10-K 1 midsouth10k2019.htm FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-K

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

          For the Fiscal Year Ended December 31, 2019 
 
                 OR

[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 001-38491

MID-SOUTHERN BANCORP, INC.
 (Exact name of registrant as specified in its charter)
 
Indiana
 
82-4821705
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer I.D. Number)
 
 
 
300 North Water Street, Salem, Indiana
 
47167
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant's telephone number, including area code:
 
(812) 883-2639
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 

 Title of each class  
Trading Symbol(s)
  Name of each exchange on which registered
Common Stock, Par Value $.01 per share   MSVB
  Nasdaq Stock Market LLC 
 
Securities registered pursuant to Section 12(g) of the Act:   
None
   

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [   ]   No  [X]

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

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X]     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 definition of "large accelerated filer," "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer [   ]                                                      Accelerated filer  [   ]                                               Non-accelerated filer  [  ]
Smaller reporting company  [X]                                            Emerging growth company [X]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  [   ]

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

The aggregate market value of the voting stock held by non-affiliates of the registrant based upon the closing price of the registrant’s common stock of $12.61 per share as quoted on the Nasdaq Global Select Market System on June 30, 2019 was $42.0 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)  As of March 17, 2020, there were 3,565,430 issued and 3,548,928 outstanding shares of the registrant’s common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of registrant's Definitive Proxy Statement for the 2020 Annual Meeting of Stockholders (Part III).



Table of Contents
PART I
 
PAGE
Item 1.
Business
5
Item 1A.
Risk Factors
37
Item 1B.
Unresolved Staff Comments
45
Item 2.
Properties
45
Item 3.
Legal Proceedings
46
Item 4.
Mine Safety Disclosures
46
 
PART II
   
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
  Equity Securities
47
Item 6.
Selected Financial Data
47
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
50
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
64
Item 8.
Financial Statements and Supplementary Data
64
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
116
Item 9A.
Controls and Procedures
116
Item 9B.
Other Information
117
 
PART III
   
Item 10.
Directors, Executive Officers and Corporate Governance
117
Item 11.
Executive Compensation
117
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
  Matters
118
Item 13.
Certain Relationships and Related Transactions, and Director Independence
118
Item 14.
Principal Accounting Fees and Services
118
 
PART IV
   
Item 15.
Exhibits and Financial Statement Schedules
119
Item 16.
Form 10-K Summary
119
     
Signatures
 
120








2


Forward-Looking Statements

This Form 10-K contains “forward-looking statements.”  You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future.  These forward-looking statements include, but are not limited to:


changes in economic conditions, either nationally or in our market area;

fluctuations in interest rates;

the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of our allowance for loan losses;

the possibility of other-than-temporary impairments of securities held in our securities portfolio;

our ability to access cost-effective funding;

fluctuations in the demand for loans, the number of unsold homes, land and other properties, and fluctuations in real estate values and both residential and commercial and multifamily real estate market conditions in our market area;

secondary market conditions for loans and our ability to sell loans in the secondary market;

our ability to attract and retain deposits;

our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and expected cost savings and other benefits within the anticipated time frames or at all;

legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;

monetary and fiscal policies of the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the U.S. Government and other governmental initiatives affecting the financial services industry;

results of examinations of Mid-Southern Bancorp and Mid-Southern Savings Bank by their regulators, including the possibility that the regulators may, among other things, require us to increase our allowance for loan losses or to write-down assets, change Mid-Southern Savings Bank’s regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

our ability to control operating costs and expenses;

the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

difficulties in reducing risks associated with the loans on our balance sheet;

staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions;

our ability to retain key members of our senior management team;

costs and effects of litigation, including settlements and judgments;

our ability to implement our business strategies;

increased competitive pressures among financial services companies;

3


changes in consumer spending, borrowing and savings habits;

the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

our ability to pay dividends on our common stock;

adverse changes in the securities markets;

the inability of key third-party providers to perform their obligations to us;

statements with respect to our intentions regarding disclosure and other changes resulting from the JOBS Act;

changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and

other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services including the potential effects of coronavirus on international trade (including supply chains and export levels), and the other risks described from time to time in our filings with the SEC.
Some of these and other factors are discussed in this prospectus under the caption “Risk Factors” and elsewhere in this Form 10-K.  Such developments could have an adverse impact on our financial position and our results of operations.

Any of the forward-looking statements are based upon management’s beliefs and assumptions at the time they are made.  We undertake no obligation to publicly update or revise any forward-looking statements included in this prospectus or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise.  In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this prospectus might not occur and you should not put undue reliance on any forward-looking statements.

As used throughout this report, the terms “we,” “our,” “us,” or the “Company” refer to Mid-Southern Bancorp, Inc. and its consolidated subsidiary, Mid-Southern Savings Bank, unless the context otherwise requires.






4

PART I

Item 1.  Business

General

Mid-Southern Bancorp, Inc., an Indiana corporation, is the savings and loan holding company of Mid-Southern Savings Bank, FSB (the “Bank” or “Mid-Southern Savings Bank”). On July 11, 2018, Mid-Southern Bancorp, Inc. completed a public offering and share exchange as part of the Bank’s “second step” conversion from the mutual holding company structure and the elimination of Mid Southern M.H.C. (the “Conversion”). Upon consummation of the Conversion, the Company became the holding company for the Bank and now owns all of the issued and outstanding shares of the Bank’s common stock. Concurrent with the offering, shares of Bank common stock owned by public stockholders were exchanged for 2.3462 shares of the Company’s common stock, with cash being paid in lieu of issuing fractional shares.  All share and per share information in this report for periods prior to the Conversion has been adjusted to reflect the 2.3462:1 exchange ratio on publicly traded shares. See Note 1 of the Notes to Consolidated Financial Statements contained in Item 8 of this report for more information.

At December 31, 2019, the Company had total assets of $208.4 million, total deposits of $147.0 million and stockholders’ equity of $50.8 million. The Company’s executive offices are located in Salem, Indiana. The Company is subject to regulation by the Federal Reserve. Substantially all of the Company’s business is conducted through the Bank which is regulated by the Office of the Comptroller of the Currency ("OCC"), its primary regulator, and by the Federal Deposit Insurance Corporation ("FDIC"), the insurer of its deposits. The Bank's deposits are insured by the FDIC up to applicable legal limits under the Deposit Insurance Fund ("DIF"). The Bank is a member of the Federal Home Loan Bank of Indianapolis ("FHLB" or “FHLB of Indianapolis”) which is one of the 11 regional banks in the Federal Home Loan Bank System (“FHLB System”).

Our Business
Our business activities are primarily conducted through Mid-Southern Savings Bank, a federally chartered savings bank headquartered in Salem, Indiana, which is located in Southern Indiana approximately 40 miles northwest of Louisville, Kentucky. Mid-Southern Savings Bank conducts business from its main office in Salem and through its branch offices located in Mitchell and Orleans, Indiana and a loan production office located in New Albany, Indiana. Mid-Southern Savings Bank’s market area includes Washington, Lawrence, Orange and Floyd counties in Indiana, and, to a lesser extent, contiguous counties.
Mid-Southern Savings Bank’s principal business consists of originating one-to-four family residential real estate mortgage loans, including home equity lines of credit, and to a lesser extent, commercial and multifamily real estate, and construction loans. We also offer commercial business and other consumer loans. We offer a variety of retail deposits to the general public in the areas surrounding our main office and our branch offices with interest rates that are competitive with those of similar products offered by other financial institutions in our market area. We also may utilize borrowings as a source of funds. Our revenues are derived primarily from interest on loans and, to a lesser extent, interest on investment securities and mortgage-backed securities.
Our principal executive offices are located at 300 North Water Street, Salem, Indiana 47167 and our telephone number is (812) 883-2639. Our web site address is www.mid-southern.com.

Market Area
We are headquartered in Salem, Indiana (Washington County).  Salem is the county seat of Washington County and is located approximately 40 miles northwest of Louisville, Kentucky. We have a branch located in each of Mitchell, Indiana (Lawrence County) and Orleans, Indiana (Orange County) and a loan production office in New Albany, Indiana (Floyd County).  Our market area includes all of Lawrence, Orange, Washington and Floyd counties and extends into surrounding areas.
Based on the 2010 U.S. Census the market area had an aggregate population of 168,814. Two of the four counties’ population rate is estimated to decrease in our market area between 2018 and 2023.  The median household income in the four-county market area is $50,834 which is lower than the state and national levels.  In addition, all four counties’ 2019 unemployment rate was lower than the national rate and one county is higher than the state rate.

5

Our markets provide a diversified economic and employment base in the manufacturing, service, health care, agricultural, and governmental sectors. Within Washington County, nine of the top ten employers are located in Salem where we are headquartered. Salem’s largest employers include a mix of the manufacturing, retail, health care, and public-sector industries. Manufacturing employs 16.8% of the workforce in Salem. The two largest employers in this sector are GKN Sinter Metals (powdered metal products) and Peerless Gear (industrial gear manufacturer) each employing approximately 500 individuals. Kimball Office, a privately held wood furniture manufacturer headquartered in Salem, is also a major employer in the area. A Walmart Supercenter, which opened in November 2016, is the largest Walmart in Southern Indiana and employs approximately 300 individuals.

Orange County’s largest industry concentrations are in the healthcare, accommodation/food services, manufacturing and governmental sectors. A majority of the major employers in the county (including Electricom, Wildwood Association, Paoli Peaks, Walmart Supercenter, and IU Health Paoli Hospital) are located in the county seat of Paoli. The White Castle Meat Processing Company is among Orange County’s largest employers. It operates a processing plant in Orleans. Paoli, Inc., headquartered in Orleans, is a manufacturer of wood office furniture. A family-owned business for more than 90 years, it was recently acquired by the Jasper Group.

Lawrence County’s largest industry concentrations are in the healthcare, retail trade, manufacturing, and governmental sectors. A majority of the largest employers in the county (including IU Health Bedford Hospital, Walmart Supercenter, Times-mail, Garden Ville, Tri Star Engineering, and Lowe’s Home Improvement) are located in the county seat of Bedford. Lehigh Hanson, a leading supplier of cement and other building materials, operates a cement facility in Mitchell. Mitchell is located approximately ten miles south of Bedford.

Floyd County offers a diverse mix of industry among the health care, manufacturing, retail trade and governmental sectors. Baptist-Floyd Memorial Hospital and Health Services is the top employer in the county with nearly 1,800 employees. Floyd County Consolidated School Corp. is the second largest with approximately 1,640 employees. New Albany is home to a majority of Floyd County’s largest employers including Baptist Health, Beach Mold & Tool, Indiana University Southeast, Samtec Inc., Hitachi Cable America, and Walmart Supercenter.

Lending Activities

General. Our historical principal lending activity has been originating one- to four-family residential real estate loans and, to a lesser extent, commercial real estate loans, commercial business loans, home equity lines of credit, construction and consumer loans. More recently, we have sought to increase our commercial real estate and commercial construction and commercial business lending in an effort to diversify our overall loan portfolio, increase the overall yield earned on our loans and assist in managing interest rate risk.

Our strategic plan continues to focus on residential real estate lending and to gradually increase our commercial real estate loans, commercial real estate construction loans and commercial business loans in our market area.  As part of the commercial loan strategy, we seek to use our commercial relationships to grow our commercial transactional deposit accounts. While we generally retain in our portfolio all loans we originate, beginning in October 2019, we began brokering fixed rate one-to-four family residential loans for sale in the secondary market.




6

The following table presents information concerning the composition of our loan portfolio, by the type of loan as of the dates indicated:

 
At December 31,
 
2019
 
2018
 
2017
 
2016
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
                               
 
(Dollars in thousands)
Real estate loans:
                             
One-to-four family residential
$    71,606
 
57.4%
 
$    80,322
 
62.9%
 
$    79,899
 
68.6%
 
$    80,982
 
69.2%
Multi-family residential
9,260
 
7.4
 
7,054
 
5.5
 
6,352
 
5.4
 
5,464
 
4.7
Residential construction
367
 
0.3
 
--
 
--
 
108
 
0.1
 
767
 
0.7
Commercial real estate
32,311
 
25.9
 
27,153
 
21.3
 
22,315
 
19.1
 
23,184
 
19.8
Commercial real estate construction
2,867
 
2.3
 
5,100
 
4.0
 
2,061
 
1.8
 
710
 
0.6
  Total real estate loans
116,411
 
93.3
 
119,629
 
93.7
 
110,735
 
95.0
 
111,107
 
95.0
                               
Commercial business loans
6,456
 
5.2
 
5,939
 
4.6
 
3,875
 
3.3
 
3,776
 
3.2
                               
Consumer loans
1,875
 
1.5
 
2,199
 
1.7
 
1,978
 
1.7
 
2,118
 
1.8
                               
Total loans
124,742
 
100.0%
 
127,767
 
100.0%
 
116,588
 
100.0%
 
117,001
 
100.0%
                               
Deferred loan origination fees and costs, net
28
     
30
     
31
     
24
   
Allowance for loan losses
(1,498)
     
(1,504)
     
(1,723)
     
(2,503)
   
  Total loans, net
$  123,272
     
$   126,293
     
$   114,896
     
$   114,522
   



7

Loan Maturity Table

The following table illustrates the contractual maturity of our loan portfolio at December 31, 2019.  Mortgages that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due.  The total amount of loans due after December 31, 2020, which have fixed interest rates, is $13.0 million, while the total amount of loans due after such date, which have adjustable interest rates, is $97.5 million.  The table does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

 
Real Estate Mortgage
           
 
One-to-Four Family
 
Multi-
Family
 
Residential Construction
 
Commercial
 
Commercial Construction
 
Commercial Business
 
Consumer
 
Total (1)
                               
 
(Dollars in thousands)
Amounts due in:
                             
One year or less (2)
$   4,216
 
$    476
 
$   367
 
$   4,238
 
$    1,247
 
$ 3,062
 
$     654
 
$  14,260
More than one year to five years
12,833
 
1,995
 
--
 
9,404
 
587
 
3,160
 
1,195
 
29,174
More than five years
54,557
 
6,789
 
--
 
18,669
 
1,033
 
234
 
26
 
81,308
Total
$ 71,606
 
$ 9,260
 
$   367
 
$ 32,311
 
$ 2,867
 
$ 6,456
 
$ 1,875
 
$ 124,742

___________________________________________
(1) Excludes net deferred loan origination fees and costs.
(2) Includes demand loans, loans having no stated maturity and overdraft loans.






8

Largest Borrowing Relationships.   At December 31, 2019, the maximum amount under federal law that we could lend to any one borrower and the borrower’s related entities was approximately $5.7 million.  Our five largest lending relationships totaled $10.0 million in the aggregate, or 8.0% of our $124.7 million total loan portfolio, at December 31, 2019. The largest relationship at December 31, 2019 consisted of $2.2 million in loans to a business collateralized by multi-family and non-owner occupied one-to-four family residential property.  The next four largest lending relationships at December 31, 2019, were $2.2 million in loans to commonly owned businesses, collateralized by commercial real estate and non-owner occupied one-to-four family residential property; $1.9 million in loans to commonly owned businesses collateralized by commercial real estate and commercial business property with unfunded loan commitments to this relationship totaling $83,000; $1.9 million in loans to commonly owned businesses collateralized by commercial real estate; and $1.8 million to commonly owned businesses collateralized by non-owner occupied one-to-four family residential property.  As of December 31, 2019, all of these loans were performing in accordance with their repayment terms. 

One- to Four-Family Real Estate Lending.  Our primary lending activity consists of the origination of loans secured by first mortgages on one- to four-family residences, substantially all of which are secured by property located in our geographic lending area.  We originate primarily adjustable-rate loans.  Beginning in October 2019, we entered into a loan brokering agreement with United Wholesale Mortgage (“UWM”).  Under the agreement we perform loan application and preliminary underwriting activities to determine if potential loans conform to the underwriting standards of Fannie Mae (“conforming”).  Conforming loans are then funded by UWM and we receive a fee for services performed.  In the fourth quarter of 2019, we brokered seven loans with UWM.  Residential loans which do not conform to the underwriting standards of Fannie Mae ("non-conforming"), may be funded by us and held in our loan portfolio.

Most of our loans are written using generally accepted underwriting guidelines.  The one-to-four family loans we originate are generally retained in our portfolio.   Our pricing strategy for mortgage loans includes establishing interest rates that are competitive with other local financial institutions and consistent with our internal asset and liability management objectives.  During the year ended December 31, 2019, we originated $7.5 million and $390,000 of one- to four-family adjustable rate mortgage (“ARM”) and fixed-rate mortgage loans, respectively. At December 31, 2019, one- to four-family residential mortgage loans totaled $71.6 million, or 57.4%, of our total loan portfolio, of which $68.0 million were ARM loans and $3.6 million, were fixed-rate loans.

A large portion of the one- to four-family residential mortgage loans we originate and retain in our portfolio consist of loans that would be considered non-conforming as it relates to the ability to sell to Fannie Mae or other secondary market purchasers.  Some of these loans are also originated to meet the needs of borrowers who cannot otherwise satisfy Fannie Mae credit requirements because of personal and financial reasons (i.e., divorce, bankruptcy, length of time employed, etc.), and other aspects, which do not conform to Fannie Mae's guidelines.  Such borrowers may have higher debt-to-income ratios, or the loans are secured by unique properties in rural markets for which there are no sales of comparable properties to support the value according to secondary market requirements.  We may require additional collateral or lower loan-to-value ratios to reduce the risk of these loans.  We believe that these loans satisfy a need in our market area.  As a result, subject to market conditions, we intend to continue to originate these types of loans.

We generally underwrite our one- to four-family loans based on the applicant’s employment and credit history and the appraised value of the subject property.  We generally lend up to 80% of the lesser of the appraised value or purchase price for one- to four-family first mortgage loans and non-owner occupied first mortgage loans.  At December 31, 2019 we had $15.4 million of non-owner occupied first mortgage loans.  Properties securing our one- to four-family loans are generally appraised by independent fee appraisers who are selected in accordance with criteria approved by the board of directors.  It is Mid-Southern Savings Bank’s policy to require title insurance policies on all mortgage real estate loans originated in the amount of $500,000 or more.  Homeowners, liability, fire and, if required, flood insurance policies are also required for one-to four-family loans. Our real estate loans generally contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.  The average size of our one- to four-family residential loans was approximately $76,000 at December 31, 2019.


9

Fixed-rate loans secured by one- to four-family residences have contractual maturities of up to 30 years, however, at December 31, 2019 we had no one- to four-family loans with an original contractual maturity in excess of 30 years.

ARM loans are offered with an initial fixed rate for five or seven years.  Adjustments and life-time rate caps that vary based on the product, generally with a maximum annual rate change of 2.25% and a maximum overall rate change of 6.00%.  We generally use the rate on the five-year Treasury Bills to re-price our ARM loans, however, as a consequence of using caps, the interest rates on ARM loans may not be as rate sensitive as our cost of funds. Furthermore, because loan indexes may not respond perfectly to changes in market interest rates, upward adjustments on loans may occur more slowly than increases in our cost of interest-bearing liabilities, especially during periods of rapidly increasing interest rates.  Because of these characteristics, yields on ARM loans may not be sufficient to offset increases in our cost of funds.

Included in our one- to four-family loans are manufactured home loans that are considered a permanent dwelling. We originate new and used manufactured home loans to borrowers who intend to use the home as a primary residence.  Our weighted average yield on manufactured home loans at December 31, 2019 was 4.86%, compared to 4.70% for one- to four-family mortgages.  At December 31, 2019, these loans totaled $7.6 million, or 6.1% of our total loan portfolio.  We underwrite these loans based on our review of creditworthiness of the borrower, including credit scores, and the value of the collateral, for which we hold a security interest under Indiana law.

Manufactured home loans are higher risk than loans secured by residential real property, though this risk is reduced if the owner also owns the land on which the home is located.  A small portion of our manufactured home loans involve properties on which we also have financed the land for the owner.  The primary additional risk in manufactured home loans is the difficulty in obtaining adequate value for the collateral due to the cost and limited ability to move the collateral.  In addition to the cost of moving a manufactured home, it is difficult for these borrowers to find a new location for their home.  First-time homebuyers of manufactured homes tend to be a higher credit risk than first-time homebuyers of single-family residences, due to more limited financial resources.  We attempt to work out delinquent loans with the borrower and, if that is not successful, any repossessed manufactured homes are repossessed and sold.  At December 31, 2019, there was $341,000 in nonperforming manufactured home loans and no manufactured home properties in our other real estate owned ("OREO") or repossessed assets portfolio.

Home Equity Lending.  We originate home equity loans that consist of variable-rate lines of credit. We do not originate fixed-rate home equity loans. We originate home equity loans in amounts of up to 80% of the value of the collateral, minus any senior liens on the property. Home equity lines of credit are typically originated with an adjustable rate of interest, based on the Wall Street Journal Prime Rate plus a marginHome equity lines of credit generally have up to a ten-year draw period, during which time the funds may be paid down and redrawn up to the committed amount.  Once the draw period has lapsed, the home equity line of credit matures with all moneys owed being due and payable.  At December 31, 2019, home equity lines of credit totaled $3.1 million, or 2.5% of our total loan portfolio. At December 31, 2019, unfunded commitments on these lines of credit totaled $2.0 million.

Commercial and Multifamily Real Estate Lending.  We offer a variety of commercial real estate and multifamily loans.  Most of these loans are secured by commercial income producing properties, including retail centers, multifamily apartment buildings, warehouses, and office buildings located in our market area.  At December 31, 2019, commercial and multifamily loans totaled $41.6 million, or 33.3% of our total loan portfolio.

Our loans secured by commercial and multifamily real estate are generally originated with a variable interest rate, fixed for a five, seven or ten-year term and a 20-year amortization period.  At the end of the initial term, there is a balloon payment or the loan re-prices every one to five years during the remaining term based on an independent index matching the ongoing repricing term plus a margin of 1% to 4%.  Loan-to-value ratios on our commercial and multifamily loans typically do not exceed 80% of the lower of cost or appraised value of the property securing the loan at origination.


10

Loans secured by commercial and multifamily real estate are generally underwritten based on the net operating income of the property, global cash flow of the borrower, quality and location of the real estate, the credit history and financial strength of the borrower and the quality of management involved with the property.  The net operating income or global cash flow of the borrower must be sufficient to cover the payments related to the outstanding debt plus an additional coverage requirement.  We generally impose a minimum project debt coverage ratio of approximately 1.2x for the borrower or 1.35x global cash flow.  The global cash flow takes into consideration the living expenses of the persons involved in the request and tax obligations.  For originated loans secured by income producing commercial properties, if the borrower is other than an individual, we generally require the personal guaranty of the borrower. We also generally require an assignment of rents or leases in order to be assured that the cash flow from the project will be used to repay the debt.  Appraisals on properties securing commercial and multifamily loans are performed by independent state certified or licensed fee appraisers and approved by the board Loan Committee. In order to monitor the adequacy of cash flows on income-producing properties, the borrower is required to provide, at a minimum, annual financial information.  From time to time we also acquire participation interests in commercial and multifamily loans originated by other financial institutions secured by properties located in our market area or in the general proximity of our market area.  During 2019 we did not purchase any commercial or multifamily loan participations.

Historically, loans secured by commercial and multifamily properties generally involve different credit risks than one- to four-family properties, including because they cannot be sold as easily on the secondary market.  These loans typically involve larger balances to single borrowers or groups of related borrowers.  Because payments on loans secured by commercial and multifamily properties are often dependent on the successful operation or management of the properties, repayment of these loans may be subject to adverse conditions in the real estate market or the economy.  If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired.  Commercial and multifamily loans also expose a lender to greater credit risk than loans secured by one-to four-family because the collateral securing these loans typically cannot be sold as easily as one-to four-family.  In addition, some of our commercial and multifamily loans are not fully amortizing and contain large balloon payments upon maturity.  Balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment.  Our largest single commercial and multifamily borrowing relationship at December 31, 2019, totaled $1.9 million and is collateralized by multiple commercial real estate properties.  At December 31, 2019, these loans were performing in accordance with their repayment terms.

Construction Lending.  We originate construction loans secured by single-family residences and commercial and multifamily real estate.  We also originate land and lot loans, which are secured by raw land or developed lots on which the borrower intends to build a residence, and land acquisition and development loans.  At December 31, 2019, our construction loans, including land and lot loans and land acquisition and development loans totaled $3.2 million, or 2.6% of our total loan portfolio.  At December 31, 2019, unfunded construction loan commitments totaled $1.8 million.

We originate construction loans to individuals and contractors for the construction and acquisition of personal residences whether or not the collateral property underlying the loan is under contract for sale.  At December 31, 2019, construction loans to contractors for homes that were not pre-sold totaled $1.4 million and are classified as commercial real estate construction loans.

Our residential construction loans generally provide for the payment of interest only during the construction phase, which is typically up to twelve months.  We typically convert construction loans to individuals to permanent loans on completion of construction but if Mid-Southern Savings Bank does not intend to provide the permanent financing, we require a take-out financing commitment prior to origination. At the end of the construction phase, the construction loan generally either converts to a longer-term mortgage loan or is paid off through a permanent loan from another lender.  Residential construction loans are made up to the lesser of a maximum loan-to-value ratio of 90% of cost or 80% of appraised value at completion.


11

At December 31, 2019, residential construction mortgage loans to individuals totaled $367,000.   Before making a commitment to fund a residential construction loan, we require an appraisal of the subject property by an independent licensed appraiser.  During the construction phase, we make periodic inspections of the construction site and loan proceeds are disbursed directly to the contractors or borrowers as construction progresses. Typically, disbursements are made in monthly draws during the construction period. Loan proceeds are disbursed after inspection based on the percentage of completion method. We also require general liability, builder’s risk hazard insurance, title insurance (loans in excess of $500,000), and flood insurance (as applicable, for properties located or to be built in a designated flood hazard area) on all construction loans.

We also originate developed lot and land loans to individuals intending to construct in the future a residence on the property.  We will generally originate these loans in an amount up to 80% of the lower of the purchase price or appraisal.  These lot and land loans are secured by a first lien on the property and have a fixed rate of interest with an initial term of five years of less and a maximum amortization of 20 years. At December 31, 2019, we had no lot and land loans to individuals.

We make land acquisition and development loans to experienced home builders or residential lot developers in our market area.  The maximum loan-to-value limit applicable to these loans is generally 80% of the appraised market value upon completion of the project.  We do not require any cash equity from the borrower if there is sufficient equity in the land being used as collateral.  Development plans are required from developers prior to making the loan.  Our loan officers are required to personally visit the proposed site of the development.  We require that developers maintain adequate insurance coverage.  Land acquisition and development loans generally are originated with a loan term up to 24 months, have adjustable rates of interest based on the Wall Street Journal Prime Rate and require interest only payments during the term of the loan.  Development loan proceeds are disbursed periodically in increments as construction progresses and as inspection by our approved inspectors warrant.  We also require these loans to be paid on an accelerated basis as the lots are sold, so that we are repaid before all the lots are sold.  At December 31, 2019, we had $2.7 million in land acquisition and development loans within our commercial real estate and construction loan portfolios.  At December 31, 2019, our largest land acquisition and development relationship consisted of two loans totaling $798,000, secured by single family residential lots located in our market area.  At December 31, 2019, this loan relationship was performing in accordance with its repayment terms. At December 31, 2019, unfunded loan commitments related to land acquisition and development totaled $806,000.

We also offer commercial and multifamily construction loans.  These loans are underwritten with construction financing for up to 12 months under terms similar to our residential construction loans.  On completion of the construction period the loan by its terms converts to a permanent commercial real estate loans with terms similar to our other permanent commercial and multifamily real estate loans. At December 31, 2019, we had $2.9 million in commercial and multifamily construction loans.

Construction and land financing is generally considered to involve a higher degree of credit risk than longer-term financing on improved, owner-occupied real estate.  Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions.  If the estimate of construction costs is inaccurate, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property and may have to hold the property for an indeterminate period of time.  Additionally, if the estimate of value is inaccurate, we may be confronted with a project that, when completed, has a value that is insufficient to generate full payment. Land loans also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral.  The value of the lots securing our loans may be affected by the success of the development in which they are located.  As a result, construction loans and land loans often involve the disbursement of funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest.  The nature of these loans is also such that they are generally more difficult to monitor.  In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk than construction loans to individuals on their personal residences.


12

Consumer Lending.  We offer a variety of secured consumer loans, including new and used manufactured homes, automobiles, boats and recreational vehicle loans, and loans secured by savings deposits.  We also offer unsecured consumer loans.  We originate our consumer loans primarily in our market area.  All of our consumer loans are originated on a direct basis.

We make loans on new and used automobiles.  Our automobile loan portfolio totaled $1.0 million at December 31, 2019, or 54.3% of our consumer loan portfolio and 0.8% of our total loan portfolio.  Automobile loans may be written for a term of up to 72 months and have fixed rates of interest.  Loan-to-value ratios are generally up to 100% of the purchase price for qualified borrowers if the Fair Isaac and Company, Incorporated (“FICO”), credit score is 700 or greater of either the borrower or co-borrower and the debt to income ratio is 35% or less. Borrowers who do not meet these criteria but still qualify in accordance with our underwriting guidelines may borrow up to 80% of the purchase price.   We follow our internal underwriting guidelines in evaluating automobile loans, including credit scoring, verification of employment, reviewing debt to income ratios and valuation of the underlying collateral.

Our consumer loans also include loans secured by new and used manufactured homes not considered permanent dwellings, new and used boats, motorcycles and recreational vehicles, loans secured by deposits and unsecured personal loans, all of which, at December 31, 2019, totaled $858,000 or 45.7% of our consumer loan portfolio and 0.7% of our total loan portfolio.  These loans typically have terms from five to ten years depending on the collateral and loan-to-value ratios up to 80% and have either fixed or adjustable interest rates.

Our unsecured consumer loans have either a fixed rate of interest generally for a maximum term of 36 months, or are revolving lines of credit of generally up to $25,000.  At December 31, 2019 there were no outstanding loans or unfunded commitments for unsecured consumer lines of credit.

Consumer loans (other than our manufactured homes) generally have shorter terms to maturity, which reduces our exposure to changes in interest rates.  In addition, management believes that offering consumer loan products helps to expand and create stronger ties to our existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.

Consumer loans generally entail greater risk than do one- to four-family residential mortgage loans, particularly in the case of consumer loans that are secured by rapidly depreciable assets, such as manufactured homes, automobiles, boats and recreational vehicles.  In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance.  As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

Commercial Business Lending.  At December 31, 2019, commercial business loans totaled $6.5 million, or 5.2% of our total loan portfolio.  Substantially all of our commercial business loans have been to borrowers in our market area.  Our commercial business lending activities encompass loans with a variety of purposes and security, including loans to finance commercial vehicles and equipment.  Approximately $742,000 of our commercial business loans at December 31, 2019 were unsecured.  Our commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of other conditions affecting the borrower.  Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis.  We generally require personal guarantees on both our secured and unsecured commercial business loans.  Nonetheless, commercial business loans are believed to carry higher credit risk than residential mortgage loans.

Our interest rates on commercial business loans are dependent on the type of lending.  Our secured commercial business loans typically have a loan to value ratio of up to 80% and are term loans ranging from three to five years.  Secured commercial business term loans generally have a fixed rated based on the average yield of the U.S. Treasury security with a term similar to that of the length of the fixed rate commitment on the note.  In addition, we typically charge loan fees of 1/2% to 2% of the principal amount at origination, depending on the credit quality and account relationships of the borrower.  Business lines of credit are usually adjustable-rate and are based on the prime rate as reported in the Wall Street Journal plus 0% to 3%, and are generally originated with both a floor and ceiling to the interest rate.  Our business lines of credit have terms ranging from 12 months to 24 months and provide for interest-only monthly payments during the term.


13

Our commercial business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower.  The borrowers’ cash flow may be unpredictable, and collateral securing these loans may fluctuate in value.  Most often, this collateral is accounts receivable, inventory, equipment or real estate.  In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.  Other collateral securing loans may depreciate over time, may be difficult to appraise, may be illiquid and may fluctuate in value based on the specific type of business and equipment used.  As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, is often dependent in part upon general economic conditions).

Lending Authority.  Both our President and Chief Executive Officer (“CEO”) and Executive Vice President and Senior Loan Officer may individually approve unsecured loans up to $100,000 and all types of secured loans up to $200,000.   The Lending Group (defined as President and CEO, Senior Loan Officer and Chief Credit Officer) may approve unsecured loans up to $150,000 and all types of secured loans up to $1.0 million.  The Director’s Loan Committee approves unsecured loans up to $500,000 and secured loans up to $2.0 million.  Any loans over the Director’s Loan Committee limit must be approved by the full board of directors.  All loan policy exceptions must be approved by the Director’s Loan Committee, the CEO or the Senior Loan Officer up to the committee’s, CEO’s or Senior Loan Officer’s lending authority.  All policy exception loans of $10,000 or more must be reported to the board of directors within 45 days.

Loan Originations, Purchases, Sales, Repayments and Servicing

We originate both fixed-rate and adjustable-rate loans.  Our ability to originate loans, however, is dependent upon customer demand for loans in our market area.  Over the past few years, we have continued to originate residential and consumer loans, and increased our emphasis on commercial and multifamily, construction and land, and commercial business lending.  Demand is affected by competition and the interest rate environment.  During the past few years, we, like many other financial institutions, have experienced significant prepayments on loans due to the low interest rate environment prevailing in the United States.  During the years ended December 31, 2018 and 2019, we did not acquire any loans.  We underwrite participations to the same standards as an internally-originated loan.

In addition to interest earned on loans and loan origination fees, we receive fees for loan commitments, late payments and other miscellaneous services.

Asset Quality

When a borrower fails to make a required payment on a one-to four-family loan, we attempt to cure the delinquency by contacting the borrower.  In the case of loans secured by a one-to four-family property, a late notice typically is sent 15 days after the due date, and the borrower is contacted by phone within 30 days after the due date.  Generally, a delinquency letter is mailed to the borrower.  All delinquent accounts are reviewed by a loan account executive or branch manager who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due.  If the account becomes 90 days delinquent and an acceptable repayment plan has not been agreed upon, we generally refer the account to legal counsel with instructions to prepare a notice of intent to foreclose.

Delinquent consumer loans, as well as delinquent home equity loans and lines of credit, are handled in a similar manner to one-to four-family loans, except that appropriate action may be taken to collect any loan payment that is delinquent for more than 15 days.  Once the loan is 90 days past due, it is classified as nonaccrual.  Generally, credits are charged-off at 120 days past due.  Our procedures for repossession and sale of consumer collateral are subject to various requirements under the applicable consumer protection laws as well as other applicable laws and the determination by us that it would be beneficial from a cost basis.

Delinquent loans are initially handled by the loan officer in charge of the loan, who is responsible for contacting the borrower.  In addition, management meets weekly and reviews past due and classified loans, as well as other loans that management feels may present possible collection problems, which are reported to the board on a monthly basis.  If an acceptable workout of a delinquent loan cannot be agreed upon, we generally initiate foreclosure or repossession proceedings on any collateral securing the loan.


14

Delinquent Loans.
Nonperforming Assets.  The table below sets forth the amounts and categories of nonperforming assets in our loan portfolio.  Loans are placed on nonaccrual status when the collection of principal and/or interest become doubtful or when the loan is more than 90 days past due.  Foreclosed assets include assets acquired in settlement of loans.  We had no accruing loans 90 days or more delinquent for the periods reported.

 
December 31,
 
2019
 
2018
 
2017
 
2016
               
 
(Dollars in thousands)
Non-accruing loans:
             
  Real estate loans:
             
    One- to four-family residential
$    947
 
$    978
 
$ 1,333
 
$ 1,668
    Multi-family residential
--
 
--
 
--
 
--
    Residential construction
--
 
--
 
--
 
--
    Commercial real estate
235
 
313
 
535
 
699
    Commercial real estate construction
--
 
--
 
--
 
--
        Total real estate loans
1,182
 
1,291
 
1,868
 
2,367
               
Commercial business loans
--
 
4
 
10
 
19
               
  Consumer loans
--
 
--
 
--
 
11
        Total non-accruing loans
1,182
 
1,295
 
1,878
 
2,397
               
Foreclosed real estate
             
      One- to four-family residential
--
 
--
 
138
 
313
      Commercial real estate
--
 
--
 
38
 
--
        Total foreclosed real estate
--
 
--
 
176
 
313
               
Repossessed automobiles, recreational vehicles
--
 
--
 
--
 
--
               
        Total nonperforming assets
$ 1,182
 
$ 1,295
 
$ 2,054
 
$ 2,710
               
Total nonperforming assets as a percentage of total assets
0.6%
 
0.6%
 
1.2%
 
1.5%
               
Restructured loans (excluding those on nonaccrual status)
             
  Real estate loans:
             
    One- to four-family residential
$    484
 
$    879
 
$    877
 
$ 1,258
    Commercial real estate
365
 
439
 
484
 
759
        Total real estate loans
849
 
1,318
 
1,361
 
2,017
               
Commercial business loans
412
 
467
 
514
 
567
               
Consumer loans
--
 
--
 
--
 
14
               
Total
$ 1,261
 
$ 1,785
 
$ 1,875
 
$ 2,598


15

For the year ended December 31, 2019, total interest income that would have been recorded had the nonaccrual loans been current in accordance with their original terms amounted to $59,000, all of which was excluded in interest income for the year ended December 31, 2019.

See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition at December 31, 2019 Compared to December 31, 2018 – Delinquencies and Nonperforming Assets” for more information on troubled assets.

Troubled Debt Restructured Loans.  Troubled debt restructurings, which are accounted for under Accounting Standards Codification (“ASC”) 310-40, are loans which have renegotiated loan terms to assist borrowers who are unable to meet the original terms of their loans.  Such modifications to loan terms may include a lower interest rate, a reduction in principal, or a longer term to maturity.  All troubled debt restructurings are initially classified as impaired, regardless of whether the loan was performing at the time it was restructured.  Once a troubled debt restructuring has performed according to its modified terms for six months and the collection of principal and interest under the revised terms is deemed probable, we remove the troubled debt restructuring from nonperforming status.  At December 31, 2019 and 2018, we had $1.3 million and $1.8 million, respectively, of loans that were classified as troubled debt restructurings and still on accrual. Included in nonperforming loans at December 31, 2019 and 2018 were troubled debt restructured loans of $137,000 and $159,000 respectively.

Foreclosed Assets.   We owned no real estate owned or other repossessed assets at December 31, 2019.

Other Loans of Concern.   In addition to the nonperforming assets set forth in the table above, as of December 31, 2019, there were 16 loans totaling $941,000 with respect to which known information about the possible credit problems of the borrowers have caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the nonperforming asset categories.  These loans have been considered individually in management’s determination of our allowance for loan losses.  The largest loan relationship of concern at December 31, 2019, totaled $543,000 and was secured by owner occupied commercial real estate and all related business assets located in Washington County, Indiana.  The remaining loans of concern consist of $325,000 in residential first mortgages and $73,000 in commercial real estate loans. Loans of concern had specific loan loss reserves of $78,000 at December 31, 2019.

Classified Assets.  Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the OCC to be of lesser quality, as “substandard,” “doubtful” or “loss.”  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected.  Assets classified as “doubtful” have all of the weaknesses in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.”  Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  Assets which do not currently expose Mid-Southern Savings Bank to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated as special mention.

When we classify problem assets as either substandard or doubtful, we may establish specific allowance for loan losses in an amount deemed prudent by management.  Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the OCC and the FDIC, which may order the establishment of additional general or specific loss allowances.

We regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations.  On the basis of management’s review of our assets, at December 31, 2019, we had classified $2.1 million of our assets as substandard, which represented a variety of outstanding loans.  Classified assets totaled $2.1 million, or 4.2% of our equity capital and 1.0% of our assets at December 31, 2019 and $3.3 million, or 6.7% of our equity capital and 1.6% of our assets at December 31, 2018.  We had no assets classified as special mention at December 31, 2019 and 2018.

16

Allowance for Loan Losses.  We maintain an allowance for loan losses to absorb probable loan losses in the loan portfolio.  The allowance is based on ongoing, monthly assessments of the estimated probable incurred losses in the loan portfolio.  In evaluating the level of the allowance for loan losses, management considers the types of loans and the amount of loans in the loan portfolio, peer group information, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions.  Large groups of smaller balance homogeneous loans, such as one-to four-family, small commercial and multifamily, home equity and consumer loans, are evaluated in the aggregate using historical loss factors and peer group data adjusted for current economic conditions.

Our allowance for loan losses totaled $1.5 million, representing 1.2% of total loans at both December 31, 2019 and 2018.  Specific valuation reserves totaled $78,000 and $100,000 at December 31, 2019 and 2018, respectively.

Assessing the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.  In the opinion of management, the allowance, when taken as a whole, properly reflects estimated probable loan losses in our loan portfolio.  See Notes 1 and 4 of the Notes to Consolidated Financial Statements for additional information.







17

The following table sets forth an analysis of our allowance for loan losses at the dates indicated:
 
December 31,
 
2019
 
2018
 
2017
 
2016
 
(Dollars in thousands)
Balance at beginning of period
$ 1,504
 
$ 1,723
 
$ 2,503
 
$ 3,130
Charge-offs:
             
One-to four-family residential
58
 
182
 
64
 
218
Multi-family residential
--
 
--
 
--
 
--
Construction
--
 
--
 
--
 
--
Commercial real estate
--
 
--
 
19
 
1
Commercial business
--
 
2
 
--
 
--
Consumer
17
 
16
 
18
 
25
Total charge-offs
75
 
200
 
101
 
244
               
Recoveries:
             
One-to four-family residential
48
 
162
 
6
 
54
Multi-family residential
--
 
--
 
--
 
--
Construction
--
 
1
 
--
 
--
Commercial real estate
--
 
--
 
1
 
1
Commercial business
--
 
2
 
--
 
--
Consumer
9
 
16
 
14
 
11
        Total recoveries
57
 
181
 
21
 
66
     Net charge-offs
(18)
 
(19)
 
(80)
 
(178)
     Provision for loan losses (recapture)
12
 
(200)
 
(700)
 
(449)
Balance at end of period
$ 1,498
 
$ 1,504
 
$ 1,723
 
$ 2,503
               
Net charge-offs during the period as a percentage of
average loans outstanding during the period
0.0%
 
0.0%
 
0.1%
 
0.2%
               
Net charge-offs during the period as a percentage of
average nonperforming assets
1.5%
 
1.1%
 
3.4%
 
6.6%
               
Allowance as a percentage of nonperforming loans
126.7%
 
116.1%
 
91.7%
 
104.4%
Allowance as a percentage of total loans (end of period)
1.2%
 
1.2%
 
1.5%
 
2.1%

Nonperforming loans decreased to $1.2 million at December 31, 2019 from $1.3 million at December 31, 2018.  The allowance for loan losses as a percentage of total loans was 1.2% at both December 31, 2019 and 2018.


18

The distribution of our allowance for losses on loans at the dates indicated is summarized as follows:
 
At December 31,
 
2019
Amount
 
Percent of Allowance
To Total Allowance
 
Percent of Loans In Category
To Total Loans
 
2018
Amount
 
Percent of Allowance
To Total Allowance
 
Percent of Loans In Category
To Total Loans
 
2017
Amount
 
Percent of Allowance
To Total Allowance
 
Percent of Loans In Category
To Total Loans
 
2016
Amount
 
Percent of Allowance
To Total Allowance
 
Percent of Loans In Category
To Total Loans
                                               
 
(Dollars in thousands)
Allocated at end of period to:
                                             
One- to four- family residential
$    955
 
0.8%
 
57.4%
 
$ 1,012
 
0.8%
 
62.9%
 
$ 1,070
 
0.9%
 
68.6%
 
$ 1,571
 
1.3%
 
69.2%
Multi-family residential
83
 
0.1
 
7.4
 
59
 
0.0
 
5.5
 
220
 
0.2
 
5.4
 
338
 
0.3
 
4.7
Construction
44
 
0.0
 
2.6
 
48
 
0.0
 
4.0
 
20
 
--
 
1.9
 
9
 
--
 
1.3
Commercial real estate
289
 
0.2
 
25.9
 
259
 
0.2
 
21.3
 
269
 
0.2
 
19.1
 
404
 
0.3
 
19.8
Commercial business
102
 
0.1
 
5.2
 
98
 
0.1
 
4.6
 
111
 
0.1
 
3.3
 
134
 
0.1
 
3.2
Consumer
25
 
0.0
 
1.5
 
28
 
0.0
 
1.7
 
33
 
--
 
1.7
 
47
 
--
 
1.8
   Total
$ 1,498
 
1.2%
 
100.0%
 
$ 1,504
 
1.1%
 
100.0%
 
$ 1,723
 
1.4%
 
100.0%
 
$ 2,503
 
2.0%
 
100.0%






19

Investment Activities

Federal savings banks have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, including callable agency securities, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds.  Subject to various restrictions, federal savings banks may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that the institution is otherwise authorized to make directly.

Specific investment strategies are formulated by the ALCO committee.  The ALCO committee is composed of Mid-Southern Savings Bank’s executive management team. The board of directors will review and approve these investment strategies and then can delegate the authority to execute to ALCO.  In addition to authorizing and approving the investment policy, the board of directors has the responsibility for the approval of strategies and for monitoring the investment portfolio of Mid-Southern Savings Bank. Investment activities will be conducted in accordance with Mid-Southern Savings Bank’s policy and consistent with Mid-Southern Savings Bank’s asset/liability management policy. The board of directors has the ultimate responsibility for establishing policy and monitoring management’s compliance with the policy.  The President is responsible for all investment executions in the portfolio. Mid-Southern Savings Bank retains the services of an investment advisor to provide advice to and consult with the board and ALCO on various investment strategies.

The ALCO committee considers various factors when making strategic recommendations to the board of directors including the marketability, maturity and tax consequences of the proposed investment.  The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.

The general objectives of our investment portfolio will be to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk.  Our investment quality will emphasize safer investments with the yield on those investments secondary to not taking unnecessary risk with the available funds.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management.”

As a condition of membership at the FHLB, we are required to purchase and hold a certain amount of FHLB stock.  At December 31, 2019, we owned $778,000 in FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB.  FHLB stock has a par value of $100, and is carried at cost.

The composition of our investment securities portfolio at December 31, 2019, excluding FHLB stock, is as follows:  Federal agency mortgage-backed securities with an amortized cost of $20.3 million and a fair value of $20.5 million and municipal bonds with an amortized cost of $36.4 million and a fair value of $37.9 million.

We review investment securities on an ongoing basis for the presence of other-than-temporary impairment (“OTTI”) taking into consideration current market conditions, fair value in relationship to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether we intend to sell a security or if it is likely that we will be required to sell the security before recovery of our amortized cost basis of the investment, which may be maturity, and other factors.  For debt securities, if we intend to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI.  If we do not intend to sell the security and it is not more likely than not that we will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings.  The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected.


20

Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI.  The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and the fair value, is recognized as a charge to other comprehensive income.  Impairment losses related to all other factors are presented as separate categories within other comprehensive income.
At December 31, 2019, we held no investment securities for which declines in value are considered other-than-temporary.  We do not intend to sell these securities and it is more likely than not that we will not be required to sell the securities before anticipated recovery of the remaining amortized cost basis.  We closely monitor our investment securities for changes in credit risk. If market conditions deteriorate and we determine our holdings of these or other investment securities are OTTI, our future earnings, stockholders’ equity, regulatory capital and continuing operations could be materially adversely affected.

The following table sets forth the composition of our securities portfolio and other investments at the dates indicated. At December 31, 2019, our securities portfolio did not contain securities of any issuer with an aggregate carrying value in excess of 10% of our equity capital, excluding those issued by the United States Government or its agencies.

   
December 31,
   
2019
 
2018
 
2017
   
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
   
(Dollars in thousands)
Securities available for sale:
                       
   Municipal obligations
 
$ 36,390
 
$ 37,935
 
$ 28,653
 
$ 28,710
 
$ 21,474
 
$ 21,742
   Mortgage-backed
 
20,323
 
20,482
 
24,709
 
24,430
 
23,304
 
22,975
   Federal agency securities
 
--
 
--
 
--
 
--
 
1,000
 
999
      Total available-for-sale
 
56,713
 
58,417
 
53,362
 
53,140
 
45,778
 
45,716
                         
Securities held to maturity:
                       
   Municipal obligations
 
--
 
--
 
45
 
45
 
85
 
87
   Mortgage-backed
 
42
 
42
 
55
 
56
 
78
 
80
      Total held to maturity
 
42
 
42
 
100
 
101
 
163
 
167
                         
Restricted equity securities:
                       
   Federal Home Loan Bank stock
 
778
 
778
 
778
 
778
 
778
 
778
                         
Total securities
 
$ 57,533
 
$ 59,237
 
$ 54,240
 
$ 54,019
 
$ 46,719
 
$ 46,661




21

Maturity of Securities

The composition and contractual maturities of our investment portfolio at December 31, 2019, excluding Federal Home Loan Bank stock, are indicated in the following table. Weighted average yields on tax exempt securities are presented on a tax-equivalent basis using a federal marginal tax rate of 21%. Certain mortgage-backed securities, including collateralized mortgage obligations, have adjustable interest rates and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the table below.

    One Year or Less    
More than One Year to
Five Years
   
More than Five Year
to Ten Years
    More Than 10 Years     Total  
   
Carrying
Value
    Weighted
Average
Yield
   
Carrying
Value
    Weighted
Average
Yield
   
Carrying
Value
    Weighted
Average
Yield
   
Carrying
Value
    Weighted
Average
Yield
   
Carrying
Value
    Weighted
Average
Yield
 
    (Dollars in thousands)  
Securities available-for-sale:
                                                         
Municipal obligations
 
$
-
     
-%

 
$
1,568
     
3.53%

 
$
8,225
     
3.37%

 
$
28,142
     
3.17%

 
$
37,935
     
3.22%

Mortgage-backed securities
   
-
     
-%

   
3,470
     
1.88%

   
3,159
     
1.90%

   
13,853
     
3.01%

   
20,482
     
2.64%

Total available-for-sale
 
$
-
     
-%

 
$
5,038
     
2.39%

 
$
11,384
     
2.96%

 
$
41,995
     
3.12%

 
$
58,417
     
3.02%

Securities held to maturity:
                                                                           
Municipal obligations
 
$
-
     
-%

 
$
-
     
    -%

 
$
-
     
    -%

 
$
-
     
    -%

 
$
-
     
    -%

Mortgage-backed securities
   
-
     
-%

   
9
     
4.94%

   
4
     
2.21%

   
29
     
4.01%

   
42
     
4.04%

Total held to maturity
 
$
-
     
-%

 
$
9
     
4.94%

 
$
4
     
2.21%

 
$
29
     
4.01%

 
$
42
     
4.04%






22

Sources of Funds

General.  Our sources of funds are primarily deposits, borrowings, payments of principal and interest on loans and funds provided from operations.

Deposits.  We offer a variety of deposit accounts to both consumers and businesses having a wide range of interest rates and terms.  Our deposits consist of savings accounts, money market deposit accounts, demand accounts and certificates of deposit.  We solicit deposits primarily in our market area; however, at December 31, 2019, approximately 2.1% of our deposits were from persons outside the state of Indiana.  As of December 31, 2019, core deposits, which we define as our non-certificate or non-time deposit accounts, represented approximately 64.1% of total deposits, compared to 65.2% as of December 31, 2018.  We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits and we expect to continue these practices in the future.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition.  The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand.  We have become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious.  We manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors.  Based on our experience, we believe that our deposits are relatively stable sources of funds.  Despite this stability, our ability to attract and maintain these deposits and the rates paid on them has been and will continue to be significantly affected by market conditions.





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We are a public funds depository and as of December 31, 2019, we had $15.4 million in public funds.  These funds consisted of $8.5 million in certificates of deposit and savings accounts and $6.9 million in checking accounts at December 31, 2019.

 
At December 31,
 
2019
 
2018
 
2017
 
Amount
Percent
of Total
Increase/
(Decrease)
 
Amount
Percent
of Total
 
Amount
Percent
of Total
                   
 
(Dollars in thousands)
                   
Noninterest bearing checking
$  17,796
12.2%
$     (538)
 
$  18,334
12.2%
 
$  18,008
11.8%
Interest bearing checking
39,750
27.0
(1,319)
 
41,069
27.2
 
36,797
24.2
Savings and money market
36,632
24.9
(2,358)
 
38,990
25.8
 
45,514
30.0
Time deposits:
                 
  Maturing:
                 
  Within one year
31,335
21.3
13,925
 
17,410
11.5
 
16,415
10.8
  After one year, but within two years
20,882
14.2
2,572
 
18,310
12.1
 
9,242
6.1
  After two years, but within five years
574
0.4
(16,421)
 
16,995
11.2
 
25,917
17.1
  Maturing thereafter
--
--
--
 
--
--
 
--
--
     Total
$146,969
100.0%
$  (4,139)
 
$151,108
100.0%
 
$151,893
100.0%





24

Jumbo Certificates

The following table indicates the amount of our jumbo certificates of deposit by time remaining until maturity as of December 31, 2019. Jumbo certificates of deposit are certificates in amounts of $100,000 or more.

Maturity Period
 
Total
   
(In thousands)
Three months or less
 
 $      513
Over three through six months
 
7,253
Over six through twelve months
 
8,093
Over twelve months
 
7,658
   Total
 
$ 23,517

Deposit Maturities

The following table sets forth the amount and maturities of time deposits categorized by rates at December 31, 2019.
 
Amount due
 
Within 1 Year
 
After 1 Year
Through 3
Years
 
After 3 Years
Through 5
Years
 
After 5
Years
 
Total
 
Percent of
Total
 
(Dollars in thousands)
0.00 – 0.99%
$   7,828
 
$   1,390
 
$       --
 
$ --
 
$  9,218
 
17.5%
1.00 – 1.99%
13,767
 
11,334
 
3,791
 
--
 
28,892
 
54.7%
2.00 – 2.99%
9,740
 
4,520
 
421
 
--
 
14,681
 
27.8%
Total certificates of deposit
$ 31,335
 
$ 17,244
 
$ 4,212
 
$ --
 
$52,791
 
100.0%

Borrowings.  Although deposits are our primary source of funds, we may utilize borrowings as a cost-effective source of funds when they can be invested at a positive interest rate spread, for additional capacity to fund loan demand, or to meet our asset/liability management goals.  Our borrowings currently consist of advances from the FHLB.  See Note 3 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional information.

We are a member of the Federal Home Loan Bank of Indianapolis, which is part of the Federal Home Loan Bank System.  The eleven regional Federal Home Loan Banks provide a central credit facility for their member institutions.  We may use advances from the Federal Home Loan Bank of Indianapolis to supplement our supply of investable funds. The FHLB functions as a central reserve bank providing credit for its member financial institutions. As a member, we are required to own capital stock in the FHLB and are authorized to apply for advances on the security of such stock and certain of our whole first mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the FHLB’s assessment of the institution’s creditworthiness. At December 31, 2019, we had $15.0 million of available borrowing capacity with the FHLB.  On June 27, 2019, the Company borrowed $10.0 million from the FHLB which matures on June 27, 2024 and bears an interest rate of 1.73%. Average short-term borrowings have not exceeded 30% of stockholders' equity in the past two years.


25

The following table sets forth certain information concerning the Company's borrowings for the periods indicated (dollars in thousands):


   
Year Ended December 31,
 
   
2019
     
2018
 
Maximum amounts of FHLB advances outstanding at any month end
$
10,000
   
$
3,000
 
Average FHLB advances outstanding
 
5,151
     
912
 
Weighted average rate on FHLB advances
 
1.73
%
   
1.64
%
Maximum amounts of FRB borrowings outstanding at any month end
$
--
   
$
--
 
Balance outstanding at end of period:
             
     FHLB Advances
$
10,000
   
$
--
 

There were no borrowings outstanding at any time during 2017.

Taxation

For details regarding the Company’s taxes, see Note 11 of the Notes the Consolidated Financial Statements contained in Item 8 of this report.

Personnel

As of December 31, 2019, the Company had 42 full‑time equivalent employees, none of whom are represented by a collective bargaining unit. The Company believes its relationship with its employees is good.

Corporate Information

The Company’s principal executive offices are located at 300 N. Water Street, Salem, Indiana 47167. Its telephone number is (812) 883-2639. The Company maintains a website with the address www.mid-southern.com. The information contained on the Company’s website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own internet access charges, the Company makes available free of charge through its website the Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after it has electronically filed such material with, or furnished such material to, the Securities and Exchange Commission (“SEC”).

Subsidiary Activities

Under OCC regulations, the Bank is authorized to invest up to 3% of its assets in subsidiary corporations classified as service corporations, with amounts in excess of 2% only if primarily for community purposes, and unlimited amounts in operating subsidiaries.

Mid-Southern Investments, Inc. was formed in 2017 to invest in general market municipal bonds, rather than bank qualified municipal bonds which, although tax advantaged, may not have the yield we seek. Our capital investment in the Mid-Southern Investments as of December 31, 2019 was $24.9 million which was within the OCC limitations.

Competition

We face strong competition in attracting deposits and originating loans.  Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, credit unions, life insurance companies and mortgage brokers.  Other savings institutions, commercial banks, credit unions and finance companies provide vigorous competition in consumer lending.  Commercial business competition is primarily from local commercial banks, but other savings banks and credit unions also compete for this business.  We compete by consistently delivering high-quality, personal service to our customers which results in a high level of customer satisfaction.


26

Our market area has a high concentration of financial institutions, many of which are branches of large money center and regional banks that have resulted from the consolidation of the banking industry in Indiana and other Mid-Western states.  These include such large national lenders as PNC Bank, JP Morgan, Chase, US Bank and Branch Banking and Trust Company and others in our market area that have greater resources than we do and offer services that we do not provide.  For example, we do not offer trust services or non-FDIC insured investments.  Customers who seek "one-stop shopping" may be drawn to institutions that offer services that we do not.

We attract our deposits through our branch office system.  Competition for those deposits is principally from other savings institutions, commercial banks and credit unions located in the same community, as well as mutual funds and other alternative investments.  We compete for these deposits by offering superior service and a variety of deposit accounts at competitive rates.  Based on the most recent data provided by the FDIC, there are approximately 40 other commercial banks and savings institutions operating in the Louisville/Jefferson County, KY-IN MSA and 14 other commercial banks and savings institutions in Lawrence, Orange and Washington counties of Indiana.  Based on the most recent branch deposit data provided by the FDIC, our share of deposits in the Louisville/Jefferson County, KY-IN MSA was approximately 0.32%.  The five largest financial institutions in that area have 66.9% of those deposits.  In addition, our share of deposits in Lawrence, Orange and Washington counties was the largest in the three-county area at 16.1%, with the five largest institutions in the three-county area having 59.4% of the deposits.

Executive Officers.  The following table sets forth certain information regarding the executive officers of the Company and its subsidiaries:

Name
Age (1)
Position
Alexander G. Babey
51
President and Chief Executive Officer, Mid-Southern Bancorp, Inc.
and Mid-Southern Savings Bank, FSB
Frank (Buzz) M. Benson, III.
58
Executive Vice President and Senior Loan Officer, Mid-Southern
Savings Bank, FSB
Erica B. Schmidt
41
Executive Vice President and Chief Financial Officer, Mid-Southern
Savings Bank, FSB
Robert W. DeRossett
50
Chief Financial Officer, Mid-Southern Bancorp, Inc.
_____________
(1) At December 31, 2019

Alexander G. Babey has been President and Chief Executive Officer of Mid-Southern Bancorp since its formation in January 2018 and the President of Chief Executive Officer of Mid-Southern Savings Bank and Mid-Southern, M.H.C. since October 2016.  Prior to that, he was Executive Vice President and Chief Credit Officer from December 2013 until October 2016.  He was a credit administration consultant from June 2013 until December 2013, having served as Executive Vice President and Senior Loan Officer of The BANK-Oldham County from May 2005 until its acquisition in May 2013.  Mr. Babey brings a wealth of banking knowledge to our Board, with particular expertise in lending and experience at both large regional and community banks.

Frank (Buzz) M. Benson III, has served as the Executive Vice President and Senior Loan Officer of Mid-Southern Savings Bank since June 2014.  Prior to that, he was the Senior Vice President of Lending at Main Source Bank from 1998 until June 2014.

Erica B. Schmidt, has been the Executive Vice President and Chief Financial Officer of Mid-Southern Savings Bank, since January 2014.  Prior to that, she served as Controller of Mid-Southern Savings Bank from September 2005 through December 2013.  Ms. Schmidt has also been our Corporate Secretary since 2013 and Treasurer since 2008.

Robert W. DeRossett joined the Company as Chief Financial Officer of Mid-Southern Bancorp, Inc. in February 2020.  He brings significant expertise to the Company’s financial management and reporting areas.  For the past five years, Mr. DeRossett served as an independent CFO consultant for start-up companies and non-profit entities in the Louisville, Kentucky area.  He recently was the Director of Finance for Rabbit Hole Spirits, LLC in Louisville, Kentucky until it was acquired by Pernod-Ricard of Paris, France in 2019.  Prior to that, Mr. DeRossett performed financial reporting, investor relations and project management roles for Providian Corporation in

27

Louisville, Kentucky, which was acquired by AEGON of The Hague, The Netherlands in 1997.  Mr. DeRossett is a Certified Public Accountant licensed in the Commonwealth of Kentucky since 1993 and has been a holder of the Chartered Financial Analyst designation since 2009.

REGULATION

The following is a brief description of certain laws and regulations which are applicable to the Company and the Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.

Legislation is introduced from time to time in the United States Congress (“Congress”) that may affect the Company’s and Bank’s operations. In addition, the regulations governing the Company and the Bank may be amended from time to time by the OCC, the FDIC, the Federal Reserve Board or the SEC, as appropriate. Any such legislation or regulatory changes in the future could have an adverse effect on our operations and financial condition. We cannot predict whether any such changes may occur.

General

As a federally chartered savings bank, the Bank is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and the FDIC, as the insurer of its deposits. Additionally, the Company is subject to extensive regulation, examination and supervision by the Federal Reserve as its primary federal regulator. The Bank is a member of the FHLB System and its deposits are insured up to applicable limits by the DIF, which is administered by the FDIC. The Bank must file reports with the OCC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations of the Bank by the OCC and of the Company by the Federal Reserve to evaluate safety and soundness and compliance with various regulatory requirements. This regulatory structure establishes a comprehensive framework of activities in which the Bank may engage and is intended primarily for the protection of the DIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OCC, the Federal Reserve, the FDIC or Congress, could have a material adverse impact on the Company and the Bank and their operations.

In connection with the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), the laws and regulations affecting depository institutions and their holding companies have changed, particularly affecting the bank regulatory structure and the lending, investment, trading and operating activities of depository institutions and their holding companies. Among other changes, the Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”) as an independent bureau of the Federal Reserve Board. The CFPB assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. The Bank is subject to consumer protection regulations issued by the CFPB, but as a smaller financial institution, the Bank is generally subject to supervision and enforcement by the OCC with respect to its compliance with consumer financial protection laws and CFPB regulations.

On May 23, 2018, the President signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act passed by Congress (the “Act”). The Act contains a number of provisions extending regulatory relief to banks and savings institutions and their holding companies. Some of these provisions may benefit the Company and the Bank, such as (1) a simplified capital ratio, called the Community Bank Leverage Ratio, computed as the ratio of tangible equity capital to average consolidated total assets to be set by the federal banking regulators at not less than 8% and not more than 10%, which for most institutions with less than $10 billion in consolidated assets will replace the leverage and risk-based capital ratios under current regulations; (2) an option for federal savings institutions to operate as national banks with respect to limits on lending, investments, and subsidiaries, without changing their charters to national bank charters; and (3) a lower risk weight on certain loans currently classified as


28

high volatility commercial real estate exposures. Effective January 1, 2020, the Community Bank Leverage Ratio is 9.0%.

Federal Regulation of Savings Institutions

Office of the Comptroller of the Currency.  The OCC has extensive authority over the operations of federal savings institutions. As part of this authority, the Bank is required to file periodic reports with the OCC and is subject to periodic examinations by the OCC. The OCC also has extensive enforcement authority over all federal savings institutions, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate prompt corrective action orders. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC. Except under certain circumstances, public disclosure of final enforcement actions by the OCC is required by law.

All federal savings institutions are required to pay assessments to the OCC to fund the agency's operations. The general assessments, paid on a semi-annual basis, are determined based on the savings institution's total assets, including consolidated subsidiaries. The Bank's OCC assessment for the fiscal year ended December 31, 2019 was $71,000.

The Bank's general permissible lending limit for loans to one borrower is generally equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At December 31, 2019, the Bank's lending limit under this restriction was $5.7 million.  We have no loans in excess of our lending limit.

The OCC’s oversight of the Bank includes reviewing its compliance with the customer privacy requirements imposed by the Gramm-Leach-Bliley Act of 1999 (“GLBA”) and the anti-money laundering provisions of the USA Patriot Act. The GLBA privacy requirements place limitations on the sharing of consumer financial information with unaffiliated third parties. They also require each financial institution offering financial products or services to retail customers to provide such customers with its privacy policy and with the opportunity to “opt out” of the sharing of their personal information with unaffiliated third parties. The USA Patriot Act significantly expands the responsibilities of financial institutions in preventing the use of the U.S. financial system to fund terrorist activities. Its anti-money laundering provisions require financial institutions operating in the U.S. to develop anti-money laundering compliance programs and due diligence policies and controls to ensure the detection and reporting of money laundering. These compliance programs are intended to supplement requirements under the Bank Secrecy Act and the regulations of the Office of Foreign Assets Control.

The OCC, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.

Capital Requirements.  Federally insured savings institutions, such as the Bank, are required by the OCC to maintain minimum levels of regulatory capital, including a common equity Tier 1 (“CET1”) capital to risk-based assets ratio, a Tier 1 capital to risk-based assets ratio, a total capital to risk-based assets ratio and a Tier 1 capital to total assets leverage ratio. The capital standards require the maintenance of the following minimum capital ratios: (i) a CET1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%.

Certain changes in what constitutes regulatory capital are subject to transition periods, including the phasing-out of certain instruments as qualifying capital. The Bank does not have any of these instruments. In addition, Tier 1 capital includes accumulated other comprehensive income (loss), which includes all unrealized gains and losses on available for sale debt and equity securities. Because of the Bank’s asset size, the Bank elected to take a one-time option to permanently opt-out of the inclusion of unrealized gains and losses on available for sale debt and equity securities in its capital calculations.


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The Bank also must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum risk-based capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses.

In order to be considered well-capitalized under the prompt corrective action regulations, the Bank must maintain a CET1 risk-based ratio of 6.5%, a Tier 1 risk-based ratio of 8%, a total risk-based capital ratio of 10% and a leverage ratio of 5%, and the Bank must not be subject to any of certain mandates by the OCC requiring it as an individual institution to meet any specified capital level.  Effective January 1, 2020, a bank or savings institution that elects to use the Community Bank Leverage Ratio will generally be considered well-capitalized and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%. To be eligible to elect the Community Bank Leverage Ratio, the bank or institution also must have total consolidated assets of less than $10 billion, off-balance sheet exposures of 25% or less of its total consolidated assets, and trading assets and trading liabilities of 5.0% or less of its total consolidated assets, all as of the end of the most recent quarter.  The Bank intends to elect to use the Community Bank Leverage Ratio.

As of December 31, 2019, the most recent notification from the OCC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. For additional information, see Note 15 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

Prompt Corrective Action.  An institution is considered adequately capitalized if it meets the minimum capital ratios described above. The OCC is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization. Subject to a narrow exception, the OCC is required to appoint a receiver or conservator for a savings institution that is critically undercapitalized. OCC regulations also require that a capital restoration plan be filed with the OCC within 45 days of the date a savings institution receives notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. Significantly undercapitalized and critically undercapitalized institutions are subject to more extensive mandatory regulatory actions. The OCC also can take a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. An institution that is not well-capitalized is subject to certain restrictions on deposit rates and brokered deposits. At December 31, 2019, the Bank met the regulatory requirements described above under “Capital Requirements” to be considered well-capitalized.

Federal Home Loan Bank System.  The Bank is a member of the FHLB of Indianapolis, which is one of 11 regional Federal Home Loan Banks that administer the home financing credit function of savings institutions, each of which serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Agency. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. See “Business – Deposit Activities and Other Sources of Funds – Borrowings.” As a member, the Bank is required to purchase and maintain stock in the FHLB. At December 31, 2019, the Bank held $778,000 in FHLB stock, which was in compliance with this requirement. During the year ended December 31, 2019, the Bank did not purchase any FHLB stock.

The FHLB continues to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a decrease in net income and possibly capital.

Federal Deposit Insurance Corporation.  The DIF of the FDIC insures deposits in the Bank up to $250,000 per separately insured deposit ownership right or category. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. The Bank’s deposit insurance premiums for the fiscal year ended December 31, 2019 were $33,000.


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Under its regulations, the FDIC sets assessment rates for established small institutions (generally, those with total assets of less than $10 billion) based on an institution’s weighted average CAMELS component ratings and certain financial ratios. Total base assessment rates currently range from 3 to 30 basis points, subject to certain adjustments. Assessment rates are expected to decrease in the future as the reserve ratio increases in specified increments.  The FDIC may increase or decrease its rates by two basis points without further rule-making. In an emergency, the FDIC may also impose a special assessment.

As required by the Dodd Frank Act, the FDIC has adopted a rule to offset the effect of the increase in the minimum reserve ratio of the DIF on small institutions by imposing a surcharge on institutions with assets of $10 billion or more commencing on July 1, 2016 and ending when the reserve ratio reaches 1.35%, which, the FDIC announced occurred on September 30, 2018.  When the reserve ratio reaches 1.38%, small institutions will receive credits for the portions of their regular assessments that contributed to growth in the reserve ratio between 1.15% and 1.35%.  Subject to certain limitations, the credits will apply to reduce regular assessments until exhausted.

In addition to the FDIC assessments, the Financing Corporation was authorized to impose and collect, through the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The final such assessment was collected by the FDIC in March 2019.

The FDIC also may prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious risk to the DIF. The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances which would result in termination of the deposit insurance of the Bank.

Qualified Thrift Lender Test.  All federal savings institutions, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its total assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a) (19) of the Internal Revenue Code ("Code"). Under either test, such assets primarily consist of residential housing related loans and investments.

Any institution that fails to meet the QTL test is subject to certain operating restrictions and may be required to convert to a national bank charter, and a savings and loan holding company of such an institution may become regulated as a bank holding company. As of December 31, 2019, the Bank met the QTL test.

Limitations on Capital Distributions. OCC regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, savings institutions, such as the Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year equal to up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision by the OCC may have its dividend authority restricted by the OCC. If the Bank, however, proposes to make a capital distribution when it does not meet its capital requirements (or will not following the proposed capital distribution) or that will exceed these net income-based limitations, it must obtain the OCC's approval prior to making such distribution. In addition, the Bank must file a prior written notice of a dividend with the Federal Reserve. The Federal Reserve or the OCC may object to a capital distribution based on safety and soundness concerns. Additional restrictions on Bank dividends may apply if the Bank fails the QTL test. In addition, as noted above, if the Bank does not have the required capital conservation buffer, its ability to pay dividends to the Company would be limited, which may limit the ability of the Company to pay dividends to its stockholders.


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Activities of Associations and their Subsidiaries.  When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the savings institution controls, the savings institution must file a notice or application with the OCC and, in certain circumstances with the FDIC, and receive regulatory approval or non-objection. Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders.

With respect to subsidiaries generally, the OCC may determine that investment by a savings institution in, or the activities of, a subsidiary must be restricted or eliminated based on safety and soundness or legal reasons.

Transactions with Affiliates. The Bank’s authority to engage in transactions with affiliates is limited by Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve’s Regulation W. The term affiliates for these purposes generally mean any company that controls or is under common control with an institution except subsidiaries of the institution. The Company and its non-savings institution subsidiaries are affiliates of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates. In addition, certain types of transactions are restricted to an aggregate percentage of the institution’s capital. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. FDIC-insured institutions are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. Collateral in specified amounts must be provided by affiliates in order to receive loans from an institution. In addition, these institutions are prohibited from engaging in certain tying arrangements in connection with any extension of credit or the providing of any property or service.

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) generally prohibits a company that makes filings with the SEC from making loans to its executive officers and directors. That act, however, contains a specific exception for loans by a depository institution to its executive officers and directors, if the lending is in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% stockholders (“insiders”), as well as entities which such persons control, is limited. The law restricts both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. There are additional restrictions applicable to loans to executive officers.

Community Reinvestment Act and Consumer Protection Laws. Under the Community Reinvestment Act of 1977 (“CRA”), every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OCC, in connection with the examination of the Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank. The OCC may use an unsatisfactory rating as the basis for the denial of an application. Similarly, the Federal Reserve is required to take into account the performance of an insured institution under the CRA when considering whether to approve an acquisition by the institution’s holding company. Due to the heightened attention being given to the CRA in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community.

In connection with its deposit-taking, lending and other activities, the Bank is subject to a number of federal laws designed to protect consumers and promote lending to various sectors of the economy and population. The CFPB issues regulations and standards under these federal consumer protection laws, which include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act and the Real Estate Settlement Procedures Act. Through its rulemaking authority, the CFPB has promulgated several proposed and final regulations under these laws that will affect our consumer businesses. Among these regulatory initiatives are final


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regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and establishing new mortgage loan servicing and loan originator compensation standards. The Bank devotes substantial compliance, legal and operational business resources to ensure compliance with these consumer protection standards. In addition, the OCC has enacted customer privacy regulations that limit the ability of the Bank to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated parties.

Enforcement.  The OCC has primary enforcement responsibility over federally-chartered savings institutions and has the authority to bring action against all "institution-affiliated parties," including shareholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations.  The FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings institution. If action is not taken by the OCC, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

Standards for Safety and Soundness. As required by statute, the federal banking agencies have adopted interagency guidelines prescribing standards for safety and soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OCC determines that a savings institution fails to meet any standard prescribed by the guidelines, the OCC may require the institution to submit an acceptable plan to achieve compliance with the standard.

Federal Reserve System. The Federal Reserve requires that all depository institutions maintain reserves on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. Interest-bearing checking accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits at a bank. At December 31, 2019, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy any liquidity requirements that may be imposed by the OCC.

Commercial Real Estate Lending Concentrations.  The federal banking agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending. The particular focus is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be sensitive to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a bank’s commercial real estate lending but to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance directs the FDIC and other bank regulatory agencies to focus their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the following supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:

Total reported loans for construction, land development and other land represent 100% or more of the bank’s capital; or

Total commercial real estate loans (as defined in the guidance) represent 300% or more of the bank’s total capital or the outstanding balance of the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months.

The guidance provides that the strength of an institution’s lending and risk management practices with respect to such concentrations will be taken into account in supervisory guidance on evaluation of capital adequacy.


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Environmental Issues Associated with Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), is a federal statute that generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing that the term “owner and operator” excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which could substantially exceed the value of the collateral property.

Bank Secrecy Act/Anti-Money Laundering Laws. The Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of their customers. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing mergers and acquisitions.

Other Consumer Protection Laws and Regulations.  The Dodd-Frank Act established the CFPB and empowered it to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. The Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10 billion, the Bank is generally subject to supervision and enforcement by the OCC with respect to compliance with consumer financial protection laws and CFPB regulations.

The Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers. While the following list is not exhaustive, these include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfers Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans, and providing other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.

Savings and Loan Holding Company Regulations

General. The Company is a unitary savings and loan holding company subject to regulatory oversight of the Federal Reserve. Accordingly, the Company is required to register and file reports with the Federal Reserve and is subject to regulation and examination by the Federal Reserve. In addition, the Federal Reserve has enforcement authority over the Company and its non-savings institution subsidiaries, which also permits the Federal Reserve to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution. In accordance with the Dodd-Frank Act, the federal banking regulators must require any company that controls an FDIC-insured depository institution to serve as a source of strength for the institution, with the ability to provide financial assistance if the institution suffers financial distress. These and other Federal Reserve policies, as well as the capital conservatism buffer requirement, may restrict the Company’s ability to pay dividends.


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Capital Requirements. For a savings and loan holding company, such as the Company, the capital regulations apply on a consolidated basis. The Act raised the maximum amount of consolidated assets a qualifying holding company may have to $3 billion under the Federal Reserve’s “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” pursuant to which the Company is generally not subject to the Federal Reserve’s capital regulations, which are generally the same as the capital regulations applicable to the Bank. A major result of this change is to exclude most such holding companies from the minimum capital requirements of the Dodd-Frank Act. The Federal Reserve made this change effective August 30, 2019. The Federal Reserve expects the holding company’s subsidiary banks to be well capitalized under the prompt corrective action regulations. If the Company were subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets at December 31, 2019, the Company would have exceeded all regulatory requirements. See “Federal Regulation of Savings Institutions-- Capital Requirements” above.

Activities Restrictions. The GLBA provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies. Further, the GLBA specifies that, subject to a grandfather provision, existing savings and loan holding companies may only engage in such activities. The Company qualifies for grandfathering and is therefore not restricted in terms of its activities. Upon any non-supervisory acquisition by the Company of another savings association as a separate subsidiary, the Company would become a multiple savings and loan holding company and would be limited to activities permitted by Federal Reserve regulation.

Mergers and Acquisitions. The Company must obtain approval from the Federal Reserve before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets. In evaluating an application for the Company to acquire control of a savings institution, the Federal Reserve would consider the financial and managerial resources and future prospects of the Company and the target institution, the effect of the acquisition on the risk to the DIF, the convenience and the needs of the community and competitive factors.

The Federal Reserve may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions; (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

Acquisition of the Company. Any company, except a bank holding company, that acquires control of a savings association or savings and loan holding company becomes a “savings and loan holding company” subject to registration, examination and regulation by the Federal Reserve and must obtain the prior approval of the Federal Reserve under the Savings and Loan Holding Company Act before obtaining control of a savings association or savings and loan holding company. A bank holding company must obtain the prior approval of the Federal Reserve under the Bank Holding Company Act before obtaining control of, or more than 5% of a class of voting stock of, a savings association or savings and loan holding company and remains subject to regulation under the Bank Holding Company Act. The term “company” includes corporations, partnerships, associations, and certain trusts and other entities. “Control” of a savings association or savings and loan holding company is deemed to exist if a company has voting control, directly or indirectly, of more than 25% of any class of the savings association’s voting stock or controls in any manner the election of a majority of the directors of the savings association or savings and loan holding company, and may be presumed under other circumstances, including, but not limited to, holding in certain cases 10% or more of a class of voting securities. In addition, a savings and loan holding company must obtain Federal Reserve approval prior to acquiring voting control of more than 5% of any class of voting stock of another savings association or another savings association holding company. A similar provision limiting the acquisition by a bank holding company of 5% or more of a class of voting stock of any company is included in the Bank Holding Company Act.



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Accordingly, the prior approval of the Federal Reserve would be required:

before any savings and loan holding company or bank holding company could acquire 5% or more of the common stock of the Company; and

before any other company could acquire 25% or more of the common stock of the Company and may be required for an acquisition of as little as 10% of such stock.

In addition, persons that are not companies are subject to the same or similar definitions of control with respect to savings and loan holding companies and savings associations and requirements for prior regulatory approval by the Federal Reserve in the case of control of a savings and loan holding company or by the OCC in the case of control of a savings association not obtained through control of a holding company of such savings association.

Dividends and Stock Repurchases.  The Federal Reserve’s policy statement on the payment of cash dividends applicable to savings and loan holding companies expresses its view that a savings and loan holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company’s net income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the company’s capital needs, asset quality, and overall financial condition. The Federal Reserve policy statement also indicates that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. In addition, a savings and loan holding company is required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order or any condition imposed by, or written agreement with, the Federal Reserve. The capital conservation buffer requirement may also limit or preclude dividends payable by the Company.

Sarbanes-Oxley Act of 2002.  The Sarbanes-Oxley Act was enacted in 2002 in response to public concerns regarding corporate accountability in connection with recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934, including the Company.

The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, and requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and related rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  The Dodd-Frank-Act imposed new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions, and capital regulations discussed above under “- Regulation and Supervision of the Bank - Capital Requirements.” In addition, among other requirements, the Dodd-Frank Act requires public companies, such as the Company, to (i) provide their shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the executive compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K to require companies to disclose the ratio of the Chief Executive Officer's annual total compensation to the median annual total compensation of all other employees.

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Item 1A.  Risk Factors

An investment in our common stock is subject to risks inherent in our business. 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 report. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations. The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment. The risks below also include forward-looking statements. This report is qualified in its entirety by these risk factors.

A significant portion of our loans are commercial real estate, multi-family, construction and commercial and business loans, which carry greater credit risk than loans secured by owner occupied one- to four-family real estate.

At December 31, 2019, commercial real estate and multi-family loans totaled $41.6 million, or 33.3%, commercial real estate construction loans totaled $2.9 million, or 2.3% (excluding unfunded loan commitments of $1.5 million) of our loan portfolio, commercial business loans totaled $6.5 million, or 5.2%, and consumer loans totaled $1.9 million, or 1.5%, of our total loan portfolio.  We continue to focus on commercial and business loans as well as consumer loans, and we intend to continue to originate commercial real estate and multi-family loans.  Given their larger balances and the complexity of the underlying collateral, commercial real estate, multi-family, construction and commercial business loans generally expose a lender to greater credit risk than loans secured by owner occupied one- to four-family real estate.  These loans, as well as consumer loans, also have greater credit risk than residential real estate for the following reasons:


Commercial real estate and multi-family loans – repayment is dependent on income being generated in amounts sufficient to cover operating expenses, property maintenance and debt service;


 Construction loans – repayment is generally dependent on the borrower's ability to sell the completed project, the value of the completed project, or the successful operation of the borrower's business after completion;


Commercial business loans – repayment is generally dependent upon the successful operation of the borrower's business; and


Consumer loans – repayment is dependent on the borrower's continuing stability and the collateral may not provide an adequate source of repayment.

If loans that are collateralized by real estate or other business assets or consumer assets become troubled and the value of the collateral has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.

Commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to owner-occupied one-to-four family residential mortgage loans. Also, many of these types of borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan.

Further, a significant portion of our commercial real estate loans are secured by non-owner-occupied properties.  These loans expose us to greater risk of non-payment and loss than loans secured by owner-occupied properties because repayment of such loans depend primarily on the tenant's continuing ability to pay rent to the property owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner's ability to repay the loan without the benefit of a rental income stream.  In addition, the physical condition of non-owner-occupied properties is often below that of owner-occupied properties due to lax property maintenance standards, which has a negative impact on the value of the collateral properties.


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Furthermore, a key component of our strategy is to continue to increase our origination of commercial business and consumer loans, and to continue to originate commercial and multifamily real estate loans in our market area to diversify our loan portfolio and increase our yields.  The proposed increase in these types of loans significantly increases our exposure to the risks inherent in these types of loans and our potential for losses.

Our business may be adversely affected by credit risk associated with residential property.

At December 31, 2019, $71.6 million, or 57.4% of our total loan portfolio, was secured by one-to-four family real estate, including home equity lines of credit of $3.1 million. One- to four-family residential loans are generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict.  A decline in residential real estate values resulting from a downturn in the housing market in our market areas may reduce the value of the real estate collateral securing these types of loans and increase our risk of loss if borrowers default on their loans.  A deterioration in economic conditions, declines in the volume of real estate sales and/or the sales prices or elevated unemployment rates in our market areas may result in higher rates of delinquencies, default and losses on our residential loans.

Greater seasoning of our loan portfolio could result in credit defaults in the future.

As a result of our planned growth, a significant portion of our loan portfolio at any given time may be of relatively recent origin.  Typically, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time (which varies by loan duration and loan type), a process referred to as "seasoning."  As a result, a portfolio of more seasoned loans may more predictably follow a bank's historical default or credit deterioration patterns than a newer portfolio.  The current level of delinquencies and defaults may not represent the level that may prevail as the portfolio becomes more seasoned.  If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

Our business may be adversely affected by downturns in the national economy and economic conditions in our market area which could reduce demand for our products and services and/or result in increases in our level of non-performing loans, which could adversely affect our operations, financial condition and earnings.

As of December 31, 2019, approximately $77.2 million, or 61.9%, of our total loans were to individuals and/or secured by properties located in our primary market area of Washington, Lawrence, Orange and Floyd counties in Indiana. As a result, our revenues and profitability are subject to prevailing economic, regulatory, demographic and other conditions in Washington, Lawrence, Orange and Floyd Counties. Because our business is concentrated in this area, adverse economic, regulatory, demographic or other developments that are limited to this area may have a disproportionately greater effect on us than they would have if we did business in markets outside that particular geographic area.  Local economic conditions have a significant impact on the ability of our borrowers to repay loans and the value of the collateral securing loans.

The coronavirus outbreak may also have an adverse effect on our customer’s directly or indirectly, including those engaged in international trade, travel and tourism.  These effects could include disruptions or restrictions in customers' supply chains or employee productivity, closures of customers' facilities, decreases in demand for customers' products and services or in other economic activities.  Their businesses may be adversely affected by quarantines and travel restrictions in countries most affected by the coronavirus.  In addition, entire industries such as agriculture, may be adversely impacted due to lower exports caused by reduced economic activity in the affected countries.  If our customers are adversely affected, or if the virus leads to a widespread health crisis that impacts U.S. economic growth, our condition and results of operations could be adversely affected, despite having no direct operations in China.


38


A deterioration in economic conditions in our market areas could have the following consequences, any of which could have a material adverse effect on our business, financial condition, liquidity and results of operations:


for our products and services may decline;


loan delinquencies, problem assets and foreclosures may increase;


collateral for loans, especially real estate, may decline in value, thereby reducing customers' future borrowing power, and reducing the value of assets and collateral associated with existing loans;


the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and


the balance of our low-cost or non-interest-bearing deposits may decrease.

Many of the loans in our portfolio are secured by real estate. Deterioration in the markets where collateral for a mortgage loan is located could negatively affect the borrower's ability to repay the loan and the value of the collateral securing the loan. Decreases in asset quality have required and may require further additions to our allowance for loan losses through increased provisions for loan losses, which would hurt our profits. Also, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, governmental rules or policies and natural disasters.

Adverse changes in the regional and general economy could reduce our planned growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.

Our small size makes it more difficult for us to compete.

Our small asset size makes it more difficult to compete with other financial institutions which are generally larger and can more easily afford to invest in the marketing and technologies needed to attract and retain customers. Because our principal source of income is the net interest income we earn on our loans and investments after deducting interest paid on deposits and other sources of funds, our ability to generate the revenues needed to cover our expenses and finance such investments is limited by the size of our loan and investment portfolios. Accordingly, we are not always able to offer new products and services as quickly as our competitors. Our ability to originate larger loans is limited by our lower loans to one borrower limit, which reduces our ability to compete for certain types of loans and can reduce our interest income. Our lower earnings also make it more difficult to offer competitive salaries and benefits. In addition, our smaller customer base makes it difficult to generate meaningful non-interest income. Finally, as a smaller institution, we are disproportionately affected by the ongoing increased costs of compliance with banking and other regulations.

Future expansion may negatively impact our earnings.

We consider our primary market area to consist of Washington, Lawrence, Orange and Floyd counties, Indiana. We currently operate three branches with our headquarters located in Salem, Indiana and two additional branch locations in Orleans and Mitchell, Indiana and a loan production office in New Albany, Indiana. Although we do not currently have any specific plans for expansion, in the future we may consider expanding our presence throughout our market area and may also decide to pursue further expansion through the establishment of one or more branches or additional loan production offices, including within Louisville, Kentucky. The profitability of any expansion policy will depend on whether the income that we generate from the additional branches or loan production offices we may establish will offset the increased expenses resulting from operating new branches. It may take a period of time before any new branches or loan production offices would become profitable, especially in areas in which we do not have an established presence. During this period, operating any new branches or loan production offices would likely have a negative impact on our net income.


39

The loss of any one of our senior executive officers could hurt our operations.

We rely heavily on our senior executive officers. The loss of any one of these officers could have an adverse effect on us because, as a small community bank, each of these officers has more responsibilities than would be typical at a larger financial institution with more employees. In addition, as a small community bank, we have fewer management level personnel who are in a position to assume the responsibilities of such officers' positions with us should we need to find replacements for any of these senior members of management. 

Our business strategy includes growth, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively. Growing our operations could also cause our expenses to increase faster than our revenues.

Our business strategy includes growth in assets, deposits and the scale of our operations. Achieving such growth will require us to attract customers that currently bank at other financial institutions in our market area. Our ability to successfully grow will depend on a variety of factors, including our ability to attract and retain experienced bankers, the continued availability of desirable business opportunities, competition from other financial institutions in our market area and our ability to manage our growth.  Growth opportunities may not be available or we may not be able to manage our growth successfully. If we do not manage our growth effectively, our financial condition and operating results could be negatively affected. Furthermore, there can be considerable costs involved in opening branches or loan production offices and expanding lending capacity, and generally a period of time is required to generate the necessary revenues to offset these costs, especially in areas in which we do not have an established presence. Accordingly, any such business expansion can be expected to negatively impact our earnings until certain economies of scale are reached. Our expenses could be further increased if we encounter delays in the opening of new branches or loan production offices.

We are subject to interest rate risk which could reduce our profitability and affect the value of our assets.

Our earnings and cash flows are largely dependent upon our net interest income.  Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve.  Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities and (iii) the average duration of our mortgage-backed securities portfolio and other interest-earning assets.  If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected.  Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. 

A sustained increase in market interest rates could adversely affect our earnings. A significant portion of our loans have fixed interest rates and longer terms than our deposits and borrowings. As a result of the relatively low interest rate environment, an increasing percentage of our deposits have been comprised of certificates of deposit and other deposits yielding no or a relatively low rate of interest having a shorter duration than our assets. At December 31, 2019, we had $31.3 million in certificates of deposit that mature within one year and $17.8 million in non-interest-bearing demand deposits. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. Our net interest income could be adversely affected if the rates we pay on deposits and borrowings increase more rapidly than the rates we earn on loans. In addition, a substantial amount of our home equity lines of credit have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising interest rate environment

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet.  For additional information see Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management.”

40

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

Liquidity is essential to our business.  An inability to raise funds through deposits, borrowings, the sale of loans or other sources could have a substantial negative effect on our liquidity.  Our access to funding sources in amounts adequate to finance our activities or the terms of which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general.  Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the Indiana markets in which our loans are concentrated or adverse regulatory action against us.  Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.  Deposit flows, calls of investment securities and wholesale borrowings, and the prepayment of loans and mortgage-related securities are also strongly influenced by such external factors as the direction of interest rates, whether actual or perceived, and competition for deposits and loans in the markets we serve. Furthermore, changes to the underwriting guidelines of the FHLB, for wholesale borrowings or lending policies may limit or restrict our ability to borrow, and could therefore have a significant adverse impact on our liquidity. A decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or to fulfill such obligations as repaying our borrowings or meeting deposit withdrawal demands.

Strong competition within our market area may limit our growth and profitability.
 
We face substantial competition in all phases of our operations from a variety of different competitors.  Our future growth and success will depend on our ability to compete effectively in this highly competitive environment.  To date, we have been competitive by focusing on our business lines in our market area and emphasizing the high level of service and responsiveness desired by our customers.  We compete for loans, deposits and other financial services with other commercial banks, thrifts, credit unions, brokerage houses, mutual funds, insurance companies and specialized finance companies, including “FinTech” companies.  Many of our competitors offer products and services which we do not offer, and many have substantially greater resources and lending limits, name recognition and market presence that benefit them in attracting business.  In addition, larger competitors may be able to price loans and deposits more aggressively than we do, and newer competitors may also be more aggressive in terms of pricing loan and deposit products than we are in order to obtain a share of the market.  Some of the financial institutions and financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies, federally insured state-chartered banks and national banks and federal savings banks.  As a result, these nonbank competitors have certain advantages over us in accessing funding and in providing various services. Our profitability depends upon our continued ability to successfully compete in our market area.  The greater resources and deposit and loan products offered by some of our competitors may limit our ability to increase our interest earning assets.

Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.

Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms, or that any underlying collateral will not be sufficient to assure repayment.  This risk is affected by, among other things:

 cash flow of the borrower and/or the project being financed;

 the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;

 the duration of the loan;

 the character and creditworthiness of a particular borrower; and

 changes in economic and industry conditions.


41

We maintain an allowance for loan losses, which we believe is an appropriate reserve to provide for probable losses in our loan portfolio.  The allowance is funded by provisions for loan losses charged to expense.  The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to:

our general reserve, based on our historical default and loss experience, certain macroeconomic factors, and management's expectations of future events;

our specific reserve, based on our evaluation of non-performing loans and their underlying collateral; and

an unallocated reserve to provide for other credit losses inherent in our portfolio that may not have been contemplated in the other loss factors.

The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes.  Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.  In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management.  In addition, if charge-offs in future periods exceed the allowance for loan losses we will need additional provisions to replenish the allowance for loan losses.  Any additional provisions will result in a decrease in net income and possibly capital, and may have a material adverse effect on our financial condition and results of operations.

A new accounting standard may require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.

The Financial Accounting Standards Board has adopted a new accounting standard referred to as Current Expected Credit Loss, or CECL, which will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans and recognize the expected credit losses as allowances for credit losses. This will change the current method of providing allowances for credit losses only when they have been incurred and are probable, which may require us to increase our allowance for loan losses, and may greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for credit losses.  This accounting pronouncement is expected to be applicable to us as an emerging growth company, for fiscal years beginning after December 15, 2022 and for interim reporting periods beginning after December 15, 2022.  We are evaluating the impact the CECL accounting model will have on our accounting, but expect to recognize a onetime cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective. We cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results of operations. The federal banking regulators, including the Federal Reserve, OCC and the FDIC, have adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its regulatory capital. For more on this new accounting standard, see Note 1 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.

Impairment of our investment securities could require charges to earnings, which could result in a negative impact on our results of operations.

In assessing the impairment of investment securities, we consider the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuers, whether the decline in market value was affected by macroeconomic conditions and whether we have the intent to sell the security or will be required to sell the security before its anticipated recovery.  During years ended December 31, 2019 and 2018, we did not recognize any non-cash OTTI charges. There can, however, be no assurance that future declines in market value of our investment securities will not result in OTTI of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.


42

Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.

The USA PATRIOT and Bank Secrecy Acts and related regulations require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury's Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions, including restrictions on pursuing acquisitions or establishing new branches. The policies and procedures we have adopted that are designed to assist in compliance with these laws and regulations may not be effective in preventing violations of these laws and regulations.
 
We continually encounter technological change, and we may have fewer resources than our competitors to continue to invest in technological improvements.

The financial services industry continues to undergo rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to serving customers better, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success may depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We cannot assure you that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

In October 2019, we upgraded our core processing system with the objective to improve internal reporting capabilities for both management and the board of directors and create a scalable corporate infrastructure that will significantly expand our ability to handle continued growth and improve our levels of operational efficiency.  Further, our new system will enhance our capabilities and capacity to offer new products and services for loan and deposit customers and will enable us to offer more state-of-the-art technology-based services and delivery channels such as remote deposit capture and other business banking services.  As a result of this conversion, we recognized approximately $389,000 in several one-time expenses related to contract termination expenses.  We do not anticipate any additional contract termination and deconversion expenses to be recognized in the future.

We rely on other companies to provide key components of our business infrastructure.

We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations. We also could be adversely affected to the extent such an agreement is not renewed by the third-party vendor or is renewed on terms less favorable to us.  Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties.  Disruptions or failures in the physical infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.

We are subject to certain risks in connection with our use of technology.

Our security measures may not be sufficient to mitigate the risk of a cyber-attack. Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks.


43

Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation of service attacks, misuse, computer viruses, malware or other malicious code and cyber-attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our customers’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.

Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation. Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions. Any compromise of our security could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. Although we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, these precautions may not protect our systems from compromises or breaches of our security measures, and could result in losses to us or our customers, our loss of business and/or customers, damage to our reputation, the incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties, or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.

Our security measures may not protect us from system failures or interruptions. While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. While we select third-party vendors carefully, we do not control their actions. If our third-party providers encounter difficulties including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. We may not be insured against all types of losses as a result of third-party failures and insurance coverage may be inadequate to cover all losses resulting from breaches, system failures or other disruptions. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations.

The board of directors oversees the risk management process, including the risk of cybersecurity, and engages with management on cybersecurity issues.


44

Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.

As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customers’ information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation.  Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts.  Nationally, reported incidents of fraud and other financial crimes have increased.  We have also experienced losses due to apparent fraud and other financial crimes.  While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.

We are subject to environmental liability risk associated with lending activities or properties we own.

A significant portion of our loan portfolio is secured by real estate, and we could become subject to environmental liabilities with respect to one or more of these properties, or with respect to properties that we own in operating our business. During the ordinary course of business, we may foreclose on and take title to properties securing defaulted loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous conditions or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage, civil fines and criminal penalties regardless of when the hazardous conditions or toxic substances first affected any particular property. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property's value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Our policies, which require us to perform an environmental review before initiating any foreclosure action on non-residential real property, may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on us.

Because we have elected to use the extended transition period for complying with new or revised accounting standards for an emerging growth company, our financial statements may not be comparable to companies that comply with these accounting standards as of the public company effective dates.

We have elected to use the extended transition period for complying with new or revised accounting standards under Section 7(a)(2)(B) of the Securities Act. This election allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with these accounting standards as of the public company effective dates. Because our financial statements may not be comparable to companies that comply with public company effective dates, investors may have difficulty evaluating or comparing our business, financial results or prospects in comparison to other public companies, which may have a negative impact on the value and liquidity of our common stock. We cannot predict if investors will find our common stock less attractive because we plan to rely on this exemption. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

Item 1B. Unresolved Staff Comments

None.

Item 2.  Properties

At December 31, 2019, we had our main office that includes a full-service branch and two full-service branches and a loan production office with an aggregate net book value of $1.9 million.  All of our offices are owned except for the loan production office which we lease.  The operating leases require us to pay property taxes and operating expenses on the properties.  See also Note 7 of the Notes to Consolidated Financial Statements for additional information.  In the opinion of management, the facilities are adequate and suitable for our current needs.  We may open additional banking offices to better serve current customers and to attract new customers in subsequent years.


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Item 3.  Legal Proceedings

Periodically, there have been various claims and lawsuits involving the Company, such as claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Company’s business. The Company is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition, results of operations or liquidity of the Company.

Item 4.  Mine Safety Disclosures

Not applicable.








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PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

At December 31, 2019, there were 3,565,430 shares of Company common stock issued and 3,557,728 shares of the Company common stock outstanding, 295 stockholders of record and an estimated 574 holders in nominee or “street name.”

Our cash dividend payout policy is reviewed regularly by management and the board of directors.  Our board of directors has declared quarterly cash dividends on our common stock for six consecutive quarters.  Any dividends declared and paid in the future would depend upon a number of factors, including capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions.  No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in future periods.  Our future payment of dividends may depend, in part, upon receipt of dividends from the Bank, which are restricted by federal regulations.

Stock Repurchase

The Company’s board of directors approved its first stock repurchase program in July 2019 pursuant to which the Company may repurchase up to 178,260 shares of its common stock.  The repurchase program may be suspended, terminated or modified at any time for any reason, including market conditions, the cost of repurchasing shares, the availability of alternative investment opportunities, liquidity, and other factors deemed appropriate.  The repurchase program does not obligate the Company to purchase any particular number of shares.  The following table sets forth information with respect to our repurchases of our outstanding common shares during the three months ended December 31, 2019:
 
Total Number
of Shares
Purchased (1)
 
Average Price
Paid per Share
 
Total number of
shares purchased
as part of
publicly
announced plans
or programs
 
Maximum number
of shares that may
yet be purchased
under the plans or
programs
October 1, 2019 – October 31, 2019
9,500
   
$
13.20
   
9,500
   
144,660
 
November 1, 2019 – November 30, 2019
4,800
   
13.25
   
4,800
   
139,860
 
December 1, 2019 – December 31, 2019
-
   
-
   
-
   
139,860
 
Total
14,300
   
$
13.22
   
14,300
       

Securities for Equity Compensation Plans

Please refer to Item 12 in this Form 10-K for a listing of securities authorized for issuance under equity compensation plans.

Item 6.  Selected Financial Data

The summary financial information presented below is derived in part from the consolidated financial statements of the Company.  The following is only a summary and you should read it in conjunction with the consolidated financial statements and notes beginning on page F-1.  The information at December 31, 2019 and 2018 and for the years ended December 31, 2019 and 2018 is derived in part from the audited consolidated financial statements of the Company that appear in this Form 10-K.  The following information is only a summary and you should read it in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and notes thereto contained elsewhere in this Form 10-K.


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December 31,
 
   
2019
 
2018
 
2017
 
               
   
(In thousands)
 
Selected Financial Condition Data:
             
Total assets
 
$ 208,436
 
$ 200,662
 
$ 176,677
 
Cash and cash equivalents
 
18,817
 
12,700
 
7,464
 
Loans receivable, net(1)
 
123,272
 
126,293
 
114,896
 
Investment securities available-for-sale,
  at fair value
 
58,417
 
53,140
 
45,716
 
Investment securities, held to maturity
 
42
 
100
 
163
 
Deposits
 
146,969
 
151,108
 
151,893
 
Borrowings
 
10,000
 
-
 
-
 
Total stockholders’ equity
 
50,813
 
48,843
 
24,154
 


   
Years Ended December 31,
 
   
2019
 
2018
 
2017
 
               
   
(In thousands)
 
Selected Operations Data:
             
Interest income
 
$  8,000
 
$  7,276
 
$  6,478
 
Interest expense
 
925
 
729
 
655
 
Net interest income
 
7,075
 
6,547
 
5,823
 
Provision for loan losses (recapture)
 
12
 
(200)
 
(700)
 
Net interest income after provision
             
    for loan losses
 
7,063
 
6,747
 
6,523
 
Noninterest income
 
803
 
840
 
884
 
Noninterest expenses
 
6,821
 
5,879
 
5,252
 
Income before income taxes
 
1,045
 
1,708
 
2,155
 
Income tax expense
 
85
 
295
 
982
 
  Net income
 
$     960
 
$   1,413
 
$   1,173
 

 (1)  Net of allowances for loan losses, loans in process and deferred loan fees.




48


   
At or For the
 
   
Years Ended December 31,
     
   
2019
 
2018
 
2017
   
               
Selected Financial Ratios and Other Data:
             
Performance ratios:
             
  Return on average assets
 
0.47
%
0.74
%
0.67
%
  Return on average stockholders’ equity
 
1.92
 
4.51
 
5.10
 
  Interest rate spread(1)
 
3.52
 
3.48
 
3.40
 
  Net interest margin(2)
 
3.73
 
3.60
 
3.50
 
  Efficiency ratio(3)
 
86.6
 
79.6
 
78.3
 
  Average interest-earning assets to average
             
     interest-bearing liabilities
 
144.6
 
130.0
 
125.1
 
  Total loans to deposits ratio
 
84.9
 
84.6
 
76.8
 
  Average stockholders’ equity to average assets
 
24.6
 
16.3
 
13.1
 
  Stockholders’ equity to total assets at end of period
 
24.4
 
24.3
 
13.7
 
               
Capital ratios:
             
Total risk-based capital (to risk-weighted assets)
 
33.4
 
31.9
 
23.4
 
Tier 1 core capital (to risk-weighted assets)
 
32.2
 
30.7
 
22.1
 
Common equity Tier 1 (to risk-weighted assets)
 
32.2
 
30.7
 
22.1
 
Tier 1 leverage (to average adjusted total assets)
 
17.9
 
18.0
 
13.5
 
               
Asset quality ratios:
             
  Allowance for loan losses as a percent of total loans
 
1.2
 
1.2
 
1.5
 
  Allowance for loan losses as percent of non-
    performing loans
 
126.7
 
116.0
 
91.7
 
  Net charge-offs to average outstanding loans
   during the period
 
0.0
 
0.0
 
0.1
 
  Non-performing loans as a percent of total loans
 
0.9
 
1.0
 
1.6
 
  Non-performing assets as a percent of total assets(4)
 
0.6
 
0.6
 
1.2
 
               
Other data:
             
  Number of full-service offices
 
3
 
3
 
3
 
  Full-time equivalent employees
 
42
 
43
 
38
 
_________________________________
(1)
Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of funds on average interest-bearing liabilities. Tax exempt income is reported on a tax equivalent basis using a federal marginal tax rate of 21% for both years ended December 31, 2019 and 2018 and 34% for the year ended December 31, 2017.
(2)
Represents net interest income as a percent of average interest-earning assets. Tax exempt income is reported on a tax equivalent basis using a federal marginal tax rate of 21% for both years ended December 31, 2019 and 2018 and 34% for the year ended December 31, 2017.
(3)
Represents non-interest expense divided by the sum of net interest income and total non-interest income.
(4)
Non-performing assets consists of non-performing loans (which include non-accruing loans and accruing loans more than 90 days past due), and foreclosed real estate.


49


Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Our principal business consists of attracting retail deposits from the general public and investing those funds, along with borrowed funds, in loans secured by first and second mortgages on one- to four-family residences (including home equity loans and lines of credit), commercial and multifamily, consumer and commercial business loans and, to a lesser extent, construction and land loans.  We offer a wide variety of consumer loan products, including automobile loans, boat loans, manufactured homes not secured by permanent dwellings and recreational vehicle loans.  We intend to continue emphasizing our residential mortgage, home equity and consumer lending, while also expanding our emphasis in commercial and multifamily and commercial business lending.

Our operating revenues are derived principally from earnings on interest earning assets, service charges and fees.  Our primary sources of funds are deposits, FHLB advances and other borrowings, and payments received on loans and securities.  We offer a variety of deposit accounts that provide a wide range of interest rates and terms, generally including savings, money market, term certificate and checking accounts.  Our noninterest expenses consist primarily of salaries and employee benefits, expenses for occupancy, marketing and computer services and FDIC deposit insurance premiums.  Salaries and benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits.  Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of lease payments, property taxes, depreciation charges, maintenance and costs of utilities.

Our strategic plan targets individuals, small and medium size businesses in our market area for loan and deposit growth.  In pursuit of these goals, and while managing the size of our loan portfolio, we focused on including a significant amount of commercial business and commercial and multifamily loans in our portfolio. A significant portion of these commercial and multifamily and commercial business loans have adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages.  Our commercial loan portfolio (commercial and multifamily real estate, commercial construction and commercial business loans) increased to $50.9 million, or 40.8% of our total loan portfolio at December 31, 2019, from $45.2 million or 35.4% of our total loan portfolio, at December 31, 2018.  The impact of additional commercial and multifamily, commercial construction and commercial business loans has had a positive impact on our interest income and has helped to further diversify our loan portfolio mix.  In particular, our emphasis on commercial real estate, commercial real estate construction and commercial business loans has increased our commercial loan portfolio.  At December 31, 2019, our commercial real estate and commercial real estate construction portfolios totaled $35.2 million, which represents a 9.1% increase since December 31, 2018.  At December 31, 2019, our commercial business loans were $6.5 million, which represents an 8.7% increase since December 31, 2018.

Our primary market area is in Washington, Lawrence, Orange and Floyd counties, Indiana.  Adverse economic conditions in our market area can reduce our rate of growth, affect our customers’ ability to repay loans and adversely impact our financial condition and earnings.  Weak economic conditions and ongoing strains in the financial and housing markets in portions of the United States, including our market area, have presented an unusually challenging environment for banks and their holding companies, including us.  This has been particularly evident in our need to provide for credit losses during these periods at significantly higher levels than our historical experience and has also adversely affected our net interest income and other operating revenues and expenses.

Business Strategy

We intend to operate as a well-capitalized and profitable community bank dedicated to providing exceptional personal service to our individual and business customers. We believe that we have a competitive advantage in the markets we serve because of our knowledge of the local marketplace and our long-standing history of providing superior, relationship-based customer service. Our current executive management team is comprised of individuals with strong banking backgrounds.  Erica B. Schmidt, our Executive Vice President and Chief Financial Officer, joined Mid-Southern Savings Bank in 2005. In December 2013, Alexander Babey joined Mid-Southern Savings Bank as Executive Vice President and Chief Credit Officer, and we appointed him as our President and Chief Executive Officer in October 2016. In June 2014, we hired Frank (Buzz) Benson, III as Executive Vice


50

President and Senior Loan Officer.  The management team has worked to revise our business strategy and position Mid-Southern Savings Bank for future growth and profitability.

Our current business strategy consists of the following:

Continuing to emphasize the origination of one- to four-family residential mortgage loans. We have been and will continue to be a significant one-to-four family residential mortgage lender to borrowers in our market area. As of December 31, 2019, $71.6 million, or 34.4%, of our total assets consisted of one- to four-family residential mortgage loans. We historically have held all of our loan originations, including our fixed-rate one-to four-family residential mortgage loans, in our loan portfolio, however, beginning in October 2019 we began brokering one-to-four family residential mortgage loans..

Increasing commercial and multi-family real estate and commercial business lending. In order to increase the yield on our loan portfolio and reduce the term to repricing, our new management team began to increase our commercial and multi-family real estate and commercial business loan portfolios while maintaining what we believe are conservative underwriting standards. We focus our commercial lending to small businesses located in our market area, targeting owner occupied businesses such as manufacturers and professional service providers. Our commercial and multifamily real estate and commercial business loan portfolios have grown to $41.6 million and $6.5 million, respectively, at December 31, 2019.

Increasing our lower-cost core deposits. NOW, Demand, savings and money market accounts are a lower cost source of funds than certificates of deposit, and we have made a concerted effort to increase these lower-cost transaction deposit accounts. We plan to continue to market our core transaction accounts, emphasizing our high-quality service and competitive pricing of these products. We also offer the convenience of technology-based products, such as bill pay, internet and mobile banking.

Managing credit risk to maintain a low level of non-performing assets. We believe strong asset quality is a key to our long- term financial success. Our strategy for credit risk management focuses on having an experienced team of credit professionals, well-defined policies and procedures, appropriate loan underwriting criteria and active credit monitoring. Our non-performing assets to total assets ratio was 0.6% at both December 31, 2019 and 2018. At December 31, 2019, we had $947,000 of non-performing one-to four-family residential loans and $235,000 in non-performing commercial real estate loans.

Growing organically and through opportunistic branch acquisitions. We expect to consider both organic growth as well as acquisition opportunities that we believe would enhance the value of our franchise and yield potential financial benefits for our stockholders. We expect to focus our growth in our primary market areas and Louisville, Kentucky. We will consider expanding our branch network through the acquisition of other financial institutions, opening of additional branches or loan production offices or the acquisition of branches if the right opportunity occurs.

Summary of Significant Accounting Policies

The discussion and analysis of the financial condition and results of operations are based on our financial statements, which are prepared in conformity with U.S. GAAP. The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be significant accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.


51

The JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected to take advantage of this extended transition period, which means that the financial statements included in this annual report on Form 10-K, as well as any financial statements that we file in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as we remain an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period under the JOBS Act.

The following represent our significant accounting policies:

Allowance for Loan Losses. The allowance for loan losses represents management's estimate of losses inherent in the loan portfolio as of the date of the statement of condition and it is recorded as a reduction of loans.  The allowance is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan and the entire allowance is available to absorb all loan losses.

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified impaired, an allowance is established when the discounted cash flows or collateral value of the impaired loan are lower than the carrying value of that loan.

The general component covers pools of loans, by loan class, including commercial loans not considered impaired, as well as smaller balance homogenous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based on historical loss rates for each of these categories of loans, which are adjusted for qualitative factors. The qualitative factors include:

Lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices;

National, regional and local economic and business conditions as well as the condition of various market segments, including the value of underlying collateral for collateral dependent loans;

Nature and volume of the portfolio and terms of the loans;

Experience, ability and depth of the lending management and staff;

Volume and severity of past due, classified and non-accrual loans, as well as other loan modifications; and

Quality of our loan review system and the degree of oversight by our board of directors.

Each factor is assigned a value to reflect improving, stable or declining conditions based on management's best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss analysis and calculation.


52

An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

In addition, various bank regulatory agencies periodically review the allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs based on their judgment about information available to them at the time of their examination.

Income Taxes. Income taxes are provided for the tax effects of certain transactions reported in the consolidated financial statements. Income taxes consist of taxes currently due plus deferred taxes related primarily to temporary differences between the financial reporting and income tax basis of the allowance for loan losses, premises and equipment, certain state tax credits, and deferred loan origination costs. The deferred tax assets and liabilities represent the future tax return consequences of the temporary differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Estimation of Fair Values. Fair values for securities available-for-sale are obtained from an independent third-party pricing service. Where available, fair values are based on quoted prices on a nationally recognized securities exchange. If quoted prices are not available, fair values are measured using quoted market prices for similar benchmark securities. Management generally makes no adjustments to the fair value quotes provided by the pricing source. The fair values of foreclosed real estate and the underlying collateral value of impaired loans are typically determined based on evaluations by third parties, less estimated costs to sell. When necessary, appraisals are updated to reflect changes in market conditions.

Comparison of Financial Condition at December 31, 2019 and December 31, 2018

Cash and Cash Equivalents.  At December 31, 2019 and 2018, cash and cash equivalents totaled $18.8 million and $12.7 million, respectively.  Cash and cash equivalents increased primarily from excess funds provided by a $10.0 million advance from the FHLB.  We have focused on investing excess liquidity in higher yielding loans and investment securities in an effort to increase net interest income.

Loans.  Our primary lending activity is the origination of loans secured by real estate.  We originate one-to-four family residential loans, multifamily residential loans, commercial real estate loans and construction loans.  To a lesser extent, we originate commercial business loans and consumer loans.  In August 2016, we opened a loan production office in New Albany, Indiana as part of our effort to increase our business lending and diversify the loan portfolio.  Net loans receivable decreased $3.0 million, or 12.4%, to $123.3 million at December 31, 2019 from $126.3 million at December 31, 2018.  The decrease in net loans receivable was due primarily to decreases in one-to-four family residential loans and construction loans partially offset by increases in commercial real estate, multi-family residential and commercial business loans.

One-to-four family residential loans comprise the largest segment of our loan portfolio.  At December 31, 2019, these loans totaled $71.6 million, or 57.4% of total loans, compared to $80.3 million, or 62.9% of total loans, at December 31, 2018.   The Bank originates both fixed and adjustable rate one-to-four family residential loans.  We have recently increased our efforts to originate adjustable rate one-to-four family residential loans and originated $7.5 million and $14.7 million of adjustable rate loans in 2019 and 2018, respectively.  Management intends to continue its focus on offering adjustable rate mortgage loans at attractive rates.

Multifamily residential mortgage loans totaled $9.3 million, or 7.4% of total loans, at December 31, 2019 compared to $7.1 million, or 5.5% of total loans at December 31, 2018.  The total balance of


53

multifamily real estate loans has increased over the past year due to a concerted effort to originate this type of loan.

Commercial real estate loans totaled $32.3 million, or 25.9% of total loans, at December 31, 2019 compared to $27.2 million, or 21.3% of total loans, at December 31, 2018.  During 2019 and 2018, we originated $5.7 million and $7.6 million, respectively, of commercial real estate loans with an emphasis on adjustable rate loans.

Our construction loan portfolio consists of residential and commercial construction loans.  Construction loans totaled $3.2 million, or 2.6% of total loans (excluding unfunded construction loan commitments of $1.8 million), at December 31, 2019, compared to $5.1 million, or 4.0% of total loans (excluding $2.1 million of construction loans in process), at December 31, 2018.  Commercial construction loan originations decreased to $2.7 million during 2019 from $10.9 million in 2018.

Commercial business loans totaled $6.5 million, or 5.2% of total loans at December 31, 2019, compared to $5.9 million, or 4.6% of total loans, at December 31, 2018.   During 2019 and 2018, we originated commercial business loans of $2.3 million and $5.7 million, respectively.

Consumer loans totaled $1.9 million, or 1.5% of total loans at December 31, 2019, compared to $2.2 million, or 1.7% of total loans, at December 31, 2018. Originations of consumer loans were $1.0 million in 2019 compared to $1.6 million in 2018.

Securities Available for Sale.  Our available for sale securities portfolio consists primarily of U.S. government agency debt securities, including mortgage-backed securities and collateralized mortgage obligations, and municipal obligations.  Available for sale securities increased by $5.3 million, or 10.0%, to $58.4 million at December 31, 2019 from $53.1 million at December 31, 2018.  Investment securities increased primarily due to purchases of non-taxable municipal and mortgage-backed available for sale securities of $8.6 million and $4.0 million, respectively, and a $1.9 million increase in the net unrealized gain on available for sale securities, which were partially offset by $8.8 million in principal repayments and maturities of available for sale securities.  The increase in available for sale securities during 2019 was primarily funded by an advance from the FHLB. During 2019, we continued our strategy to increase our investment in municipal obligations as a component of our available for sale securities portfolio due to their higher tax-equivalent yield.  At December 31, 2019, our investment in municipal obligations was $37.9 million compared to $28.7 million at December 31, 2018.

Securities Held to Maturity.  Our held to maturity securities portfolio consists primarily of U.S. government agency mortgage-backed securities, as well as municipal obligations.  Held to maturity securities decreased $58,000 for the year ended December 31, 2019.  The decrease during 2019 was due to principal repayments on mortgage-backed securities and maturities of municipal obligations.  We have not purchased investment securities as held to maturity during the past three years.

Premises and Equipment.  Premises and equipment were $1.9 million at both December 31, 2019 and 2018. See Note 7 of the Notes to Consolidated Financial Statements contained in Item 8 of this report for further information.

Other Assets.  Other assets decreased $493,000 to $442,000 at December 31, 2019 from $935,000 at December 31, 2018 primarily due to a decrease in the net deferred tax asset during 2019.

Deposits.  Deposit accounts, primarily obtained from individuals and businesses throughout our local market area, are the primary source of funds for our lending and investments.  Our deposit accounts are comprised of noninterest-bearing checking, interest-bearing checking, savings, and money market accounts and certificates of deposit.  Deposits decreased $4.1 million or 2.7%, during the year ended December 31, 2019, primarily as a result of decreases in interest bearing checking, savings and money market accounts.


54

Borrowings.   The Company borrowed $10.0 million from the FHLB which matures on June 27, 2024 and bears interest at a rate of 1.73%.  The Company had no outstanding borrowings at December 31, 2018.
Stockholders’ Equity.   Stockholders’ equity increased $2.0 million to $50.8 million at December 31, 2019 from $48.8 million at December 31, 2018.  The increase was primarily due to an increase in accumulated other comprehensive income, net of tax, of $1.5 million primarily due to improvements in the fair market value of our available-for-sale investments, net income of $960,000 and stock-based compensation of $329,000 for the year ended December 31, 2019.  These increases were partially offset by the purchase of 38,400 treasury shares at an average cost per share of $12.93 or $497,000 in total due to the Company’s implementation of a stock repurchase program in August 2019 and cash dividends paid of $269,000.





55

Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities respectively, for the periods presented. Average balances are calculated using daily balances. Nonaccrual loans are included in average daily balances only. Loan fees are included in interest income on loans and are not material. Tax exempt income on loans and investment securities has been calculated on a tax equivalent basis using a federal marginal tax rate of 21% for the years ended December 31, 2019 and 2018 and using a federal marginal tax rate of 34% for the year ended December 31, 2017.  Weighted average yields for tax exempt loans and investment securities at December 31, 2019 have been calculated on a tax equivalent basis using a federal marginal tax rate of 21%.

   
At
 
Years Ended December 31,
   
December 31,
 
2019
 
2018
 
2017
   
Weighted Average Yield/Cost
 
Average Balance
 
Interest
 
Yield/Cost
 
Average Balance
 
Interest
 
Yield/Cost
 
Average Balance
 
Interest
 
Yield/Cost
                                         
   
(Dollars in thousands)
Interest-earning assets:
                                       
 Interest bearing deposits with banks
 
1.40%
 
$  14,481
 
$    278
 
1.92%
 
$  14,552
 
$    236
 
1.62%
 
$    8,930
 
$     71
 
0.80%
 Loans receivable, net (1)
 
4.71
 
127,556
 
6,146
 
4.82
 
123,361
 
5,809
 
4.71
 
117,220
 
5,381
 
4.59
 Mortgage-backed securities
 
2.64
 
21,773
 
555
 
2.55
 
23,493
 
448
 
1.91
 
24,740
 
486
 
1.96
 Other investment securities
 
3.22
 
30,683
 
1,185
 
3.86
 
23,510
 
877
 
3.73
 
18,353
 
631
 
3.44
 Federal Home Loan Bank stock
 
4.25
 
778
 
42
 
5.40
 
778
 
40
 
5.14
 
778
 
33
 
4.24
    Total interest-earning assets
 
3.94%
 
195,271
 
8,206
 
4.20
 
185,694
 
7,410
 
3.99
 
170,021
 
6,602
 
3.88
                                         
Non-interest earning assets
     
7,971
         
6,222
         
5,871
       
      Total assets
     
$203,242
         
$191,916
         
$175,892
       
                                         
Interest-bearing liabilities:
                                       
 Interest-bearing checking
 
0.11%
 
$  39,903
 
44
 
0.11%
 
$  45,722
 
44
 
0.10%
 
$  35,616
 
41
 
0.12%
 Savings and money market
 
0.16
 
37,564
 
60
 
0.16
 
42,736
 
87
 
0.20
 
44,971
 
96
 
0.21
 Certificates of deposit
 
1.47
 
52,462
 
731
 
1.39
 
53,497
 
583
 
1.09
 
55,372
 
518
 
0.94
   Total deposits
 
0.68%
 
129,929
 
835
 
0.64%
 
141,955
 
714
 
0.50%
 
135,959
 
655
 
0.48%
  FHLB borrowings
 
1.73%
 
5,138
 
90
 
1.75
 
912
 
15
 
1.64
 
--
 
--
 
--
    Total interest-bearing liabilities
     
135,067
 
925
 
0.68
 
142,867
 
729
 
0.51
 
135,959
 
655
 
0.48
                                         
Non-interest-bearing liabilities
     
18,095
         
17,687
         
16,915
       
    Total liabilities
     
153,162
         
160,554
         
152,874
       
                                         
Total equity
     
50,080
         
31,362
         
23,018
       
    Total liabilities and equity
     
$203,242
         
$191,916
         
$175,892
       
Net interest income (taxable equivalent basis)
         
7,281
         
6,681
         
5,947
   
Less: taxable equivalent adjustment
         
(206)
         
(134)
         
(124)
   
Net interest income
         
$ 7,075
         
$ 6,547
         
$ 5,823
   
Net interest rate spread
             
3.52%
         
3.48%
         
3.40%
Net interest margin
             
3.73%
         
3.60%
         
3.50%
Average interest-earnings assets to average
    interest-bearing liabilities
             
144.6%
         
130.0%
         
125.1%

(1) Loan amount is net of deferred loan origination fees and costs, undisbursed loan funds and includes nonperforming loans.
56

Rate/Volume Analysis

The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities.  It distinguishes between the changes related to outstanding balances and that due to the changes in interest rates.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume).  For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.

 
Years Ended December 31,
 
2019 Compared to 2018
 
2018 Compared to 2017
 
Increase (Decrease) Due to
 
Increase (Decrease) Due to
 
Rate
 
Volume
 
Net
 
Rate
 
Volume
 
Net
 
(Dollars in thousands)
Interest income
                     
 Interest-bearing deposits with banks (1)
$   43
 
$    (1)
 
$    42
 
$  102
 
$    63
 
$  165
 Loans receivable, net
135
 
195
 
330
 
145
 
289
 
434
 Mortgage-backed securities
137
 
(30)
 
107
 
(13)
 
(25)
 
(38)
 Other investment securities
7
 
238
 
245
 
72
 
165
 
237
    Total interest-earning assets
322
 
402
 
724
 
306
 
492
 
798
                       
Interest expense:
                     
 Interest-bearing checking
--
 
--
 
--
 
(4)
 
7
 
3
 Savings and money market
(31)
 
4
 
(27)
 
(18)
 
9
 
(9)
 Certificates of deposit
159
 
(11)
 
148
 
83
 
(18)
 
65
 FHLB borrowings
1
 
74
 
75
 
--
 
15
 
15
    Total interest-bearing liabilities
129
 
67
 
196
 
61
 
13
 
74
                       
Net increase in net interest income
$  193
 
$  335
 
$  528
 
$  245
 
$  479
 
$  724
____________________
(1)  Includes interest-bearing deposits (cash) at other financial institutions.




57

Comparison of Operating Results Years Ended December 31, 2019 and 2018

Overview.  The Company reported net income of $960,000 ($0.29 per common share diluted) for the year ended December 31, 2019, compared to net income of $1.4 million ($0.41 per common share diluted) for the year ended December 31, 2018.  The significant factors that contributed to the decrease in net income for 2019 was an increase in noninterest expenses of $942,000, partially offset by an increase in net interest income after provision for loan losses of $316,000 and a decrease in income tax expense of $210,000.

Net Interest Income.  Net interest income increased $528,000, or 8.1%, to $7.1 million for 2019 from $6.5 million for 2018 primarily as the result of an increase in both the average balance of and yield earned on interest-earning assets.  The ratio of average interest-earning assets to average interest-bearing liabilities increased to 144.6% for 2019 from 130.0% for 2018.  The interest rate spread increased to 3.52% for 2019 from 3.48% for 2018.

Total interest income increased $724,000, or 10.0%, to $8.0 million for 2019 from $7.3 million for 2018.  The increase is primarily due to an increase in both the average balance of and yield earned on interest-earning assets.  The average balance of interest-earning assets increased to $195.3 million for 2019 from $185.7 million for 2018. The average tax-equivalent yield on interest-earning assets increased to 4.20% for 2019 from 3.99% for 2018 primarily due to higher market interest rates.

Interest income on loans was $6.1 million for 2019 compared to $5.8 million for 2018.  The increase was due to an increase in the average tax-equivalent yield on loans to 4.82% for 2019 from 4.71% for 2018, and an increase in average loans outstanding of $4.2 million, or 3.4%, to $127.6 million in 2019 from $123.4 million in 2018.

Interest income on investment securities increased $352,000, or 29.2%, to $1.6 million for 2019 from $1.2 million for 2018, primarily due to a 64 basis point increase in the average tax-equivalent yield on mortgage-backed securities and a $5.4 million increase in the average balance of total investment securities to $53.2 million for 2019 from $47.8 million for 2018.

Interest income on interest-bearing deposits with banks increased $42,000, or 17.8%, due to an increase in the average yield to 1.92% for 2019 from 1.62% for 2018.

Total interest expense increased $196,000, or 26.9%, due to an increase in cost of interest-bearing liabilities partially offset by a decrease in the average balance of interest-bearing liabilities.  The average cost of interest-bearing liabilities increased to 0.68% for 2019 from 0.51% for 2018.  The average balance of interest-bearing liabilities decreased $7.8 million to $135.1 million for 2019 from $142.9 million for 2018.

Provision for Loan Losses. Based on an analysis of the factors described in "Summary of Significant Accounting Policies – Allowance for Loan Losses”, the Company recognized a provision for loan losses of $12,000 for 2019 compared to a recapture of the provision for loan losses of $200,000 for 2018.  The recapture in 2018 was attributable to the continued improvement in the credit quality of the loan portfolio.  Non-performing loans decreased to $1.2 million, or 0.9% of total loans at December 31, 2019, compared to $1.3 million, or 1.0% of total loans at December 31, 2018. During the year ended December 31, 2019, net charge-offs totaled $18,000 compared to $19,000 for 2018.  Impaired loans decreased $635,000 or 20.6%, from $3.1 million at December 31, 2018 to $2.4 million at December 31, 2019. Management was successful in reducing the impaired loans though pay-offs by customers, borrower refinancing with other financial institutions and liquidating the collateral assets with minimal realized losses.

Noninterest Income.  Noninterest income decreased $37,000, or 4.4%, to $803,000 for 2019 as compared to $840,000 for 2018. The year-over-year decrease in noninterest income was primarily due to decreases of $60,000 in deposit account service charges related to overdrafts and $9,000 in other income, partially offset by an increase in ATM and debit card fee income of $26,000 and a $7,000 net gain on sale of available for sale securities.

Noninterest Expense.  Noninterest expense increased $942,000, or 16.0%, to $6.8 million for 2019 as compared to $5.9 million for 2018.  Compensation and benefits and directors’ compensation increased $185,000 and $123,000, respectively, due to the recognition of stock compensation expense for the year ended December 31, 2019 of $64,000 and $123,000, respectively.  In addition, compensation and benefits also increased due to the recognition


58

of $146,000 in ESOP compensation expense for the year ended December 31, 2019 compared to $63,000 for 2018.  Data processing expense increased $275,000 primarily driven by contract termination expenses recognized during 2019 related to the Bank’s core processing system conversion.  In October 2019, we upgraded our core processing system with the objective to improve internal reporting capabilities for both management and the board of directors and create a scalable corporate infrastructure that will significantly expand our ability to handle continued growth and improve our levels of operational efficiency.  Further, our new system will enhance our capabilities and capacity to offer new products and services for loan and deposit customers and will enable us to offer more state-of-the-art technology-based services and delivery channels such as remote deposit capture and other business banking services.  As a result of this conversion, we recognized approximately $389,000 in several one-time expenses related to contract termination expenses during 2019.  We do not anticipate any additional contract termination expenses to be recognized in the future.  Professional fees increased $198,000 compared to last year primarily due to legal and other professional services related to operating as a public company.

Income Tax Expense.  Income tax expense was $85,000 for 2019 compared to $295,000 for 2018 resulting from reductions in pre-tax income and in the effective tax rate.  The effective tax rate for 2019 decreased to 8.1% compared to 17.3% for 2018 due largely to increased tax-exempt investment income proportionate to overall pre-tax income.  See Note 11 of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information.

Liquidity

Liquidity management is both a daily and longer-term function of management.  Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds.  On a longer-term basis, we maintain a strategy of investing in various lending products and investment securities, including municipal and mortgage-backed securities.  We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments.

We maintain cash and investments that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operation and meet demands for customer funds (particularly withdrawals of deposits).  At December 31, 2019 and 2018, we had $77.2 million and $65.8 million, respectively, in cash and investment securities available for sale generally available for our cash needs.  We can also obtain funds from borrowings, primarily FHLB advances.   At December 31, 2019, we had $10.0 million in FHLB advances outstanding and the ability to borrow an additional $15.0 million in FHLB advances, subject to certain collateral requirements.  We are required to have enough cash and investments that qualify as liquid assets in order to maintain sufficient liquidity to ensure safe and sound operations.  Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.  Historically, we have maintained liquid assets above levels believed to be adequate to meet the requirements of normal operations, including potential deposit outflows.  Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.

Liquidity management involves the matching of cash flow requirements of customers, who may be either depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs and our ability to manage those requirements.  We strive to maintain an adequate liquidity position by managing the balances and maturities of interest-earning assets and interest-bearing liabilities so that the balance we have in short-term investments at any given time will cover adequately any reasonably anticipated, immediate need for funds.  Additionally, we maintain relationships with correspondent banks, which could provide funds on short-term notice if needed.  Our liquidity, represented by cash and cash-equivalents, is a product of our operating, investing and financing activities.

Our liquidity, represented by cash and cash equivalents and investment securities, is a product of our operating, investing and financing activities.  Our primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other short-term investments and funds provided from operations.  While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates,

59

which provide liquidity to meet lending requirements.  We also generate cash through borrowings.  We utilize FHLB advances to leverage our capital base and provide funds for our lending and investment activities, and to enhance our interest rate risk management.

We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments.  At December 31, 2019, the approved outstanding loan commitments, including unused lines and letters of credit, amounted to $13.8 million.  Certificates of deposit scheduled to mature in one year or less at December 31, 2019, totaled $31.3 million.  It is management’s policy to manage deposit rates that are competitive with other local financial institutions.  Based on this management strategy, we believe that a majority of maturing deposits will remain with us.










60

Commitments and Off-Balance Sheet Arrangements

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers. For information regarding our commitments and off-balance sheet arrangements, see Notes 15 and 16 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10 K.

The following table summarizes our commitments and contingent liabilities with off-balance sheet risks as of December 31, 2019:

 
Total
Amounts
Committed
 
 
Due in
One
Year
 
       
 
(In Thousands)
       
Commitments to originate loans
     
    Fixed rate
$         --
 
$       --
    Adjustable rate
2,869
 
2,869
Undisbursed balance of commercial and
    personal lines of credit
9,162
 
--
Undisbursed balance of commercial
    construction loans
1,508
 
--
Undisbursed balance of residential
    construction loans
252
 
--
Standby letters of credit
--
 
--
 
$ 13,791
 
$ 2,869






61

Capital

Mid-Southern Savings Bank is subject to minimum capital requirements imposed by regulations of the OCC.  Based on its capital levels at December 31, 2019, Mid-Southern Savings Bank exceeded these requirements as of that date.  Consistent with our goals to operate a sound and profitable organization, our policy is for Mid-Southern Savings Bank to maintain a “well-capitalized” status under the regulatory capital categories of the OCC.  Based on capital levels at December 31, 2019, Mid-Southern Savings Bank was considered to be well-capitalized.  Management monitors the capital levels to provide for current and future business opportunities and to maintain Mid-Southern Savings Bank’s “well-capitalized” status. See Item 1. “Business-Regulation-Federal Regulation of Savings Institutions-Capital Requirements.” and Note 15 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional details on Mid-Southern Savings Bank's regulatory capital requirements.

The following table shows the capital ratios of Mid-Southern Savings Bank at December 31, 2019 (dollars in thousands):
 
Actual
 
Minimum Capital
Requirements
 
Minimum Required
to Be Well-
Capitalized
Under Prompt
Corrective
Action Provisions
 
 
Amount
  
Ratio
  
Amount
  
Ratio
  
Amount
 
Ratio
 
Tier 1 Capital to total adjusted assets(1)
$37,562
 
17.9
%
$  8,401
 
4.00
%
$ 10,501
 
5.00
%
Tier 1 Capital to risk-weighted assets(2)
37,562
 
32.2
 
9,919
 
8.50
 
9,335
 
8.00
 
Total Capital to risk-weighted assets(2)
39,021
 
33.4
 
12,253
 
10.50
 
11,669
 
10.00
 
Common Equity Tier 1 (to risk-weighted assets) (2)
37,562
 
32.2
 
8,168
 
7.00
 
7,585
 
6.50
 

(1)
Based on total adjusted assets of $210.0 million.
(2)
Based on risk-weighted assets of $116.7 million.

For a bank holding company with less than $3.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company’s subsidiary banks to be well capitalized under the prompt corrective action regulations.  If Mid-Southern Bancorp, Inc. was subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets, at December 31, 2019, Mid-Southern Bancorp, Inc. would have exceeded all regulatory capital requirements.

Asset/Liability Management

Our Risk When Interest Rates Change.  The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time.  Market rates change over time.  Like other financial institutions, our results of operations are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities.  The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.

How We Measure Our Risk of Interest Rate Changes.  As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor our interest rate risk.  In doing so, we analyze and manage assets and liabilities based on their interest rates and payment streams, timing of maturities, repricing opportunities, and sensitivity to actual or potential changes in market interest rates.

We are subject to interest rate risk to the extent that our interest-bearing liabilities, primarily deposits and FHLB advances, reprice more rapidly or at different rates than our interest-earning assets.  In order to minimize the potential for adverse effects of material prolonged increases or decreases in interest rates on our results of operations, we have adopted an asset and liability management policy.  Our board of directors sets the asset and liability policy, which is implemented by the asset/liability committee.

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The purpose of the asset/liability committee is to communicate, coordinate, and control asset/liability management consistent with our business plan and board-approved policies.  The committee establishes and monitors the volume and mix of assets and funding sources, taking into account relative costs and spreads, interest rate sensitivity and liquidity needs.  The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals.

The committee generally meets quarterly to, among other things, protect capital through earnings stability over the interest rate cycle; maintain our well-capitalized status; and provide a reasonable return on investment.  The committee recommends appropriate strategy changes based on this review.  The committee is responsible for reviewing and reporting the effects of the policy implementations and strategies to the board of directors at least quarterly.  Executive management oversee the process on a daily basis.

Our asset/liability management strategy dictates acceptable limits on the amounts of change in given changes in interest rates.  For interest rate increases of 100, 200, and 300 basis points, our policy dictates that our Economic Value of Equity (“EVE”) ratio should not fall below 10.0%, 20.0%, and 30.0%, respectively.  As illustrated in the table below, we were in compliance with this aspect of our asset/liability management policy at December 31, 2019.

Mid-Southern Savings Bank uses an EVE interest rate sensitivity analysis in order to evaluate the impact of its interest rate risk on earnings and capital. This is measured by computing the changes in net EVE for its cash flow from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. EVE modeling involves discounting present values of cash flows for on and off-balance sheet items under different interest rate scenarios and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The discounted present value of all cash flows represents the Mid-Southern Savings Bank's EVE and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off balance sheet items. The amount of base case EVE and its sensitivity to shifts in interest rates provide a measure of the longer-term re-pricing and option risk in the balance sheet.   The table presented below, as of December 31, 2019, is an internal analysis of our interest rate risk as measured by changes in EVE for instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments, from no change to up 400 basis points. A decline beyond 100 basis points is not reported as any further decline in rates is unlikely as the current federal funds rate is from 1.0% to 1.25%.

Immediate Change
 
Economic Value of Equity
 
Economic Value of
Equity as %
of Present
Value of Assets
 
In the Level
Of Interest Rates
 
$ Amount
 
$ Change
 
% Change
 
EVE
Ratio %
 
Change
 
   
(Dollars in thousands)
         
                       
400bp
 
$40,861
 
$(11,945)

(22.6)
%
19.1%
 
(5.6)
%
300bp
 
44,346
 
(8,460)
 
(16.0)
 
20.8%
 
(4.0)
 
200bp
 
47,881
 
(4,925)
 
(9.3)
 
22.4%
 
(2.3)
 
100bp
 
50,957
 
(1,849)
 
(3.5)
 
23.8%
 
(0.9)
 
Static
 
52,806
         
24.7%
 
 -
 
(100)bp
 
53,590
 
784
 
1.5
 
25.1%
 
0.4
 

In addition to monitoring selected measures of EVE, management also monitors effects on net interest income resulting from increases or decrease in rates.  This process is used in conjunction with EVE measures to identify excessive interest rate risk.  In managing our assets/liability mix, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, we may place somewhat greater emphasis on maximizing its net interest margin than on strictly matching the interest rate sensitivity of its assets and


63

liabilities.  Management also believes that the increased net income which may result from an acceptable mismatch in the actual maturity or re-pricing of its asset and liability portfolios can, during periods of declining or stable interest rates, provide sufficient returns to justify the increased exposure to sudden and unexpected increases in interest rates which may result from such a mismatch.  Management believes that our level of interest rate risk is acceptable under this approach.

In evaluating our exposure to interest rate movements, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered.  For example, although certain assets and liabilities may have similar maturities or re-pricing periods, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in interest rates.  Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset.  Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed above.  Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase.  We consider all of these factors in monitoring our exposure to interest rate risk.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises principally from interest rate risk inherent in our lending, investing, deposit and borrowings activities. Management actively monitors and manages its interest rate risk exposure. In addition to other risks that we manage in the normal course of business, such as credit quality and liquidity, management considers interest rate risk to be a significant market risk that could have a potential material effect on our financial condition and result of operations. The information contained in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset and Liability Management and Market Risk” in this Form 10-K is incorporated herein by reference.

Item 8.   Financial Statements and Supplementary Data


 
Page
 
 
Report of Independent Registered Public Accounting Firm
65  
 
 
CONSOLIDATED BALANCE SHEETS
66 
CONSOLIDATED STATEMENTS OF INCOME
 67 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
68 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
69 
CONSOLIDATED STATEMENTS OF CASH FLOWS
70 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 71-115 
 
 
 
 





64



Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of
Mid-Southern Bancorp, Inc.
Salem, Indiana

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Mid-Southern Bancorp, Inc. (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”).

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits.  We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB.  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.  Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.  Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.  We believe that our audits provide a reasonable basis for our opinion.


We have served as the Company’s, or its predecessors’, auditor since at least 1975.

New Albany, Indiana
March 23, 2020



65

MID-SOUTHERN BANCORP, INC. 
CONSOLIDATED BALANCE SHEETS 
DECEMBER 31, 2019 AND 2018
(In thousands, except share information)

    2019
    2018
 
ASSETS
           
  Cash and due from banks
 
$
1,577
   
$
884
 
  Interest-bearing deposits with banks
   
17,240
     
11,816
 
    Cash and cash equivalents
   
18,817
     
12,700
 
                 
  Securities available for sale, at fair value
   
58,417
     
53,140
 
  Securities held to maturity
   
42
     
100
 
                 
  Loans, net
   
123,272
     
126,293
 
                 
  Federal Home Loan Bank stock, at cost
   
778
     
778
 
  Real estate held for sale
   
135
     
239
 
  Premises and equipment
   
1,874
     
1,928
 
  Accrued interest receivable:
               
    Loans
   
410
     
435
 
    Securities
   
455
     
396
 
  Cash value of life insurance
   
3,794
     
3,718
 
  Other assets
   
442
     
935
 
                 
      Total Assets
 
$
208,436
   
$
200,662
 
                 
LIABILITIES
               
  Deposits:
               
    Noninterest-bearing
 
$
17,796
   
$
18,334
 
    Interest-bearing
   
129,173
     
132,774
 
      Total deposits
   
146,969
     
151,108
 
                 
  Advance from Federal Home Loan Bank
   
10,000
     
-
 
                 
  Accrued interest payable
   
7
     
-
 
  Accrued expenses and other liabilities
   
647
     
711
 
      Total Liabilities
   
157,623
     
151,819