for Central and Eastern Kentucky. It is known worldwide for its horse farms and Keeneland Race Track, and proudly boasts of itself as “The Horse Capital of the World”. It is also the home of the University of Kentucky and Transylvania University. The area’s major employers include Toyota, Xerox, Lexmark, and Valvoline. |
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Frankfort/Franklin County: Frankfort, located along Interstate 64 in Franklin County, is the capital of the Commonwealth of Kentucky and the seat of Franklin County. Frankfort is home to Kentucky’s General Assembly or Legislature which consists of the Kentucky Senate and the Kentucky House of Representatives. Frankfort is also the home of the Kentucky State University and major employers including Montaplast of North America, Inc., Buffalo Trace Distillery, Topy Corporation, Beam, Inc., and Nashville Wire Products. |
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Southern Kentucky: This market includes Bowling Green, the third largest city in Kentucky, located about 120 miles south of Louisville and 60 miles north of Nashville, Tennessee. Bowling Green, located in Warren County, is the home of Western Kentucky University and is the economic hub of the area. This market also includes communities in the contiguous Barren County, including the city of Glasgow. Major employers in Barren and Warren Counties include General Motor’s Corvette plant, automotive supply chain manufacturers, and R.R. Donnelley’s regional printing facility. |
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Owensboro/Daviess County: Owensboro, located on the banks of the Ohio River, is Kentucky’s fourth largest city. The city is called a festival city, with over 20 annual community celebrations that attract visitors from around the world, including its world famous Bar-B-Q Festival which attracts over 80,000 visitors. It is an industrial, medical, retail and cultural hub for Western Kentucky. The area employers include Owensboro Medical System, US Bank Home Mortgage, Titan Contracting, Specialty Food Group, and Toyotetsu. |
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South Central Kentucky: South of the Louisville metropolitan area, the Bank has banking offices in Butler, Edmonson, Green, Hardin, Hart, and Ohio Counties. This region includes stable community markets comprised primarily of agricultural and service-based businesses. Each of the Company’s banking offices in these markets has a stable customer and core deposit base. |
Products and Services
The Bank meets its customers’ banking needs with a broad range of financial products and services. Its lending services include real estate, commercial, mortgage, agriculture and equine, and consumer loans to those in its communities and to small to medium-sized businesses, the owners and employees of those businesses, as well as other executives and professionals. Lending operations are complemented with an array of retail and commercial deposit products. In addition, the Bank offers customers drive-through banking facilities, curbside banking services, automatic teller machines, night depository, personalized checks, credit cards, debit cards, internet banking, mobile banking, curbside banking, treasury management services, remote deposit services, electronic funds transfers through ACH services, domestic and foreign wire transfers, cash management and vault services, and loan and deposit sweep accounts.
Human Capital Resources
At December 31, 2022, the Company had 222 full-time equivalent employees and a total of 228 employees (“team members”). The Company’s team members are instrumental in building, maintaining, and servicing the customer relationships that make the community banking model a success. The Company strives to attract and retain a well-qualified, enthusiastic workforce by offering competitive compensation packages, comprehensive benefits, training, and opportunities for professional development and advancement. Team members are held accountable to the Company’s core values, which are:
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Commitment to honesty and integrity; |
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Commitment to have a positive and constructive attitude; |
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Commitment to be a team player; |
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Commitment to conduct oneself in a professional manner; and |
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Commitment to celebrate successes. |
The Company’s team members are not subject to a collective bargaining agreement, and management considers the Company’s relationship with its team members to be good. The Bank is consistently recognized as one of the “Best Places to Work in Kentucky.”
Competition
The banking business is highly competitive, and the Bank experiences competition from a number of other financial institutions and non-bank financial competitors, many of whom may not be subject to the same extensive regulatory regime as the Bank. Competition is based upon relationships, the quality and scope of services levels, interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the convenience of banking facilities, the availability of technology channels, and, in the case of loans to commercial borrowers, relative lending limits. The Bank competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, farm credit organizations, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national, and international financial institutions that operate offices within the Company’s market area and beyond.
Supervision and Regulation
Bank and Holding Company Laws, Rules and Regulations. The Company and the Bank are subject to an extensive system of the laws, rules, and regulations that are intended primarily for the protection of customers, the Deposit Insurance Fund (DIF), and the banking system in general and not for the protection of shareholders and creditors. These laws and regulations govern areas such as capital, permissible activities, allowance for loan and lease losses, loans and investments, interest rates that can be charged on loans, and consumer protection communications and disclosures. Certain elements of selected laws, rules, and regulations are described in the sections that follow. These descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the laws, rules, and regulations.
Limestone Bancorp. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As such, the Company must file with the Federal Reserve Board annual and quarterly reports and other information regarding the Company’s business operations and the business operations of the Company’s subsidiaries. The Company is also subject to examination by the Federal Reserve Board and to operational guidelines established by the Federal Reserve Board. The Company is subject to the Bank Holding Company Act and other federal laws on the types of activities in which it may engage, and to other supervisory requirements, including regulatory enforcement actions for violations of laws and regulations.
Acquisitions. As a bank holding company, the Company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of more than 5% of any class of voting stock or all or substantially all of the assets of a bank, before merging or consolidating with any other bank holding company, and before engaging, or acquiring a company that is not a bank and is engaged in certain non-banking activities. For any acquisition transaction structured as a merger of the Bank, the approval of the Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Department of Financial Institutions (“KDFI”) would be required.
The Bank Holding Company Act and the Change in Bank Control Act prohibit a person or group of persons from acquiring “control” of a bank holding company without notifying the Federal Reserve Board in advance and obtaining the Federal Reserve Board’s approval of, or non-objection to, the proposed transaction. The Federal Reserve Board has established a rebuttable presumptive standard that the acquisition of 10% or more of any class of voting securities of a bank holding company that has registered securities under Section 12 of the Securities Exchange Act of 1934 (such as the Company) constitutes an acquisition of control of the bank holding company for purposes of the Change in Bank Control Act. An acquisition of 25% of any class of voting securities of a bank holding company will conclusively be deemed to be an acquisition of control under the Change in Bank Control Act.
Permissible Activities. The Company is generally permitted under the Bank Holding Company Act to own up to 5% of the voting shares of a company and, subject to the receipt of any required approval by the Federal Reserve Board, to engage in or acquire direct or indirect control of more than 5% of the voting shares of any bank, bank holding company or company engaged in any activity that the Federal Reserve Board determines to be so closely related to banking as to be a proper incident to the business of banking.
Under current federal law, a bank holding company may elect to become a financial holding company, which enables the holding company to conduct activities that are “financial in nature,” incidental to financial activity, or complementary to financial activity that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Activities that are “financial in nature” include securities underwriting, dealing and market making in securities; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve Board has determined to be closely related to banking. No prior regulatory approval or notice is required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. The Company has not filed an election to become a financial holding company.
Source of Financial Strength. Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to, and to commit resources to support, its bank subsidiaries. This support may be required at times when, absent such a policy, the bank holding company may not be inclined to provide it. In addition, any capital loans by the bank holding company to its bank subsidiaries are subordinate in right of payment to depositors and to certain other indebtedness of the bank subsidiary. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of subsidiary banks will be assumed by the bankruptcy trustee and entitled to a priority of payment. The Federal Reserve’s “Source of Financial Strength” policy was codified in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”).
Dividends. Under Federal Reserve Board policy, bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not declare a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.
The Company is a legal entity separate and distinct from the Bank. The majority of the Company’s revenue has been from dividends paid to it by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. If, in the opinion of a federal regulatory agency, an institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the agency may require, after notice and hearing, that the institution cease such practice. The federal banking agencies have indicated that paying dividends that deplete an institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Bank is prohibited from paying any dividend if undercapitalized or if payment would cause it to become undercapitalized, and it must maintain a sufficient capital conservation buffer under the capital adequacy guidelines in order to avoid limitations on dividends. Moreover, the Federal Reserve and the FDIC have issued policy statements providing that bank holding companies and banks should generally pay dividends only out of current operating earnings.
Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. The KDFI must approve the declaration of dividends if the total dividends to be declared by a bank for any calendar year would exceed the bank’s total net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. Additionally, retained earnings must be positive. The Company is also subject to the Kentucky Business Corporation Act, which generally prohibits dividends to the extent they result in the insolvency of the corporation from a balance sheet perspective or if the corporation is unable to pay its debts as they come due.
Based on these regulations, the Bank was eligible to pay $20.4 million of dividends as of December 31, 2022. The Bank paid the Company $7.5 million of dividends during 2022.
Limestone Bank. The Bank, a Kentucky chartered commercial bank, is subject to regular bank examinations and other supervision and regulation by both the FDIC and the KDFI. Kentucky’s banking statutes contain a “super-parity” provision that permits a well-rated Kentucky banking corporation to engage in any banking activity which could be engaged in by a national bank operating in Kentucky; a state bank, a thrift or savings bank operating in any other state; or a federal chartered thrift or federal savings association meeting the qualified thrift lender test and operating in any state could engage, provided the Kentucky bank first obtains a legal opinion specifying the statutory or regulatory provisions that permit the activity.
Capital Adequacy Requirements. The Company and the Bank are required to comply with capital adequacy guidelines. Guidelines are established by the Federal Reserve Board for the Company and the FDIC for the Bank. Both the Federal Reserve Board and the FDIC have substantially similar risk based and leverage ratio guidelines for banking organizations, which are intended to ensure that banking organizations have adequate capital related to the risk levels of assets and off-balance sheet instruments. The capital adequacy guidelines are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
The minimum capital level requirements applicable to the Company and the Bank are a common equity Tier 1 capital ratio of 4.5%, a Tier 1 risk-based capital ratio of 6%, a total risk-based capital ratio of 8%, and a Tier 1 leverage ratio of 4% for all institutions. The rules also require a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. Including this buffer, the required ratios are: a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%.
An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible capital that can be utilized for such actions.
Under the capital rules, Tier 1 capital generally consists of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. Tier 2 capital may consist of subordinated debt, certain hybrid capital instruments, qualifying preferred stock, and a limited amount of the allowance for loan losses. Proceeds of trust preferred securities are excluded from Tier 1 capital unless issued before 2010 by an institution with less than $15 billion of assets. Total capital is the sum of Tier 1 and Tier 2 capital.
Prompt Corrective Action. Pursuant to the Federal Deposit Insurance Act (“FDIA”), the FDIC must take prompt corrective action to resolve the problems of undercapitalized institutions. FDIC regulations define the levels at which an insured institution would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”. A bank is “undercapitalized” if it fails to meet any one of the ratios required to be adequately capitalized. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. The degree of regulatory scrutiny increases and the permissible activities of a bank decrease as the bank moves downward through the capital categories. Depending on a bank’s level of capital, an institution may be required to submit a capital restoration plan, and its holding company must guarantee compliance with the capital restoration plan up to 5% of the institution’s assets at the time it became undercapitalized.
Deposit Insurance Assessments. The deposits of the Bank are insured by the Deposit Insurance Fund (“DIF”) of the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which calculates a bank’s premium assessment by multiplying its risk-based assessment rate by its assessment base. As required by the Dodd-Frank Act, a bank’s assessment base is determined by its consolidated total assets less average tangible equity rather than deposits.
Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to these matters. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of FDIA. See “Prompt Corrective Actions” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Incentive Compensation. The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets, such as the Company and the Bank, that encourage inappropriate risks by providing an executive officer, employee, director, or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, the Dodd-Frank Act requires the SEC to adopt rules under which listed companies must have (and disclose) a “clawback” policy for the recovery of erroneously awarded executive incentive compensation following an accounting restatement due to material noncompliance with financial reporting requirements under the securities laws. In October 2022, the SEC finalized rules to require listing standards to be updated to implement this “clawback” policy requirement and to impose related disclosure requirements on listed companies. When fully implemented, listed companies, like the Company, will be required to have a policy providing for the recovery, in the event of a required accounting restatement, of incentive-based compensation received by current or former executive officers where that compensation is based on the erroneously reported financial information.
In June 2010, the Federal Reserve, OCC, and FDIC issued comprehensive final guidance on incentive compensation policies of banking organizations intended to ensure that these policies do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. These three principles are incorporated into proposed joint compensation regulations under the Dodd-Frank Act. The agencies proposed such regulations in April 2011, and reproposed the regulations in 2016, but they have not been finalized.
The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.
Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
Branching. Kentucky law permits Kentucky chartered banks to establish a banking office in any county in Kentucky. A Kentucky bank may also establish a banking office outside of Kentucky. Well capitalized Kentucky banks that have been in operation at least three years and satisfy certain criteria relating to, among other things, their composite and management ratings, may establish a banking office in Kentucky without the approval of the KDFI upon notice to the KDFI and any other state bank with its main office located in the county where the new banking office will be located. Otherwise, branching requires the approval of the KDFI, which must ascertain and determine that the public convenience and advantage will be served and promoted and that there is reasonable probability of the successful operation of the banking office. The transaction must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community, and consistency with corporate powers.
Section 613 of the Dodd-Frank Act effectively eliminated the interstate branching restrictions set forth in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Banks located in any state may now de novo branch in any other state, including Kentucky. Such unlimited branching power may increase competition within the markets in which the Company and the Bank operate.
Insider Credit Transactions. The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured depository institutions and their subsidiaries. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests, which may not exceed the institution’s total unimpaired capital and surplus.
Consumer Protection Laws. The Bank is subject to federal consumer protection statues and regulations promulgated under those laws, including, but not limited to, the:
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Truth-In-Lending Act and Regulation Z, governing disclosures of credit terms to consumer borrowers; |
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Home Mortgage Disclosure Act and Regulation C, requiring financial institutions to provide certain information about home mortgage and refinanced loans; |
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Real Estate Settlement Procedures Act (“RESPA”), requiring lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements and prohibiting certain abusive practices; |
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Secure and Fair Enforcement for Mortgage Licensing Act (“S.A.F.E. Act”), requiring residential loan originators who are employees of financial institutions to meet registration requirements; |
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Fair Credit Reporting Act and Regulation V, governing the provision of consumer information to credit reporting agencies and the use of consumer information; |
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Equal Credit Opportunity Act and Regulation B, and the Fair Housing Act, prohibiting discrimination on the basis of race, religion, national origin, sex, and a variety of other prohibited factors in the extension of credit; |
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Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; |
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Truth in Savings Act, which requires disclosure of deposit terms to consumers; |
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Regulation CC, which relates to the availability of deposit funds to consumers; |
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Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; |
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Electronic Funds Transfer Act and Regulation E, establishing rights, liabilities, and responsibilities of participants in electronic fund transfer systems such as automated teller machine transfers, telephone bill-payment services, point-of-sale (POS) terminal transfers in stores, and preauthorized transfers from or to a consumer's account; and |
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Automated Overdraft Payment Regulations, requiring financial institutions to provide customer notices, monitor overdraft payment programs, and prohibiting financial institutions from charging consumer fees for paying overdrafts on automated teller machine and one time debit card transactions unless a consumer consents, or opts in to the service for those types of transactions. |
The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”), which has broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws. As a bank with less than $10 billion or more in assets, the Bank is subject to rules promulgated by the CFPB, but continues to be examined and supervised by the FDIC, its federal banking regulator for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive, or abusive acts or practices in connection with the offering of consumer financial products. The CFPB has established certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. The Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Economic Growth, Regulatory Relief and Consumer Protection Act created a qualified mortgage safe harbor for eligible loans that are originated and retained by a bank with total assets of less than $10 billion.
The Dodd-Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Loans to One Borrower. Under current limits, loans and extensions of credit outstanding at one time to a single borrower and not fully secured generally may not exceed 20% of an institution’s unimpaired capital and unimpaired surplus. Loans and extensions of credit fully secured by collateral may represent an additional 10% of unimpaired capital and unimpaired surplus.
Privacy. Federal law currently contains extensive customer privacy protection provisions. Under these provisions, the Bank must provide to its customers, at the inception of the customer relationship and annually thereafter, its policies and procedures regarding the handling of customers’ nonpublic personal financial information. Except for certain limited exceptions, the Bank may not provide such personal information to unaffiliated third parties unless it discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the FDIC to assess the Company’s record in meeting the credit needs of the communities the Bank serves, including low- and moderate-income neighborhoods and persons. The FDIC’s assessment of the Company’s record is made available to the public. The assessment also is part of the Federal Reserve Board’s and the FDIC’s consideration of applications to acquire, merge or consolidate with another banking institution or its holding company, to establish a new banking office or to relocate an office.
Bank Secrecy Act. The Bank Secrecy Act of 1970 (“BSA”) was enacted to deter money laundering, establish regulatory reporting standards for currency transactions, and improve detection and investigation of criminal, tax, and other regulatory violations. BSA and subsequent laws and regulations require steps to be taken to prevent the use of the Bank in the flow of illegal or illicit money, including, without limitation, ensuring effective management oversight, establishing sound policies and procedures, developing effective monitoring and reporting capabilities, ensuring adequate training, and establishing a comprehensive internal audit of BSA compliance activities. Rules issued under the BSA require the Bank to identify the beneficial owners who own or control certain legal entity customers at the time an account is opened and to include in its anti-money laundering program risk-based procedures for conducting ongoing customer due diligence.
USA Patriot Act. The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers, and certain other financial institutions. The Patriot Act requires financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism. This includes standards for verifying customer identification at account opening, as well as rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. It grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on the operations of financial institutions. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.
The Dodd-Frank Act. The Dodd-Frank Act imposed new restrictions and requirements and an expanded framework of regulatory oversight for financial institutions, including depository institutions and their holding companies. The implementation of the Dodd-Frank Act has resulted in greater compliance costs and higher fees paid to regulators. The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 provided some regulatory relief to banking organizations, primarily small, community banking organizations, by adjusting thresholds at which certain increased regulatory requirements imposed under the Dodd-Frank Act begin to apply. As a result, traditional community banking organizations with assets of less than $10 billion, such as the Company, are exempt from the Volker Rule under the Dodd-Frank Act, which places limits and restrictions on trading and hedging activities. In addition, community banking organizations with assets of less than $10 billion are now subject to reduced reporting requirements and an optional simplified capital adequacy measure is available to those that have a leverage ratio greater than 9%. The Bank elected not to use this optional capital adequacy measure.
Effect of Economic Environment. The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and bank subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits. Their use may affect interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the Company’s business and earnings and those of the Company’s subsidiaries cannot be predicted.
Legislative and Regulatory Initiatives. From time to time various laws, regulations, and governmental programs affecting financial institutions and the financial industry are introduced in Congress or otherwise promulgated by regulatory agencies. Such measures may change the environment in which the Company and its subsidiaries operate in substantial and unpredictable ways. The nature and extent of future legislative, regulatory, or other changes affecting financial institutions are unpredictable at this time. Future legislation, policies, and the effects thereof might have a significant influence on overall growth and distribution of loans, investments, and deposits. They also may affect interest rates charged on loans or paid on time and savings deposits. New legislation and policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.
FACTORS THAT MAY AFFECT FUTURE RESULTS
An investment in the Company’s common stock is subject to certain risks, which are particular to the Company, as well as the industry and markets in which the Company operates. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this filing. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially and adversely affect its business, financial condition, and results of operations in the future. The value or market price of the Company’s common stock could decline due to any of these identified or other risks, and an investor could lose all or part of their investment.
There are factors, many beyond the Company’s control, which may significantly change the results or expectations of the Company. Some of these factors are described below, however, many are described in the other sections of this Annual Report on Form 10-K.
Risks Related to the Company’s Pending Merger Transaction
Failure to complete the Company’s proposed Merger with Peoples could negatively impact the Company’s business, financial results and stock price.
If the Merger is not completed for any reason, the Company’s ongoing business may be adversely affected, and, without realizing any of the benefits of having completed the Merger, the Company will be subject to a number of risks, including the following:
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the Company may experience negative reactions from the financial markets, including negative impacts on its stock price; |
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the market price of the Company’s common stock could decline to the extent that the current market prices reflect a market assumption that the Merger will be completed; |
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the Company may experience negative reactions from the Company’s customers, vendors and team members; |
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the Company will have incurred substantial expenses and will be required to pay certain costs relating to the Merger, whether or not the Merger is completed, such as legal, accounting, investment banking and advisory and printing fees; |
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the Company’s compliance with the restrictions the Merger Agreement places on the conduct of the Company’s business prior to completion of the Merger, the waiver of which is subject to the consent of Peoples, may adversely affect the Company’s ability to pursue or execute alternative business strategies; and |
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matters relating to the Merger require substantial commitments of time and resources by the Company’s management (including integration planning), which could otherwise have been devoted to other opportunities that may have been beneficial to the Company, as an independent company. |
In addition to the above risks, if the Merger Agreement is terminated and the Company’s Board of Directors seeks another merger or business combination, the market price of the Company’s common stock could decline, which could make it more difficult to find a party willing to offer equivalent or more attractive consideration than the consideration Peoples has agreed to provide. If the Merger Agreement is terminated under certain circumstances, the Company may be required to pay a termination fee of $8.3 million to Peoples, which may adversely affect the price of the Company’s common stock. Any of the above risks could materially affect the Company’s business, financial results and stock price.
Because the market price of Peoples common stock may fluctuate, the Company’s shareholders cannot be certain of the precise value of the Merger consideration they may receive in the Merger.
At the time the Merger is completed, each issued and outstanding share of the Company’s common stock will be converted into the right to receive 0.90 of a share of Peoples common stock.
The market value of Peoples common stock may fluctuate prior to closing of the Merger as a result of a variety of factors, including general market and economic conditions, changes in Peoples’ businesses, operations and prospects, and regulatory considerations. Many of these factors are outside of the Company’s and Peoples’ control. Consequently, while the Merger Agreement includes a termination right designed to protect against a greater than 17.5% decline in the market price of Peoples common stock prior to the closing that exceeds the change in the Nasdaq Bank Index plus 17.5%, the Company’s shareholders will not know in advance the actual market value of the shares of Peoples common stock that they are to receive in the Merger. The actual market value of the shares of Peoples common stock received by the Company’s shareholders will depend on the market value of shares of Peoples common stock at the time the Merger is completed. This market value may be less or more than the value used to determine the exchange ratio stated in the Merger Agreement.
The Company faces risks and uncertainties related to its proposed Merger with Peoples.
Uncertainty about the effect of the Merger on the Company’s team members and customers may have an adverse effect on the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel until the Merger is consummated and for a period of time thereafter, and could cause customers and others that deal with the Company to seek to change their existing business relationships with the Company. Team member retention may be particularly challenging during the pendency of the Merger, as team members may experience uncertainty about their roles with the surviving corporation following the Merger.
In addition, the Merger Agreement contains provisions that restrict the Company’s ability to, among other things, solicit, knowingly encourage or facilitate inquiries or proposals or enter into any agreement with respect to, or initiate or participate in any negotiations or discussions with any person concerning any alternative business combination proposals, subject to a limited exception when required by the Company’s Board of Directors’ exercise of its fiduciary duties in response to an unsolicited acquisition proposal that is, or is reasonably capable of becoming, a superior proposal. These provisions, which include an $8.3 million termination fee payable under certain circumstances, might discourage a potential competing acquirer that might have an interest in engaging in a superior transaction from considering or proposing that acquisition, or might result in lower value received by the Company’s shareholders than would have otherwise been received.
The Company and Peoples have operated and, until the completion of the Merger, will continue to operate, independently. The success of the Merger, including anticipated benefits and cost savings among other things, will depend, in part, on the Company’s and Peoples’ ability to successfully combine and integrate the Company’s and Peoples’ businesses in a manner that facilitates growth opportunities and realizes cost savings. It is possible that the integration process could result in the loss of key employees, the loss of customers, the disruption of either company’s or both companies’ ongoing business, inconsistencies in standards, controls, procedures and policies, unexpected integration issues, higher than expected integration costs and an overall post-completion integration process that takes longer than originally anticipated. If the combined companies experience difficulties with the integration process, the anticipated benefits of the Merger may not be realized fully or at all or may take longer to realize than expected.
The Merger Agreement may be terminated in accordance with its terms and the Merger may not be completed.
The Merger Agreement is subject to a number of conditions which must be fulfilled in order to complete the Merger. Those conditions include: the approval of the Merger by the Company’s shareholders and by the shareholders of Peoples (which approvals were obtained at meetings of shareholders held on February 23, 2023); the effectiveness of the registration statement on Form S-4 for the shares of Peoples common stock to be issued in the Merger; the receipt of authorization for listing on Nasdaq of the shares of Peoples common stock to be issued in the Merger; the receipt of all required regulatory approvals; the absence of any order, decree or injunction enjoining or prohibiting the Merger; subject to certain exceptions, the accuracy of representations and warranties under the Merger Agreement; the Company’s and Peoples’ performance of the Company’s and their respective obligations under the Merger Agreement in all material respects; the absence of a material adverse effect on the Company or Peoples while the transaction is pending; and the Company’s receipt of a tax opinion to the effect that the Merger will be treated as a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended. These conditions to the closing of the Merger may not be fulfilled in a timely manner or at all, and, accordingly, the Merger may be delayed or may not be completed.
The Company and Peoples may elect to terminate the Merger Agreement under certain circumstances. Among other situations, if the Merger is not completed by July 31, 2023, either the Company or Peoples may choose not to proceed with the Merger, subject to certain exceptions. The Company and Peoples can also mutually decide to terminate the Merger Agreement at any time. If the Merger Agreement is terminated, under certain limited circumstances, the Company may be required to pay a termination fee of $8.3 million to Peoples.
The Company’s ability to complete the Merger is subject to the receipt of approval from various regulatory agencies, which may impose conditions that could adversely affect the Company or cause the Merger to be abandoned.
Before the transactions contemplated in the Merger Agreement can be completed, the Company and Peoples must obtain various regulatory approvals. The terms and conditions of the approvals that are granted may impose conditions, limitations, obligations or costs, or place restrictions on the conduct of the combined company’s business or require changes to the terms of the transactions contemplated by the Merger Agreement. Although the Company and Peoples do not currently expect that any such conditions or changes would be imposed, there can be no assurance that the regulators will not impose any such conditions, obligations or restrictions, and that such conditions, limitations, obligations or restrictions will not have the effect of delaying or preventing completion of any of the transactions contemplated by the Merger Agreement, imposing additional material costs on or materially limiting the revenues of the combined company following the Merger or otherwise reduce the anticipated benefits of the Merger if the Merger were consummated successfully within the expected timeframe, any of which might have an adverse effect on the combined company following the Merger. Neither Peoples nor the Company will be required to complete the Merger if Peoples determines any required regulatory approval contains an unduly burdensome provision.
Shareholder litigation could prevent or delay the closing of the proposed Merger or otherwise negatively impact the Company’s business and operations.
In connection with the Merger, lawsuits may be filed against the Company, Peoples, or the directors and officers of either company in connection with the Merger. Litigation filed against the Company, the Company’s Board of Directors or Peoples and its Board of Directors could prevent or delay the completion of the Merger or result in the payment of damages following completion of the Merger. The defense or settlement of any lawsuit or claim that remains unresolved at the Effective Time of the Merger may adversely affect the combined company’s business, financial condition, results of operations, cash flows and market price.
Pandemic
The COVID-19 pandemic creates significant risks and uncertainties for the Company’s business.
In March 2020, the World Health Organization declared COVID-19 as a global pandemic. The COVID-19 pandemic created economic and financial disruption and adversely affected the business, financial condition, and results of operations of the Company and its customers. The COVID-19 pandemic caused changes in the behavior of customers, businesses, and their employees, as well as supply chain interruptions, and overall economic and financial market instability.
While government, schools, and businesses have largely reopened, future effects, including any actions taken by federal, state, and local governments in response to potential disruptions in the future or their impact, are unknown. Prior and ongoing governmental actions have and continue to meaningfully influence the interest-rate environment. If these actions are sustained, it may adversely impact several industries within the Company’s geographic footprint and impair the ability of the Company’s customers to fulfill their contractual obligations. This could cause the Company to experience a material adverse effect on business operations, liquidity, asset valuations, results of operations, and financial condition, as well as its regulatory capital and liquidity ratios.
Bank Lending, Allowance for Loan Losses and Other Real Estate Owned
Global Economic and Geopolitical Instability and Inflationary Risks
Instability in global economic conditions and geopolitical matters, as well as volatility in financial markets, could have a material adverse effect on the Company’s results of operations and financial condition. The macroeconomic environment in the United States is susceptible to global events and volatility in financial markets. For example, global demand for products continues to exceed supply during the economic recovery from the COVID-19 pandemic, creating significant inflationary pressures which, in turn, may adversely impact regional and global economic conditions, as well as the Company’s financial condition and results of operations.
The Company’s business may be adversely affected by conditions in the financial markets and by economic conditions generally.
Weakness in business and economic conditions generally or specifically in the Company’s markets may have one or more of the following adverse effects on the Company’s business:
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A decrease in the demand for loans and other products and services the Bank offers; |
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A decrease in the value of collateral securing the Bank’s loans; and |
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An increase in the number of customers who become delinquent, file for protection under bankruptcy laws, or default on their loans. |
Adverse conditions in the general business environment have had an adverse effect on the Company’s business in the past. Certain economic indicators, such as real estate asset values, rents, and unemployment, may vary between geographic markets. These economic indicators typically affect the real estate and financial services industries, in which the Bank has a significant number of customers, more significantly than other economic sectors. Furthermore, the Bank has a substantial lending business that depends upon the ability of borrowers to make debt service payments on loans. Should economic conditions experience stress, the Company’s business, financial condition, or results of operations could be adversely affected.
The Bank’s profitability depends significantly on local economic conditions.
Most of the Bank’s business activities are conducted in Kentucky and contiguous states and most of its credit exposure is in that region. The Bank is at risk from adverse economic or business developments affecting this area, including declining regional and local business and employment activity, a downturn in real estate values and agricultural activities, and natural disasters. To the extent the economy weakens, delinquency rates, foreclosures, bankruptcies, and losses in the Bank’s loan portfolio will likely increase. Moreover, the value of real estate or other collateral that secures the loans could be adversely affected by the economic downturn or a localized natural disaster. Events that adversely affect business activity and real estate values have had in the past and may in the future have a negative impact on the Bank’s business, financial condition, results of operations, and future prospects.
Small to medium-sized businesses may have fewer resources to weather a downturn in the economy.
The loan portfolio includes loans to small and medium-sized businesses and other commercial enterprises. Small and medium-sized businesses frequently have smaller market shares than their competitors, may be more vulnerable to economic downturns, often need additional capital to expand or compete, and may experience variations in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small or medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability, or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay the loan. A continued economic downturn may have a more pronounced negative impact on the target market, causing the Bank to incur substantial credit losses that could materially harm operating results.
The Bank’s decisions regarding credit risk may not be accurate, and its allowance for loan losses may not be sufficient to cover actual losses, which could adversely affect its business, financial condition, and results of operations.
The Bank maintains an allowance for loan losses at a level management believes is adequate to absorb probable incurred losses in the loan portfolio based on historical loan loss experience, economic and environmental factors, specific problem loans, value of underlying collateral, and other relevant factors. If management’s assessment of these factors is ultimately inaccurate, the allowance may not be sufficient to cover actual future loan losses, which would adversely affect operating results. Management’s estimates are subjective, and their accuracy depends on the outcome of future events. Changes in economic, operating, and other conditions that are generally beyond the Bank’s control could cause actual loan losses to increase significantly. In addition, bank regulatory agencies, as an integral part of their supervisory functions, periodically review the adequacy of the allowance for loan losses. Regulatory agencies may require an increase in provision for loan losses or to recognize additional loan charge-offs when their judgment differs. Any of these events could have a material negative impact on operating results.
Levels of classified loans and non-performing assets may increase in the future if economic conditions cause borrowers to default. Furthermore, the value of the collateral underlying a given loan, and the realizable value of such collateral in a foreclosure sale, may decline, making it less likely to realize a full recovery if a borrower defaults on a loan. Any increases in the level of non-performing assets, loan charge-offs or provision for loan losses, or the inability to realize the estimated net value of underlying collateral in the event of a loan default, could negatively affect the Bank’s business, financial condition, results of operations, and the trading price of the Company’s common shares.
If the Bank experiences greater credit losses than anticipated, its operating results would be adversely affected.
As a lender, the Bank is exposed to the risk that borrowers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse effect on operating results. Credit risk with respect to the real estate and construction loan portfolio will relate principally to the creditworthiness of borrowers and the value of the real estate serving as security for the repayment of loans. Credit risk with respect to the commercial and consumer loan portfolio will relate principally to the general creditworthiness of businesses and individuals within the local markets.
Management makes various assumptions and judgments about the collectability of its loan portfolio and provides an allowance for estimated loss losses based on a number of factors. Management believes the Bank’s allowance for loan losses is adequate. However, if assumptions or judgments are wrong, the allowance for loan losses may not be sufficient to cover actual loan losses. Management may have to increase the allowance in the future at the request of one of the Bank’s primary regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of the loan portfolio. The actual amount of future provisions for loan losses cannot be determined at this time and may vary from the amounts of past provisions.
A large percentage of the Bank’s loans are collateralized by real estate, and any prolonged weakness in the real estate market may result in losses and adversely affect profitability.
Approximately 72.4% of the Bank’s loan portfolio as of December 31, 2022, was comprised of commercial and residential loans collateralized by real estate. Adverse economic conditions could decrease demand for real estate and depress real estate values in the Company’s markets. Persistent weakness in the real estate market could significantly impair the value of loan collateral and the ability to sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it will become more likely that management would be required to increase the Bank’s allowance for loan losses. If during a period of depressed real estate values, management was required to liquidate the collateral securing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce the Bank’s profitability and adversely affect its financial condition.
The Bank offers real estate construction and development loans, which carry a higher degree of risk than other real estate loans.
Approximately 12.2% of the Company’s loan portfolio as of December 31, 2022 consisted of real estate construction and development loans, up from 7.5% at December 31, 2021 and 9.7% at December 31, 2020. These loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and permanent financing or sale of the property. If the Bank is forced to foreclose on a project prior to its completion, it may not be able to recover the entire unpaid portion of the loan or it may be required to fund additional money to complete the project, or hold the property for an indeterminate period of time. Any of these outcomes may result in losses and adversely affect profitability and financial condition.
The CECL accounting standard will result in a significant change in how the Company recognizes credit losses and may have a material impact on the Company’s financial condition or results of operations.
In June 2016, the FASB issued ASU, “Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model. Whereas the incurred loss model delays recognition of loss on financial instruments until it is probable a loss has occurred, the expected loss model will recognize a loss at the time the loan is first added to the balance sheet. As a result of this differing methodology, the Company expects adoption of the CECL model will materially affect the determination of the allowance and could require a significant increase to the allowance. Any material increase to the required level of loan loss allowance could adversely affect the Company’s business, financial condition, and results of operations. The CECL standard became effective for the Company on January 1, 2023. See Note 1, “New Accounting Standards” for discussion regarding the standard and the estimated one-time cumulative-effect adjustment to the allowance and shareholders’ equity. Interagency guidance issued in December 2018 allows for a three-year phase-in of the cumulative-effect adjustment for regulatory capital reporting.
The Bank may acquire or hold from time to time OREO properties, which could increase operating expenses and result in future losses to the Company.
While there were no OREO properties held by the Bank at December 31, 2022, the Bank may acquire and dispose of a significant amount of real estate as a result of foreclosure or by deed in lieu of foreclosure that is listed on the balance sheet as other real estate owned (“OREO”). An increase in the OREO portfolio increases the expenses incurred to manage and dispose of these properties, which sometimes includes funding construction required to facilitate sale.
Interest Rates, Asset-Liability Management, Liquidity, and Common Stock
Profitability is vulnerable to fluctuations in interest rates.
Changes in interest rates could harm financial condition or results of operations. The results of operations depend substantially on net interest income, the difference between interest earned on interest-earning assets (such as investments and loans) and interest paid on interest-bearing liabilities (such as deposits and borrowings). Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic or international economic or political conditions. Factors beyond the Company’s control, such as inflation, recession, unemployment, and money supply may also affect interest rates. If, as a result of decreasing interest rates, interest-earning assets mature or reprice more quickly than interest-bearing liabilities in a given period, net interest income may decrease. Likewise, net interest income may decrease if interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period as a result of increasing interest rates.
Fixed-rate loans increase the exposure to interest rate risk in a rising rate environment because interest-bearing liabilities may be subject to repricing before assets become subject to repricing. Fixed rate investment securities are subject to fair value declines as interest rates rise. Adjustable-rate loans decrease the interest rate risk associated with rising interest rates but involve other risks, such as the inability of borrowers to make higher payments in an increasing interest rate environment. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as the borrowers refinance their loans at lower interest rates, which could reduce net interest income and harm results of operations.
The planned phasing out of the LIBOR as a financial benchmark presents risks to the financial instruments originated or held by the Company.
LIBOR is the reference rate used for many transactions, including lending and borrowing, as well as the derivatives that may be used to manage risk related to such transactions. Effective January 1, 2022, LIBOR ceased to exist as a published rate for one-week and two-month dollar settings and will cease for remaining U.S. dollar settings after June 30, 2023. The expected discontinuation of LIBOR could have a significant impact on the financial markets and market participants such as the Company. As of December 31, 2022, the Company had approximately $66.1 million in variable rate loans with interest rates tied to LIBOR for which a replacement index had not yet been identified, as well as certain investment securities and debt obligations tied to LIBOR, all of which have maturity dates beyond June 30, 2023.
All loan contracts extending beyond June 30, 2023 will need to be managed effectively to ensure appropriate benchmark rate replacements are provided for and adopted. The Adjustable Interest Rate (LIBOR) Act, enacted in 2022, provides a mechanism to replace LIBOR with a replacement benchmark rate selected by the Federal Reserve Board in existing contracts that do not provide for a clearly defined or practicable replacement benchmark rate. In December 2022, the Federal Reserve Board finalized regulations to designate the Secured Overnight Financing Rate (SOFR) as its selected replacement benchmark rate.
Failure to identify a replacement benchmark rate and/or update data processing systems could result in future interest rate changes not being correctly captured, which could result in interest rate risk not being mitigated as intended, or interest earned being miscalculated, which could adversely impact the Company’s business, financial condition, and results of operations. Uncertainty regarding the impact of LIBOR’s phasing out and the taking of discretionary actions or negotiations of fallback provisions could result in pricing volatility, adverse tax or accounting impacts, or additional compliance, legal and operational costs.
If the Bank cannot obtain adequate funding, it may not be able to meet the cash flow requirements of its depositors and borrowers, or meet the operating cash needs of the Company.
The Company’s liquidity policies and limits are established by the Board of Directors of the Bank, with operating limits managed and monitored by the Asset Liability Committee (“ALCO”), based upon analyses of the ratio of loans to deposits and the percentage of assets funded with non-core or wholesale funding. The ALCO regularly monitors the overall liquidity position of the Bank and the Company to ensure that various alternative strategies exist to meet unanticipated events that could affect liquidity. Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. If the Company’s liquidity policies and strategies do not work as well as intended, the Bank may be unable to make loans and repay deposit liabilities as they become due or are demanded by customers. The ALCO follows established board approved policies and monitors guidelines to diversify the Company’s wholesale funding sources to avoid concentrations in any one-market source. Wholesale funding sources include Federal funds purchased, securities sold under repurchase agreements, brokered deposits, and Federal Home Loan Bank (“FHLB”) advances that are collateralized with mortgage-related assets.
The Bank maintains a portfolio of securities that can be used as a secondary source of liquidity. There are other available sources of liquidity, including additional collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or common shares in public or private transactions. If the Bank is unable to access any of these funding sources when needed, it might not be able to meet the needs of customers, which could adversely impact its financial condition, its results of operations, cash flows, and its level of regulatory-qualifying capital.
As a bank holding company, the Company depends on dividends and distributions paid to it by its banking subsidiary.
The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. The principal source of cash flow, from which it would fund any dividends paid to shareholders, has historically been dividends the Company receives from the Bank. Regulations of the FDIC and the KDFI govern the ability of the Bank to pay dividends and other distributions to the Company, and regulations of the Federal Reserve govern the ability to pay dividends or make other distributions to shareholders. Based on these regulations, the Bank was eligible to pay $20.4 million of dividends at December 31, 2022. The Bank paid the Company $7.5 million of dividends during 2022. See the “Item 1. Business” “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – Dividends.”
Deferred Tax Assets
The Company may not be able to realize the value of its deferred tax assets.
Due to losses in prior years, the Company has a net operating loss carry-forward of $13.8 million, credit carry-forwards of $208,000, and other net deferred tax assets of $7.3 million. In order to realize the benefit of these tax losses, credits, and deductions, the Company must generate substantial taxable income in future periods. Deferred tax assets are calculated using a federal corporate tax rate of 21% and a state corporate tax rate of 5%. Changes in tax laws and rates may affect deferred tax assets in the future. If higher federal corporate tax rates are enacted, net deferred tax assets would be increased commensurate with the rate increase. Federal net operating loss carry-forwards begin to expire in 2033 and state net operating loss carryforwards begin to expire in 2031. Additionally, should the Company need to raise additional capital by issuing new common shares or securities convertible into common shares, then depending on the number of common share equivalents issued, it could trigger a “change in control,” as defined by Section 382 of the Internal Revenue Code. Such an event could negatively impact or limit the ability to utilize net operating loss carry-forwards, credit loss carry-forwards, and other net deferred tax assets, and result in an impairment of these deferred tax assets for financial reporting purposes.
Litigation
Risk related to legal proceedings.
From time to time, the Company is involved in judicial, regulatory, and arbitration proceedings concerning matters arising from the Company’s business activities and fiduciary responsibilities. The Company establishes reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The Company may still incur legal costs for a matter even if a reserve has not been established. In addition, the actual cost of resolving a legal claim may be substantially higher than any amounts reserved for that matter. The ultimate resolution of a pending or future legal proceeding, depending on the remedy sought and granted, could materially adversely affect results of operations and financial condition.
Deposit Insurance Expense
FDIC deposit insurance premiums and assessments can impact non-interest expense.
The Bank’s deposits are insured by the FDIC up to legal limits and, accordingly, the Bank is subject to FDIC deposit insurance premiums and assessments. FDIC assessments for deposit insurance are based on the average total consolidated assets of the insured institution during the assessment period, less the average tangible equity of the institution during the assessment period. Any increase in assessment rates may adversely affect the Bank’s business, financial condition, or results of operations.
Competition, Management
The Bank faces strong competition from other financial institutions and financial service companies, which could adversely affect the results of operations and financial condition.
The Bank competes with other financial institutions in attracting deposits and making loans. The competition in attracting deposits comes principally from other commercial banks, credit unions, savings and loan associations, securities brokerage firms, insurance companies, money market funds, and other mutual funds. The competition in making loans comes principally from other commercial banks, credit unions, farm credit associations, savings and loan associations, mortgage banking firms, and consumer finance companies. In addition, competition for business in the Louisville and Lexington metropolitan areas has grown in recent years as changes in banking law have allowed banks to enter those markets by establishing new branches.
Competition in the banking industry may also limit the ability to attract and retain banking clients. The Bank maintains smaller staffs of associates and has fewer financial and other resources than larger institutions with which it competes. Financial institutions that have far greater resources and greater efficiencies than the Bank may have several marketplace advantages resulting from their ability to:
● |
offer higher interest rates on deposits and lower interest rates on loans than the Bank can; |
● |
offer a broader range of services than the Bank does; |
● |
maintain more branch locations than the Bank does; and |
● |
mount extensive promotional and advertising campaigns. |
In addition, banks and other financial institutions with larger capitalization and other financial intermediaries may not be subject to the same regulatory restrictions and may have larger lending limits. Some of the Company’s current commercial banking clients may seek alternative banking sources as they develop needs for credit facilities larger than the Bank can accommodate. If the Bank is unable to attract and retain customers, it may not be able to maintain growth and the results of operations and financial condition may otherwise be negatively impacted.
The Company depends on its senior management team, and the unexpected loss of one or more of the senior executives could impair relationships with customers and adversely affect business and financial results.
The Company’s success significantly depends on the services and performance of key management personnel. Future performance will depend on the ability to motivate and retain key officers. The Dodd-Frank Act, and the policies of bank regulatory agencies have placed restrictions on executive compensation practices. Such restrictions and standards may further impact the ability to compete for talent with other businesses that are not subject to the same limitations. The unexpected loss of the services of members of senior management or other key officers or the inability to attract additional qualified personnel as needed could materially harm its business.
Accounting Estimates, Internal Controls, Cybersecurity
Reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates.
Accounting policies and assumptions are fundamental to the reported financial condition and results of operations. Management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner in which to report the financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in reporting materially different results than would have been reported under a different alternative.
Certain accounting policies require management to make difficult, subjective, or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These accounting policies include the valuation of securities, allowance for loan losses, and valuation of net deferred income tax asset. Because of the uncertainty of estimates involved in these matters, the Company may be required, among other things, to recognize other-than-temporary impairment on securities, significantly increase the allowance for credit losses, sustain credit losses that are higher than the reserve provided, or permanently impair deferred tax assets.
While management continually monitors and improves the system of internal controls, data processing systems, and corporate wide processes and procedures, the Company may suffer losses from operational risk in the future.
Management maintains internal operational controls and has invested in technology to help process large volumes of transactions. However, the Company may not be able to continue processing at the same or higher levels of transactions. If systems of internal controls should fail to work as expected, if systems were to be used in an unauthorized manner, or if employees were to subvert the system of internal controls, significant losses could occur.
The Company processes large volumes of transactions on a daily basis exposing it to numerous types of operational risk, which could cause it to incur substantial losses. Operational risk resulting from inadequate or failed internal processes, people, and systems includes the risk of fraud by employees or persons outside of the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.
The Company establishes and maintains systems of internal operational controls that provide management with timely and accurate information about its level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost effective levels. The Company has also established procedures that are designed to ensure policies relating to conduct, ethics and business practices are followed. Nevertheless, the Company experiences loss from operational risk from time to time, including the effects of operational errors, and these losses may be substantial.
Information systems may experience an interruption or security breach.
Failure in or breach of operational or security systems or infrastructure, or those of third party vendors and other service providers, including as a result of cyber-attacks, could disrupt the Bank’s businesses, result in the disclosure or misuse of confidential or proprietary information, damage its reputation, increase costs, and cause losses. As a financial institution, the Bank depends on its ability to process, record, and monitor a large number of customer transactions on a continuous basis. As customer, public and regulatory expectations regarding operational and information security have increased, operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Business, financial, accounting, data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond the Bank’s control. For example, there could be sudden increases in customer transaction volume, electrical or telecommunications outages, natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics, events arising from local or larger scale political or social matters, including terrorist acts, and, as described below, cyber-attacks. Although the Bank has business continuity plans and other safeguards in place, its business operations may be adversely affected by significant and widespread disruption to its physical infrastructure or operating systems that support its businesses and customers.
Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. As noted above, the Bank’s operations rely on the secure processing, transmission, and storage of confidential information in its computer systems and networks. In addition, to access the Bank’s products and services, its customers may use personal smartphones, tablet PC’s, and other mobile devices that are beyond its control systems. Although the Bank believes it has appropriate information security procedures and controls, its technologies, systems, networks, and its customers’ devices may become the target of cyber-attacks or information security breaches. These events could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of the Bank’s customers’ confidential, proprietary, and other information or that of its customers, or otherwise disrupt the business operations of the Bank, its customers, or other third parties.
Third parties with which the Bank does business or that facilitate its business activities could also be sources of operational and information security risk to the Bank, including from breakdowns or failures of their own systems or capacity constraints. Although to date the Bank has not experienced any material losses relating to cyber-attacks or other information security breaches, the Bank can give no assurance that it will not suffer such losses in the future. Risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats and the prevalence of Internet and mobile banking. As cyber threats continue to evolve, the Bank may be required to expend significant additional resources to continue to modify or enhance its protective measures or to investigate and remediate any information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support the Bank’s businesses and customers, or cyber-attacks or security breaches of the networks, systems, or devices that the Bank’s customers use to access its products and services could result in customer attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect the Bank’s business, results of operations, or financial condition.
Bank Regulation
The Company operates in a highly regulated environment and, as a result, is subject to extensive regulation and supervision that could adversely affect financial performance and ability to implement growth and operating strategies.
The Company is subject to examination, supervision, and comprehensive regulation by federal and state regulatory agencies, as described under “Item 1 – Business-Supervision and Regulation.” Regulatory oversight of banks is primarily intended to protect depositors, the federal deposit insurance funds, and the banking system as a whole, and not shareholders. Compliance with these regulations is costly and may make it more difficult to operate profitably.
Federal and state banking laws and regulations govern numerous matters including the payment of dividends, bank acquisition and merger transactions, and the establishment of new banking offices. The Company must also meet specific regulatory capital requirements. Failure to comply with these laws, regulations, and policies or to maintain required capital could affect the ability to pay dividends on common shares and the implementation of strategic plans.
In addition, the laws and regulations applicable to banks could change at any time, which could significantly impact the Company’s business and profitability. For example, new legislation or regulation could limit the manner in which the Company may conduct its business, including its ability to attract deposits and make loans. Events that may not have a direct impact on us, such as the bankruptcy or insolvency of a prominent U.S. corporation, can cause legislators and banking regulators and other agencies such as the Consumer Financial Protection Bureau, the SEC, the Public Company Accounting Oversight Board, and various taxing authorities to respond by adopting and or proposing substantive revisions to laws, regulations, rules, standards, policies, and interpretations. The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations may have a material impact on the Company’s business and results of operations. Changes in regulation may cause the Company to devote substantial additional financial resources and management time to compliance, which may negatively affect operating results.
Changes in banking laws could have a material adverse effect.
The Bank is subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and monetary policies. Management cannot predict whether any of these changes could adversely and materially affect us. The current regulatory environment for financial institutions entails significant potential increases in compliance requirements and associated costs. Federal and state banking regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums, and limitations on the Bank’s activities that could have a material adverse effect on its business and profitability.
Item 1B. Unresolved Staff Comments
Not applicable.
The Bank operates 20 banking offices in Kentucky. The following table shows the location, square footage, and ownership of each property. Management believes that each of these locations is adequately insured. Support operations are located at the main office in Louisville and in Canmer.
Markets |
Square Footage |
Owned/Leased |
||||
Frankfort/Franklin County |
||||||
Frankfort Office: 100 Highway 676, Frankfort |
3,000 | Leased |
||||
Elizabethtown/Hardin County |
||||||
Elizabethtown Office: 1690 Ring Road, Suite 100, Elizabethtown |
4,000 | Leased |
||||
Louisville/Jefferson, Bullitt and Henry Counties |
||||||
Main Office: 2500 Eastpoint Parkway, Louisville |
30,000 | Owned |
||||
Eminence Office: 646 Elm Street, Eminence |
1,500 | Owned |
||||
Hillview Office: 6890 North Preston Highway, Hillview |
3,500 | Owned |
||||
Pleasureville Office: 5440 Castle Highway, Pleasureville |
10,000 | Owned |
||||
Shepherdsville Office: 155 Conestoga Parkway, Shepherdsville |
3,900 | Owned |
||||
St. Matthews Office: 4304 Shelbyville Road, Louisville |
3,400 | Leased |
||||
Lexington/Fayette County |
||||||
Lexington Office: 3880 Fountainblue Lane, Suite 120, Lexington |
3,000 | Leased |
||||
City Center Office: 130 West Main Street, Lexington |
2,400 | Leased |
||||
South Central Kentucky |
||||||
Brownsville Office: 113 East Main Cross Street, Brownsville |
8,500 | Owned |
||||
Greensburg Office: 202 North Main Street, Greensburg |
11,000 | Owned |
||||
Horse Cave Office: 201 East Main Street, Horse Cave |
5,000 | Owned |
||||
Morgantown Office: 112 West G.L. Smith Street, Morgantown |
7,500 | Owned |
||||
Munfordville Office: 949 South Dixie Highway, Munfordville |
9,000 | Owned |
||||
Beaver Dam Office: 1300 North Main Street, Beaver Dam |
3,200 | Owned |
||||
Owensboro/Daviess County |
||||||
Owensboro Frederica Office: 3500 Frederica Street, Owensboro |
5,000 | Owned |
||||
Owensboro Gateway Commons: 3250 Hayden Road Unit #3, Owensboro |
3,000 | Leased |
||||
Southern Kentucky |
||||||
Campbell Lane Office: 751 Campbell Lane, Bowling Green |
7,500 | Owned |
||||
Glasgow Office: 1006 West Main Street, Glasgow |
12,000 | Owned |
||||
Other Properties |
||||||
Office Building: 2708 North Jackson Highway, Canmer |
3,500 | Owned |
In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amount of damages. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur.
The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated.
The Company is not currently a party to any material litigation.
Item 4. Mine Safety Disclosure
Not applicable.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
The Company’s common shares are traded on the Nasdaq Capital Market under the ticker symbol “LMST”.
As of January 31, 2023, the Company’s common shares were held by approximately 1,839 shareholders, including 336 shareholders of record and approximately 1,503 beneficial owners whose shares are held in “street” name by securities broker-dealers or other nominees, and the Company’s non-voting common shares were held by one holder.
Dividends
As a bank holding company, the Company’s ability to declare and pay dividends depends on various federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.
The principal source of revenue with which to pay dividends on common shares are dividends the Bank may declare and pay out of funds legally available for payment of dividends. A Kentucky chartered bank may declare a dividend of an amount of the bank’s net profits as the board deems appropriate. The approval of the KDFI is required if the total of all dividends declared by a bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt.
Purchase of Equity Securities by Issuer
On October 20, 2021, the Board of Directors approved a share repurchase program authorizing the Company to purchase up to $3.0 million of the Company’s Common Shares over time in the open market or in privately negotiated transactions. No shares were repurchased under the plan, which expired on December 31, 2022.
Equity Compensation Plan Information
The following table provides information about the Company’s equity compensation plans as of December 31, 2022:
Plan category |
Number of securities to |
Weighted-average |
Number of securities column 1) |
|||||||||
Equity compensation plans approved by shareholders |
— | — | 122,603 | |||||||||
Equity compensation plans not approved by shareholders |
— | — | — | |||||||||
Total |
— | — | 122,603 |
At December 31, 2022, 122,603 common shares remain available for issuance under the Company’s 2018 Omnibus Equity Compensation Plan; however, the Company is precluded from issuing additional shares based on the terms of the Merger Agreement.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis of financial condition and results of operations analyzes the consolidated financial condition and results of operations of Limestone Bancorp, Inc. (the Company) and its wholly owned subsidiary, Limestone Bank, Inc. (the Bank). The Company is a Louisville, Kentucky-based bank holding company that operates banking offices in 14 Kentucky counties. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Bullitt and Henry. The Bank serves south central, southern, and western Kentucky from banking offices in Barren, Butler, Daviess, Edmonson, Green, Hardin, Hart, Ohio, and Warren Counties. The Bank also has offices in Lexington, the second largest city in the state, and Frankfort, the state capital. The Bank is a traditional community bank with a wide range of personal and business banking products and services.
Selected Consolidated Financial Data
As of and for the Years Ended December 31, |
||||||||||||||||||||
(Dollars in thousands except per share data) |
2022 |
2021 |
2020 |
2019 |
2018 |
|||||||||||||||
Income Statement Data: |
||||||||||||||||||||
Interest income |
$ | 57,810 | $ | 49,915 | $ | 50,753 | $ | 49,584 | $ | 43,461 | ||||||||||
Interest expense |
8,732 | 5,693 | 10,152 | 14,234 | 9,790 | |||||||||||||||
Net interest income |
49,078 | 44,222 | 40,601 | 35,350 | 33,671 | |||||||||||||||
Provision (negative provision) for loan losses |
80 | 1,150 | 4,400 | — | (500 | ) |
||||||||||||||
Non-interest income (1) |
8,877 | 8,439 | 6,844 | 5,918 | 5,779 | |||||||||||||||
Non-interest expense (2) |
33,757 | 31,971 | 32,416 | 30,270 | 29,126 | |||||||||||||||
Income before income taxes |
24,118 | 19,540 | 10,629 | 10,998 | 10,824 | |||||||||||||||
Income tax expense (3) |
5,776 | 4,631 | 1,624 | 480 | 2,030 | |||||||||||||||
Net income |
18,342 | 14,909 | 9,005 | 10,518 | 8,794 | |||||||||||||||
Less: |
||||||||||||||||||||
Earnings allocated to participating securities |
302 | 219 | 68 | 106 | 144 | |||||||||||||||
Net income attributable to common |
$ | 18,040 | $ | 14,690 | $ | 8,937 | $ | 10,412 | $ | 8,650 | ||||||||||
Common Share Data: |
||||||||||||||||||||
Basic earnings per common share |
$ | 2.40 | $ | 1.96 | $ | 1.20 | $ | 1.41 | $ | 1.23 | ||||||||||
Diluted earnings per common share |
2.40 | 1.96 | 1.20 | 1.41 | 1.23 | |||||||||||||||
Cash dividends declared per common share |
0.20 | — | — | — | — | |||||||||||||||
Book value per common share |
17.52 | 17.24 | 15.47 | 14.15 | 12.34 | |||||||||||||||
Tangible book value per common share (4) |
16.48 | 16.16 | 14.34 | 12.98 | 12.34 | |||||||||||||||
Balance Sheet Data (at period end): |
||||||||||||||||||||
Total assets |
$ | 1,462,455 | $ | 1,415,692 | $ | 1,312,302 | $ | 1,245,779 | $ | 1,069,692 | ||||||||||
Debt obligations: |
||||||||||||||||||||
FHLB advances |
70,000 | 20,000 | 20,623 | 61,389 | 46,549 | |||||||||||||||
Junior subordinated debentures |
21,000 | 21,000 | 21,000 | 21,000 | 21,000 | |||||||||||||||
Subordinated capital notes |
25,000 | 25,000 | 25,000 | 17,000 | — | |||||||||||||||
Senior debt |
— | — | — | 5,000 | 10,000 | |||||||||||||||
Average Balance Data: |
||||||||||||||||||||
Average assets |
$ | 1,434,437 | $ | 1,363,397 | $ | 1,294,934 | $ | 1,112,388 | $ | 1,026,310 | ||||||||||
Average loans |
1,072,330 | 958,549 | 964,088 | 801,813 | 743,352 | |||||||||||||||
Average deposits |
1,197,906 | 1,164,355 | 1,099,383 | 936,243 | 860,825 | |||||||||||||||
Average FHLB advances |
50,274 | 20,152 | 34,101 | 35,038 | 43,363 | |||||||||||||||
Average junior subordinated debentures |
21,000 | 21,000 | 21,000 | 21,000 | 21,000 | |||||||||||||||
Average subordinated capital notes |
25,000 | 25,000 | 20,366 | 7,545 | 791 | |||||||||||||||
Average senior debt |
— | — | 2,896 | 7,781 | 10,000 | |||||||||||||||
Average stockholders’ equity |
129,453 | 123,942 | 109,958 | 100,126 | 84,860 |
(1) |
In 2022, the Company recognized a $163,000 gain on sale of premises held for sale. |
|
|
In 2021, the Company recognized a $191,000 gain on the sale of OREO and a $465,000 gain on the call of a corporate bond from the Company’s available for sale securities portfolio. |
(2) |
On October 24, 2022, Peoples and the Company entered into the Merger Agreement. Merger expenses totaled $691,000, or $0.07 per common share after taxes. |
|
|
On November 15, 2019, the Company completed a four branch acquisition. The purchase included $126.8 million in performing loans and $1.5 million in premises and equipment, as well as $131.8 million in customer deposits. Acquisition related costs totaled $775,000, or $0.08 per common share after taxes. |
(3) |
Effective January 1, 2021, the Commonwealth of Kentucky eliminated the bank franchise tax, which was previously reported as a non-interest expense, and implemented a state income tax at a statutory rate of 5%. State income tax was $1.0 million for 2022 and $939,000 for 2021. For 2020 and 2019, income tax expense benefitted $478,000 and $1.6 million, respectively, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during 2019. |
(4) |
Tangible book value per common share is a non-GAAP financial measure derived from GAAP based amounts. Tangible book value is calculated by excluding the balance of intangible assets from common stockholders’ equity. Tangible book value per common share is calculated by dividing tangible common equity by common shares outstanding, as compared to book value per common share, which is calculated by dividing common stockholders’ equity by common shares outstanding. Management believes this is consistent with bank regulatory agency treatment, which excludes tangible assets from the calculation of risk-based capital. |
As of and for the Years Ended December 31, |
||||||||||||||||||||
2022 |
2021 |
2020 |
2019 |
2018 |
||||||||||||||||
Tangible Book Value Per Share |
(in thousands, except share and per share data) |
|||||||||||||||||||
Common stockholder’s equity |
$ | 133,858 | $ | 130,959 | $ | 116,024 | $ | 105,750 | $ | 92,097 | ||||||||||
Less: Goodwill |
6,252 | 6,252 | 6,252 | 6,252 | — | |||||||||||||||
Less: Intangible assets |
1,733 | 1,989 | 2,244 | 2,500 | — | |||||||||||||||
Tangible common equity |
125,873 | 122,718 | 107,528 | 96,998 | 92,097 | |||||||||||||||
Shares outstanding |
7,638,633 | 7,594,749 | 7,498,865 | 7,471,975 | 7,462,720 | |||||||||||||||
Tangible book value per common share |
$ | 16.48 | $ | 16.16 | $ | 14.34 | $ | 12.98 | $ | 12.34 | ||||||||||
Book value per common share |
17.52 | 17.24 | 15.47 | 14.15 | 12.34 |
The following discussion should be read in conjunction with the Company’s consolidated financial statements and accompanying notes and other schedules presented elsewhere in the report.
Overview
For the year ended December 31, 2022, the Company reported net income of $18.3 million compared with net income of $14.9 million for the year ended December 31, 2021 and net income of $9.0 million for the year ended December 31, 2020. Basic and diluted income per common share were $2.40 for the year ended December 31, 2022, compared with $1.96 for 2021, and $1.20 for 2020.
On October 24, 2022, the Company entered into an Agreement and Plan of Merger (Merger Agreement) with Peoples Bancorp Inc. (Peoples). The Merger Agreement provides for a business combination whereby the Company will merge with and into Peoples (the Merger), with Peoples as the surviving corporation in the Merger. Under the terms and subject to the conditions of the Merger Agreement, at the effective time of the Merger (the “Effective Time”), each share of the Company’s common stock, issued and outstanding immediately prior to the Effective Time (except for Dissenting Shares, as provided for in the Merger Agreement), will be converted, in accordance with the procedures set forth in the Merger Agreement, into 0.90 common shares, no par value, of Peoples. Upon the terms and subject to the conditions set forth in the Merger Agreement, the Merger is expected to close in the second quarter of 2023.
The following significant items are of note for the year ended December 31, 2022:
● |
Average loans receivable increased approximately $113.8 million, or 11.9%, to $1.07 billion for the year ended December 31, 2022, compared with $958.5 million for the year ended December 31, 2021, as loan growth outpaced payoffs during 2022. SBA Paycheck Protection Program (“PPP”) loans averaged $294,000 and $15.5 million for the year ended December 31, 2022 and 2021, respectively. |
● |
Net interest margin increased 14 basis points to 3.62% for the year ended December 31, 2022, compared with 3.48% for the year ended December 31, 2021. The Federal Reserve increased the fed funds target by 425 basis points over its last seven meetings of 2022. As a result, the Bank’s fed funds sold, floating rate investment securities, loans with variable rate pricing features, and new loan originations benefitted from the upward movement in short-term rates during 2022. |
● |
The yield on earning assets increased to 4.27% for the year ended December 31, 2022, compared to 3.92% for the year ended December 31, 2021. The yield on earning assets for the year ended December 31, 2021 was significantly impacted by $2.8 million in PPP fees, compared to $45,000 for the year ended December 31, 2022. During the year ended December 31, 2022, PPP fees represented approximately one basis point of earning asset yield and net interest margin, compared to 21 basis points for the year ended December 31, 2021. The reduction in PPP fee income was offset by an increase in interest revenue due to an increase in average loans between periods. The increase in average loans resulted in an increase in interest revenue volume of approximately $5.3 million for the year ended December 31, 2022, as well as an increase in interest revenue attributable to rates of $552,000 due primarily to the impact of the increase in interest rates on new and renewed loans and the upward repricing of variable rate loans. |
● |
The cost of interest-bearing liabilities increased to 0.86% in 2022 from 0.59% in 2021 as a result of increases in short-term interest rates during 2022. |
● |
Net loan recoveries were $1.4 million for 2022, compared to net loan charge-offs of $2.1 million for 2021, and net loan charge-offs of $333,000 for 2020. During the third quarter of 2022, the Bank received a payoff on a $2.0 million nonaccrual commercial real estate loan resulting in a recovery of $1.5 million. |
● |
A provision for loan losses of $80,000 was recorded in 2022, compared to a provision for loan losses of $1.2 million in 2021. The 2022 loan loss provisions were primarily attributable to growth trends within the portfolio, offset by a significant recovery during the third quarter and its impact on the historical loss percentages. The 2021 loan loss provisions were attributable to growth trends within the portfolio and net loan charge-offs impacting historical loss percentages during the period. |
● |
Deposits were $1.20 billion at December 31, 2022, compared with $1.21 billion at December 31, 2021. Certificate of deposit balances increased $24.2 million and interest checking accounts increased $26.9 million during the year. These increases were offset by a decrease of $38.9 million in money market accounts, a decrease of $14.9 million in savings accounts, and a $5.1 million decrease in non-interest bearing demand deposits. |
● |
The Company paid a $0.20 per common share in cash dividends to shareholders of record during 2022. |
● |
In conjunction with the Merger Agreement discussed above, the Company, with the unanimous approval of the Board of Directors, terminated its Tax Benefit Preservation Plan on October 24, 2022. The Tax Benefit Preservation Plan was placed in service in 2015 and designed to preserve the benefits of the Company’s substantial tax assets. Restrictions on transfer designed to protect the Company’s tax assets remain in effect under the Company’s Articles of Incorporation, as approved by shareholders. |
These items are discussed in further detail throughout this Item 7.
Application of Critical Accounting Policies
The Company’s accounting and reporting policies comply with GAAP and conform to general practices within the banking industry. Management believes the following significant accounting policies may involve a higher degree of management assumptions and judgments that could result in materially different amounts to be reported if conditions or underlying circumstances were to change.
Allowance for Loan Losses – The Bank maintains an allowance for loan losses believed to be sufficient to absorb probable incurred credit losses existing in the loan portfolio. The Board of Directors evaluates the adequacy of the allowance for loan losses on a quarterly basis. Management evaluates the adequacy of the allowance using, among other things, historical loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral, and current economic conditions and trends. The allowance may be allocated for specific loans or loan categories, but the entire allowance is also available for any loan. The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated and measured for impairment. The general component is based on historical loss experience adjusted for qualitative environmental factors. Management develops allowance estimates based on actual loss experience adjusted for current economic conditions and trends. Allowance estimates are a prudent measurement of the risk in the loan portfolio applied to individual loans based on loan type. If the mix and amount of future charge-off percentages differ significantly from the assumptions used by management in making its determination, management may be required to materially increase its allowance for loan losses and provision for loan losses, which could adversely affect results.
In June 2016, the FASB issued ASU, “Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model. Whereas the incurred loss model delays recognition of loss on financial instruments until it is probable a loss has occurred, the expected loss model will recognize a loss at the time the loan is first added to the balance sheet. The CECL standard became effective for the Company on January 1, 2023. Management continues to refine assumptions, analyze forecast scenarios, and stress test the volatility of the model. Additionally, management is finalizing various accounting processes, and related controls. As a result, the Company estimates a one-time cumulative adjustment to the allowance for credit losses of up to $2.0 million. This estimate and the ongoing impact of adopting CECL are dependent on various factors, including credit quality, macroeconomic forecasts and conditions, composition of the loan and securities portfolios, and other management judgments. The ultimate adjustment to record the impact of adoption may differ from the current estimate as the model is subject to further review and analysis by the Company’s management team. Interagency guidance issued in December 2018 allows for a three-year phase-in of the cumulative-effect adjustment for regulatory capital reporting.
Results of Operations
The following table summarizes components of income and expense and the change in those components for 2022 compared with 2021:
For the Years Ended December 31, |
Change from Prior Period |
|||||||||||||||
2022 |
2021 |
Amount |
Percent |
|||||||||||||
(dollars in thousands) |
||||||||||||||||
Gross interest income |
$ | 57,810 | $ | 49,915 | $ | 7,895 | 15.8 | % |
||||||||
Gross interest expense |
8,732 | 5,693 | 3,039 | 53.4 | ||||||||||||
Net interest income |
49,078 | 44,222 | 4,856 | 11.0 | ||||||||||||
Provision for loan losses |
80 | 1,150 | (1,070 | ) |
(93.0 | ) |
||||||||||
Non-interest income |
8,880 | 7,979 | 901 | 11.3 | ||||||||||||
Gain (loss) on sales and calls of securities, net |
(3 | ) |
460 | (463 | ) |
NM | ||||||||||
Non-interest expense |
33,757 | 31,971 | 1,786 | 5.6 | ||||||||||||
Net income before taxes |
24,118 | 19,540 | 4,578 | 23.4 | ||||||||||||
Income tax expense |
5,776 | 4,631 | 1,145 | 24.7 | ||||||||||||
Net income |
18,342 | 14,909 | 3,433 | 23.0 |
NM: Not Meaningful
Net income of $18.3 million for the year ended December 31, 2022 increased by $3.4 million from net income of $14.9 million for 2021. Net interest income increased $4.9 million for 2022 as a result of growth in the loan portfolio and increasing yields on earning assets, offset by $3.0 million increase in the cost of interest-bearing liabilities primarily due to recent increases in short-term interest rates. A provision for loan losses of $80,000 was recorded in 2022, compared to a $1.2 million provision for loan losses in 2021. The 2022 loan loss provisions were primarily attributable to growth trends within the portfolio, offset by a significant recovery during the third quarter and its impact on the historical loss percentages. The 2021 loan loss provisions were attributable to growth trends within the portfolio and net loan charge-offs impacting historical loss percentages during the period.
Non-interest income increased $438,000 during 2022. The increase was primarily due to an increase in service charges on deposit accounts of $519,000 and an increase in bank card interchange fees of $162,000, both of which were due to an increase in transaction volumes. Bank owned life insurance income increased $180,000 for the year ended December 31, 2022 due to additional policies being purchased in March 2022. Non-interest income for the year ended December 31, 2022 also included a $163,000 gain on sale of premises held for sale from the first quarter of 2022, while the year ended December 31, 2021 included a $191,000 gain on sale of OREO from the second quarter of 2021, as well as a $465,000 gain on the call of a corporate bond from the third quarter of 2021.
Non-interest expense increased $1.8 million during 2022. The increase was primarily due to an increase of $889,000 in salaries and benefits as a result of the inflationary impact on salary administration, increased health care utilization costs, and increased performance-based incentive compensation, merger expenses of $691,000 related to the pending Merger with Peoples as announced on October 24, 2022, and a $396,000 increase in other non-interest expense primarily related to losses associated with demand deposit charge-offs and fraudulent check and debit card activity during the period. These increases from the prior year were offset by a decrease in communications expense of $262,000 for 2022 as a result of changes in information technology infrastructure during the period.
The following table summarizes components of income and expense and the change in those components for 2021 compared with 2020:
For the Years Ended December 31, |
Change from Prior Period |
|||||||||||||||
2021 |
2020 |
Amount |
Percent |
|||||||||||||
(dollars in thousands) |
||||||||||||||||
Gross interest income |
$ | 49,915 | $ | 50,753 | $ | (838 | ) |
(1.7 | )% |
|||||||
Gross interest expense |
5,693 | 10,152 | (4,459 | ) |
(43.9 | ) |
||||||||||
Net interest income |
44,222 | 40,601 | 3,621 | 8.9 | ||||||||||||
Provision for loan losses |
1,150 | 4,400 | (3,250 | ) |
(73.9 | ) |
||||||||||
Non-interest income |
7,979 | 6,849 | 1,130 | 16.5 | ||||||||||||
Gain (loss) on sales and calls of securities, net |
460 | (5 | ) |
465 | NM | |||||||||||
Non-interest expense |
31,971 | 32,416 | (445 | ) |
(1.4 | ) |
||||||||||
Net income before taxes |
19,540 | 10,629 | 8,911 | 83.8 | ||||||||||||
Income tax expense |
4,631 | 1,624 | 3,007 | 185.2 | ||||||||||||
Net income |
14,909 | 9,005 | 5,904 | 65.6 |
NM: Not Meaningful
Net income of $14.9 million for the year ended December 31, 2021 increased by $5.9 million from net income of $9.0 million for 2020. Net interest income increased $3.6 million for 2021 as a result of $1.7 million in increased PPP fee recognition connected to the forgiveness and payoff of PPP loans, partially offset by declining yields on earning assets, and a $4.5 million decrease in the cost of interest-bearing liabilities primarily due to downward repricing within the time deposit portfolio, and a reduction in the size of the time deposit portfolio. Provision for loan losses of $1.2 million was recorded in 2021, compared to a $4.4 million provision for loan losses in 2020. The 2021 loan loss provision was attributable to net loan charge-offs impacting historical loss percentages and growth trends within the portfolio during the year, while the provision for 2020 was largely attributable to the uncertainty surrounding the COVID-19 pandemic related economic and business disruptions.
Non-interest income increased $1.6 million during 2021. The increase was primarily due to an increase in bank card interchange fees of $740,000 as a result of an increase in debit card transactions, a $191,000 gain on the sale of OREO, and a $465,000 gain on the call of a corporate bond from the Bank’s available for sale securities portfolio.
Non-interest expense decreased $445,000 during 2021. The decrease was primarily attributable to a decrease of $1.1 million in deposit and state franchise tax expense as a result of the elimination of the Kentucky bank franchise tax discussed below. This decrease was partially offset by an increase in salaries and employee benefits of $381,000 attributable to moderate merit increases in compensation and performance-based incentive compensation partially offset in 2021 by year over year average FTE reductions. Additionally, deposit account related expense increased $268,000 due to an increase in debit card transactions and the related processing costs.
Income tax expense was $4.6 million and $1.6 million for the year ended December 31, 2021 and 2020, respectively. Effective January 1, 2021, the Commonwealth of Kentucky eliminated the bank franchise tax and implemented a state income tax at a statutory rate of 5%. State income tax expense was $939,000 for the year ended December 31, 2021, compared to a state income tax benefit of $478,000 for the year ended December 31, 2020 related to the establishment of a net deferred tax asset due to the tax law change.
Net Interest Income – Net interest income was $49.1 million for the year ended December 31, 2022, an increase of $4.9 million, or 11.0%, compared with $44.2 million for the same period in 2021. Net interest spread and margin were 3.41% and 3.62%, respectively, for 2022, compared with 3.33% and 3.48%, respectively, for 2021.
The Federal Reserve increased the fed funds target by 425 basis points over its last seven meetings of 2022. As a result, the Bank’s fed funds sold, floating rate investment securities, loans with variable rate pricing features, and new loan originations benefitted from the upward movement in short-term rates during 2022. The cost of interest-bearing liabilities were also impacted, although to a lesser extent.
The yield on earning assets increased to 4.27% for the year ended December 31, 2022, as compared to 3.92% for the year ended December 31, 2021 due to the rising interest rate environment. Average interest-earning assets increased $81.8 million during 2022 primarily attributable to an increase in loans and investment securities. Average loans increased approximately $113.8 million and average investment securities increased $20.2 million, while average lower yielding interest-bearing deposits in other financial institutions decreased $51.7 million during 2022. PPP loans averaged $294,000 and $15.5 million for the year ended December 31, 2022 and 2021, respectively. The increase in average loans resulted in an increase in interest revenue volume of approximately $5.3 million and an increase in interest revenue related to the increase in rates on new and renewed loans and the upward repricing of variable rate loans of $552,000. The increase in average investment securities also resulted in approximately $995,000 in additional income as compared to the prior year. Total interest income increased 15.8%, or $7.9 million, in 2022 compared to 2021.
Loan fee income can meaningfully impact net interest income, loan yields, and net interest margin. The amount of loan fee income included in total interest income was $1.0 million and $4.3 million for the years ended December 31, 2022 and 2021, respectively. This represents eight basis points of yield on earning assets and net interest margin for the year ended December 31, 2022 as compared to 33 basis points for the year ended December 31, 2021. Loan fee income for 2022 included $45,000 in fees earned on PPP loans, compared to $2.8 million in 2021, which represents approximately one basis point and 21 basis points of earning asset yield and net interest margin for those years, respectively.
The cost of interest-bearing liabilities increased to 0.86% for the year ended December 31, 2022, as compared to 0.59% for the year ended December 31, 2021. The cost of interest-bearing liabilities was negatively impacted by the increases in short-term interest rates. Average interest-bearing liabilities increased by $57.7 million during 2022 primarily due to a $73.9 million increase in average money market accounts and $30.1 million increase in FHLB advances offset by a $48.4 million decrease in average certificates of deposits. Total interest expense increased by 53.4% to $8.7 million for the year ended December 31, 2022 as compared to $5.7 million for the year ended December 31, 2021. As of December 31, 2022, time deposits comprise $290.2 million of the Company’s liabilities with $233.0 million, or 80%, set to reprice or mature within one year of which, $69.3 million with a current average rate of 0.98% reprice or mature within the first quarter of 2023.
Net interest income was $44.2 million for the year ended December 31, 2021, an increase of $3.6 million, or 8.9%, compared with $40.6 million for the same period in 2020. Net interest spread and margin were 3.33% and 3.48%, respectively, for 2021, compared with 3.15% and 3.36%, respectively, for 2020.
The yield on earning assets decreased to 3.92% for the year ended December 31, 2021, as compared to 4.20% for the year ended December 31, 2020 due to the lower interest rate environment. Average interest-earning assets increased $67.4 million during 2021 primarily attributable to an increase in investment securities. Average loans decreased approximately $5.5 million during 2021. PPP loans averaged $15.5 million and $22.5 million for the year ended December 31, 2021 and 2020, respectively. Interest revenue in 2021 declined $390,000 due to lower interest rates on new and renewed loans, the downward repricing of variable rate loans, and lower rates on securities purchased over the past eight quarters, as compared to 2020. Total interest income decreased 1.7%, or $838,000, in 2021 compared to 2020.
Loan fee income can meaningfully impact net interest income, loan yields, and net interest margin. The amount of loan fee income included in total interest income was $4.3 million and $2.1 million for the years ended December 31, 2021 and 2020, respectively. This represents 33 basis points of yield on earning assets and net interest margin for the year ended December 31, 2021 as compared to 18 basis points for the year ended December 31, 2020. Loan fee income for 2021 included $2.8 million in fees earned on PPP loans, compared to $1.1 million in 2020, which represents 21 basis points and 10 basis points of earning asset yield and net interest margin for those years, respectively.
The cost of interest-bearing liabilities decreased to 0.59% for the year ended December 31, 2021, as compared to 1.05% for the year ended December 31, 2020 primarily based on downward repricing of time and other interest-bearing deposits and reduction in the size of the time deposit portfolio, as well as a shift in deposit mix. Average interest-bearing liabilities decreased by $4.1 million during 2021 primarily due to a $13.9 million decrease in FHLB advances. Total interest expense decreased by 43.9% to $5.7 million for the year ended December 31, 2021 as compared to $10.2 million for the year ended December 31, 2020. As of December 31, 2021, time deposits comprise $266.0 million of the Company’s liabilities with $161.9 million, or 61%, set to reprice or mature within one year of which, $55.0 million with a current average rate of 0.33% reprice or mature within the first quarter of 2022.
Average Balance Sheets
The following table sets forth the average daily balances, the interest earned or paid on such amounts, and the weighted average yield on interest-earning assets and weighted average cost of interest-bearing liabilities for the periods indicated. Dividing income or expense by the average daily balance of assets or liabilities, respectively, derives such yields and costs for the periods presented.
For the Years Ended December 31, | ||||||||||||||||||||||||
2022 | 2021 | |||||||||||||||||||||||
Average Balance |
Interest Earned/Paid |
Average Yield/Cost |
Average Balance |
Interest Earned/Paid |
Average Yield/Cost |
|||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
ASSETS | ||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||
Loans receivables (1) | ||||||||||||||||||||||||
Real estate |
$ | 767,859 | $ | 35,526 | 4.63 | % |
$ | 675,791 | $ | 30,615 | 4.53 | % |
||||||||||||
Commercial |
230,519 | 10,471 | 4.54 | 211,573 | 10,266 | 4.85 | ||||||||||||||||||
Consumer |
34,237 | 1,947 | 5.69 | 34,041 | 1,608 | 4.72 | ||||||||||||||||||
Agriculture |
39,190 | 2,375 | 6.06 | 36,596 | 1,945 | 5.31 | ||||||||||||||||||
Other |
525 | 13 | 2.48 | 548 | 11 | 2.01 | ||||||||||||||||||
U.S. Treasury and agencies |
25,695 | 523 | 2.04 | 25,657 | 542 | 2.11 | ||||||||||||||||||
Mortgage-backed securities |
87,335 | 1,855 | 2.12 | 81,829 | 1,561 | 1.91 | ||||||||||||||||||
Collateralized loan obligations |
48,539 | 1,712 | 3.53 | 44,396 | 831 | 1.87 | ||||||||||||||||||
State and political subdivision securities (non-taxable) |
29,749 | 660 | 2.96 | 26,509 | 643 | 3.23 | ||||||||||||||||||
State and political subdivision securities (taxable) |
14,525 | 393 | 2.71 | 16,971 | 425 | 2.50 | ||||||||||||||||||
Corporate bonds |
45,058 | 1,682 | 3.73 | 35,340 | 1,253 | 3.55 | ||||||||||||||||||
FHLB stock |
5,031 | 199 | 3.96 | 5,493 | 115 | 2.09 | ||||||||||||||||||
Federal funds sold |
35 | 1 | 2.86 | 35 | — | — | ||||||||||||||||||
Interest-bearing deposits in other financial institutions |
32,050 | 453 | 1.41 | 83,736 | 100 | 0.12 | ||||||||||||||||||
Total interest-earning assets |
1,360,347 | 57,810 | 4.27 | % |
1,278,515 | 49,915 | 3.92 | % |
||||||||||||||||
Less: Allowance for loan losses |
(12,469 | ) |
(12,714 | ) |
||||||||||||||||||||
Non-interest-earning assets |
86,559 | 97,596 | ||||||||||||||||||||||
Total assets |
$ | 1,434,437 | $ | 1,363,397 | ||||||||||||||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||||||||||||||||||
Interest-bearing liabilities |
||||||||||||||||||||||||
Certificates of deposit and other time deposits |
$ | 262,692 | $ | 1,929 | 0.73 | % |
$ | 311,140 | $ | 1,788 | 0.57 | % |
||||||||||||
Interest checking and money market deposits |
497,811 | 2,712 | 0.54 | 423,938 | 1,289 | 0.30 | ||||||||||||||||||
Savings accounts |
159,422 | 561 | 0.35 | 157,283 | 441 | 0.28 | ||||||||||||||||||
FHLB advances |
50,274 | 1,162 | 2.31 | 20,152 | 154 | 0.76 | ||||||||||||||||||
Junior subordinated debentures |
21,000 | 867 | 4.13 | 21,000 | 521 | 2.48 | ||||||||||||||||||
Subordinated capital notes |
25,000 | 1,501 | 6.00 | 25,000 | 1,500 | 6.00 | ||||||||||||||||||
Senior debt |
— | — | — | — | — | — | ||||||||||||||||||
Total interest-bearing liabilities |
1,016,199 | 8,732 | 0.86 | % |
958,513 | 5,693 | 0.59 | % |
||||||||||||||||
Non-interest-bearing liabilities |
||||||||||||||||||||||||
Non-interest-bearing deposits |
277,981 | 271,994 | ||||||||||||||||||||||
Other liabilities |
10,804 | 8,948 | ||||||||||||||||||||||
Total liabilities |
1,304,984 | 1,239,455 | ||||||||||||||||||||||
Stockholders’ equity |
129,453 | 123,942 | ||||||||||||||||||||||
Total liabilities and stockholders’ equity |
$ | 1,434,437 | $ | 1,363,397 | ||||||||||||||||||||
Net interest income |
$ | 49,078 | $ | 44,222 | ||||||||||||||||||||
Net interest spread |
3.41 | % |
3.33 | % |
||||||||||||||||||||
Net interest margin |
3.62 | % |
3.48 | % |
||||||||||||||||||||
Ratio of average interest-earning assets to average interest-bearing liabilities |
133.87 | % |
133.39 | % |
(1) |
Includes loan fees in both interest income and the calculation of yield on loans. |
For the Years Ended December 31, | ||||||||||||||||||||||||
2021 | 2020 | |||||||||||||||||||||||
Average Balance |
Interest Earned/Paid |
Average Yield/Cost |
Average Balance |
Interest Earned/Paid |
Average Yield/Cost |
|||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
ASSETS | ||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||
Loans receivables (1) | ||||||||||||||||||||||||
Real estate |
$ | 675,791 | $ | 30,615 | 4.53 | % |
$ | 684,447 | $ | 32,572 | 4.76 | % |
||||||||||||
Commercial |
211,573 | 10,266 | 4.85 | 200,260 | 8,398 | 4.19 | ||||||||||||||||||
Consumer |
34,041 | 1,608 | 4.72 | 39,931 | 2,051 | 5.14 | ||||||||||||||||||
Agriculture |
36,596 | 1,945 | 5.31 | 38,833 | 2,058 | 5.30 | ||||||||||||||||||
Other |
548 | 11 | 2.01 | 617 | 14 | 2.27 | ||||||||||||||||||
U.S. Treasury and agencies |
25,657 | 542 | 2.11 | 20,239 | 491 | 2.43 | ||||||||||||||||||
Mortgage-backed securities |
81,829 | 1,561 | 1.91 | 82,330 | 1,863 | 2.26 | ||||||||||||||||||
Collateralized loan obligations |
44,396 | 831 | 1.87 | 45,595 | 1,234 | 2.71 | ||||||||||||||||||
State and political subdivision securities (non-taxable) |
26,509 | 643 | 3.23 | 14,139 | 370 | 3.31 | ||||||||||||||||||
State and political subdivision securities (taxable) |
16,971 | 425 | 2.50 | 16,301 | 494 | 3.03 | ||||||||||||||||||
Corporate bonds |
35,340 | 1,253 | 3.55 | 23,572 | 960 | 4.07 | ||||||||||||||||||
FHLB stock |
5,493 | 115 | 2.09 | 6,208 | 143 | 2.30 | ||||||||||||||||||
Federal funds sold |
35 | — | — | 72 | — | — | ||||||||||||||||||
Interest-bearing deposits in other financial institutions |
83,736 | 100 | 0.12 | 38,525 | 105 | 0.27 | ||||||||||||||||||
Total interest-earning assets |
1,278,515 | 49,915 | 3.92 | % |
1,211,069 | 50,753 | 4.20 | % |
||||||||||||||||
Less: Allowance for loan losses |
(12,714 | ) |
(9,819 | ) |
||||||||||||||||||||
Non-interest-earning assets |
97,596 | 93,684 | ||||||||||||||||||||||
Total assets |
$ | 1,363,397 | $ | 1,294,934 | ||||||||||||||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||||||||||||||||||
Interest-bearing liabilities |
||||||||||||||||||||||||
Certificates of deposit and other time deposits |
$ | 311,140 | $ | 1,788 | 0.57 | % |
$ | 436,083 | $ | 5,802 | 1.33 | % |
||||||||||||
Interest checking and money market deposits |
423,938 | 1,289 | 0.30 | 336,596 | 1,464 | 0.43 | ||||||||||||||||||
Savings accounts |
157,283 | 441 | 0.28 | 111,559 | 530 | 0.48 | ||||||||||||||||||
FHLB advances |
20,152 | 154 | 0.76 | 34,101 | 371 | 1.09 | ||||||||||||||||||
Junior subordinated debentures |
21,000 | 521 | 2.48 | 21,000 | 660 | 3.14 | ||||||||||||||||||
Subordinated capital notes |
25,000 | 1,500 | 6.00 | 20,366 | 1,206 | 5.92 | ||||||||||||||||||
Senior debt |
— | — | — | 2,896 | 119 | 4.11 | ||||||||||||||||||
Total interest-bearing liabilities |
958,513 | 5,693 | 0.59 | % |
962,601 | 10,152 | 1.05 | % |
||||||||||||||||
Non-interest-bearing liabilities |
||||||||||||||||||||||||
Non-interest-bearing deposits |
271,994 | 215,145 | ||||||||||||||||||||||
Other liabilities |
8,948 | 7,230 | ||||||||||||||||||||||
Total liabilities |
1,239,455 | 1,184,976 | ||||||||||||||||||||||
Stockholders’ equity |
123,942 |