10-K 1 f10k2019_sbfinancialgroup.htm ANNUAL REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

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

 

For the transition period from ___________ to ____________

   

Commission File Number 001-36785

 

SB FINANCIAL GROUP, INC.

(Exact name of Registrant as specified in its charter)

 

Ohio   34-1395608
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
401 Clinton Street, Defiance, Ohio   43512
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (419) 783-8950

   

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class  Trading Symbol(s)  Name of each exchange on which
Common Shares, No Par Value  SBFG  The NASDAQ Stock Market, LLC
(NASDAQ Capital Market)

 

Securities registered pursuant to Section 12(g) of the Act:

 

Not Applicable

 

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

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 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  ☒  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.

 

☐  Large accelerated filer ☒  Accelerated filer
☐  Non-accelerated filer ☒  Smaller reporting company
  ☐  Emerging growth company

  

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

 

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

 

The aggregate market value of the common shares of the registrant held by non-affiliates computed by reference to the price at which the common shares were last sold as of the last business day of the registrant’s most recently completed second fiscal quarter was $106.2 million.

 

The number of common shares of the registrant outstanding at February 28, 2020 was 7,810,984.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Shareholders to be held on April 15, 2020 are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 

 

 

 

SB FINANCIAL GROUP, INC.

 

2019 ANNUAL REPORT ON FORM 10-K

 

TABLE OF CONTENTS

 

PART I    
     
Item 1. Business 1
Item 1A. Risk Factors 18
Item 1B. Unresolved Staff Comments 30
Item 2. Properties 30
Item 3. Legal Proceedings 32
Item 4. Mine Safety Disclosures 32
Supplemental Item: Information about our Executive Officers 32
     
PART II    
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 33
Item 6. Selected Financial Data 34
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 35
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 43
Item 8. Financial Statements and Supplementary Data 46
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 47
Item 9A. Controls and Procedures 47
Item 9B. Other Information 47
     
PART III    
     
Item 10. Directors, Executive Officers and Corporate Governance 48
Item 11. Executive Compensation 49
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 49
Item 13. Certain Relationships and Related Transactions, and Director Independence 50
Item 14. Principal Accountant Fees and Services 50
     
PART IV    
     
Item 15. Exhibits and Financial Statement Schedules 51
Item 16. Form 10-K Summary 51
     
Signatures and Certifications 56

 

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PART I

 

Item 1. Business.

 

Certain statements contained in this Annual Report on Form 10-K which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. See “Cautionary Statement Regarding Forward-Looking Information” under Item 1A. Risk Factors on page 18 of this Annual Report on Form 10-K.

 

General

 

SB Financial Group, Inc., an Ohio corporation (the “Company”), is a financial holding company subject to regulation under the Bank Holding Company Act of 1956, as amended, and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Company was organized in 1983. The executive offices of the Company are located at 401 Clinton Street, Defiance, Ohio 43512.

 

Through its direct and indirect subsidiaries, the Company is engaged in a variety of financial activities, including commercial banking, and wealth management services, as explained in more detail below.

 

State Bank and Trust Company

 

The State Bank and Trust Company (“State Bank”) is an Ohio state-chartered bank and wholly owned subsidiary of the Company. State Bank offers a full range of commercial banking services, including checking accounts, savings accounts, money market accounts and time certificates of deposit; automatic teller machines; commercial, consumer, agricultural and residential mortgage loans; personal and corporate trust services; commercial leasing; bank credit card services; safe deposit box rentals; internet banking; private client group services; and other personalized banking services. The trust and financial services division of State Bank offers various trust and financial services, including asset management services for individuals and corporate employee benefit plans, as well as brokerage services through Cetera Investment Services, an unaffiliated company. State Bank presently operates 19 banking centers, located within the Ohio counties of Allen, Defiance, Franklin, Fulton, Hancock, Lucas, Paulding, Wood and Williams, and one banking center located in Allen County, Indiana. State Bank also presently operates seven loan production offices, located in Cuyahoga, Franklin, Lucas and Seneca Counties, Ohio, Hamilton and Steuben County, Indiana and Monroe County, Michigan. At December 31, 2019, State Bank had 247 full-time equivalent employees.

 

SBFG Title, LLC

 

SBFG Title, LLC dba Peak Title Agency (“SBFG Title”) was formed as an Ohio limited liability company in March 2019 and purchased all of the assets and real estate of an Ohio-based title agency effective March 15, 2019. At December 31, 2019 SBFG Title, LLC had five full-time equivalent employees.

 

RFCBC

 

RFCBC, Inc. (“RFCBC”) is an Ohio corporation and wholly owned subsidiary of the Company that was incorporated in August 2004. RFCBC operates as a loan subsidiary in servicing and working out problem loans and is presently inactive. At December 31, 2019, RFCBC had no employees.

 

Rurbanc Data Services

 

Rurbanc Data Services, Inc. dba RDSI Banking Systems (“RDSI”) was formed in 1964 and became an Ohio corporation in June 1976. In September 2006, RDSI acquired Diverse Computer Marketers, Inc. (“DCM”), which was merged into RDSI effective December 31, 2007. Effective January 1, 2018, the Company completed the sale of the customer contracts and certain other assets of RDSI’s remaining check and statement processing business operated through the DCM division. As a result of the sale, RDSI is presently inactive and had no material operations or employees at December 31, 2019.

 

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Rurban Mortgage Company

 

Rurban Mortgage Company (“RMC”) is an Ohio corporation and wholly owned subsidiary of State Bank. RMC is a mortgage company and is presently inactive. At December 31, 2019, RMC had no employees.

 

SBT Insurance

 

SBT Insurance, LLC (“SBI”) is an Ohio corporation and wholly owned subsidiary of State Bank. SBI is an insurance company that engages in the sale of insurance products to retail and commercial customers of State Bank. At December 31, 2019, SBI had no employees.

 

SB Captive

 

SB Captive, Inc. (“SB Captive”) is a Nevada corporation and wholly owned subsidiary of SB Financial Group, Inc. SB Captive is a self-insurance company that provides coverage to State Bank and SB Financial Group. The purpose of the Captive is to mitigate insurance risk by participating in a pool with other banks. At December 31, 2019 SB Captive, Inc. had no employees.

 

Rurban Statutory Trust II

 

Rurban Statutory Trust II (“RST II”) is a trust that was organized in August 2005. In September 2005, RST II closed a pooled private offering of 10,000 Capital Securities with a liquidation amount of $1,000 per security. The proceeds of the offering were loaned to the Company in exchange for junior subordinated debentures with terms similar to the Capital Securities. The sole assets of RST II are the junior subordinated debentures and the back-up obligations, which in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of RST II under the Capital Securities.

 

Competition

 

The Company experiences significant competition in attracting depositors and borrowers. Competition in lending activities comes principally from other commercial banks in the lending areas of State Bank, and to a lesser extent, from savings associations, insurance companies, governmental agencies, credit unions, securities brokerage firms and pension funds. The primary factors in competing for loans are interest rates and overall banking services.

 

State Bank’s competition for deposits comes from other commercial banks, savings associations, money market funds and credit unions as well as from insurance companies and securities brokerage firms. The primary factors in competing for deposits are interest rates paid on deposits and convenience of office location. State Bank operates in the highly competitive wealth management services field and its competition consists primarily of other bank wealth management departments.

 

Supervision and Regulation

 

The following is a description of the significant statutes and regulations applicable to the Company and its subsidiaries. The description is qualified in its entirety by reference to the full text of the statutes, regulations and policies that are described. Also, such statutes, regulations and policies are continually under review by the U.S. Congress and state legislatures and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to the Company or its subsidiaries could have a material effect on our business.

 

Regulation of Bank Holding Companies and Their Subsidiaries in General

 

The Company is a financial holding company and, as such, is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). The Bank Holding Company Act requires the prior approval of the Federal Reserve Board (“FRB”) before a financial or bank holding company may acquire direct or indirect ownership or control of more than 5 percent of the voting shares of any bank (unless the bank is already majority owned by the bank holding company), acquire all or substantially all of the assets of another bank or another financial or bank holding company, or merge or consolidate with any other bank holding company. Subject to certain exceptions, the Bank Holding Company Act also prohibits a financial or bank holding company from acquiring 5 percent or more of the voting shares of any company that is not a bank and from engaging in any business other than banking or managing or controlling banks. The primary exception to this prohibition allows a bank holding company to own shares in any company the activities of which the FRB had determined, as of November 19, 1999, to be so closely related to banking as to be a proper incident thereto.

 

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As a result of the Gramm-Leach-Bliley Act of 1999, also known as the Financial Services Modernization Act of 1999, which amended the Bank Holding Company Act, bank holding companies that are financial holding companies may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (1) financial in nature or incidental to such financial activity (as determined by the FRB in consultation with the Secretary of the Treasury), or (2) complementary to a financial activity, and that does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments. On January 2, 2019, the Company elected, and received approval from the FRB, to become a financial holding company.

 

The Company is subject to the reporting requirements of, and examination and regulation by, the FRB. The FRB has extensive enforcement authority over bank holding companies, including, without limitation, the ability to assess civil money penalties, issue cease and desist or removal orders, and require that a bank holding company divest subsidiaries, including its subsidiary banks. In general, the FRB may initiate enforcement actions for violations of laws and regulations and for unsafe or unsound practices. A bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with extensions of credit and/or the provision of other property or services to a customer by the bank holding company or its subsidiaries.

 

Various requirements and restrictions under the laws of the United States and the State of Ohio affect the operations of State Bank, including requirements to maintain reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon, restrictions relating to investments and other activities, limitations on credit exposure to correspondent banks, limitations on activities based on capital and surplus, limitations on payment of dividends, and limitations on branching.

 

Various consumer laws and regulations also affect the operations of State Bank. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) established the Consumer Financial Protection Bureau (the “CFPB”), which regulates consumer financial products and services and certain financial services providers. The CFPB is authorized to prevent unfair, deceptive or abusive acts or practices and ensures consistent enforcement of laws so that consumers have access to fair, transparent and competitive markets for consumer financial products and services. Since it was established, the CFPB has exercised extensively its rulemaking and interpretative authority.

 

The Federal Home Loan Bank (“FHLB”) provide credit to their members in the form of advances. As a member of the FHLB of Cincinnati, State Bank must maintain certain minimum investments in the capital stock of the FHLB of Cincinnati. State Bank was in compliance with these requirements at December 31, 2019.

 

Economic Growth, Regulatory Relief and Consumer Protection Act

 

The Regulatory Relief Act repealed or modified certain provisions of the Dodd-Frank Act and eased restrictions on all but the largest banks (those with consolidated assets in excess of $250 billion). Bank holding companies with consolidated assets of less than $100 billion, including the Company, are no longer subject to enhanced prudential standards. The Regulatory Relief Act also relieves bank holding companies and banks with consolidated assets of less than $100 billion, including the Company, from certain record-keeping, reporting and disclosure requirements. Certain other regulatory requirements applied only to banks with consolidated assets in excess of $50 billion and so did not apply to the Company even before the enactment of the Regulatory Relief Act.

 

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Restrictions on Dividends

 

There can be no assurance as to the amount of dividends which may be declared in future periods with respect to the common shares of the Company, since such dividends are subject to the discretion of the Company’s Board of Directors, cash needs, general business conditions, dividends from the Company’s subsidiaries and applicable governmental regulations and policies.

 

The ability of the Company to obtain funds for the payment of dividends and for other cash requirements is largely dependent on the amount of dividends that may be declared by State Bank and the Company’s other subsidiaries. State Bank may not pay dividends to the Company if, after paying such dividends, it would fail to meet the required minimum levels under the risk-based capital guidelines and the minimum leverage ratio requirements. In addition, State Bank must obtain the approval of the FRB and the Ohio Division of Financial Institutions (“ODFI”) if a dividend in any year would cause the total dividends for that year to exceed the sum of the current year’s net profits and the retained net profits for the preceding two years, less required transfers to surplus. At December 31, 2019, State Bank had $29.8 million of excess earnings over the preceding three years.

 

Payment of dividends by State Bank may be restricted at any time at the discretion of the regulatory authorities, if they deem such dividends to constitute an unsafe and/or unsound banking practice. Moreover, the FRB expects the Company to serve as a source of strength to its subsidiary banks, which may require it to retain capital for further investment in the subsidiary, rather than for dividends to shareholders of the Company.

 

Affiliate Transactions

 

The Company and State Bank are separate and distinct legal entities. The Federal Reserve Board’s Regulation W and various other legal limitations restrict State Bank from lending funds to, or engaging in other “covered transactions” with, the Company (or any other affiliate), generally limiting such covered transactions with any one affiliate to 10 percent of State Bank’s capital and surplus and limiting all such covered transactions with all affiliates to 20 percent of State Bank’s capital and surplus. Covered transactions, including extensions of credit, sales of securities or assets and provision of services, also must be on terms and conditions consistent with safe and sound banking practices, including credit standards, that are substantially the same or at least as favorable to State Bank as those prevailing at the time for transactions with unaffiliated companies.

 

A bank’s authority to extend credit to executive officers, directors and greater than 10 percent shareholders, as well as entities such persons control, is subject to Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated thereunder by the Federal Reserve Board. Among other things, these loans must be made on terms (including interest rates charged and collateral required) that are substantially the same as those offered to unaffiliated individuals or be made as part of a benefit or compensation program and on terms widely available to employees, and must not involve a greater than normal risk of repayment. In addition, the amount of loans a bank may make to these persons is based, in part, on the bank’s capital position, and certain approval procedures must be followed in making loans which exceed specified amounts.

 

Federally insured banks are subject, with certain exceptions, to certain additional restrictions (including collateralization) 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. In addition, such banks are prohibited from engaging in certain tying arrangements in connection with any extension of credit or the providing of any property or service.

 

Regulatory Capital

 

The risk-based capital guidelines adopted by the federal banking agencies are based on the “International Convergence of Capital Measurement and Capital Standard” (Basel I), published by the Basel Committee on Banking Supervision (the “Basel Committee”). In July 2013, the United States banking regulators issued new capital rules applicable to smaller banking organizations which also implement certain of the provisions of the Dodd-Frank Act (the “Basel III Capital Rules”). Community banking organizations, including the Company and State Bank, began transitioning to the new rules on January 1, 2015. The new minimum capital requirements became effective on January 1, 2015, whereas a new capital conservation buffer and deductions from common equity capital phased in from January 1, 2016 through January 1, 2019, and most deductions from common equity tier 1 capital phased in from January 1, 2015 through January 1, 2019.

 

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The Basel III Capital Rules include (a) a minimum common equity tier 1 capital ratio of 4.5%, (b) a minimum Tier 1 capital ratio of 6.0%, (c) a minimum total capital ratio of 8.0%, and (d) a minimum leverage ratio of 4.0%.

 

Common equity for the common equity tier 1 capital ratio includes common stock (plus related surplus) and retained earnings, plus limited amounts of minority interests in the form of common stock, less the majority of certain regulatory deductions.

 

Tier 1 capital includes common equity as defined for the common equity tier 1 capital ratio, plus certain non-cumulative preferred stock and related surplus, cumulative preferred stock and related surplus, trust preferred securities that have been grandfathered (but which are not permitted going forward), and limited amounts of minority interests in the form of additional Tier 1 capital instruments, less certain deductions.

 

Tier 2 capital, which can be included in the total capital ratio, includes certain capital instruments (such as subordinated debt) and limited amounts of the allowance for loan and lease losses, subject to new eligibility criteria, less applicable deductions.

 

The deductions from common equity tier 1 capital include goodwill and other intangibles, certain deferred tax assets, mortgage-servicing assets above certain levels, gains on sale in connection with a securitization, investments in a banking organization’s own capital instruments and investments in the capital of unconsolidated financial institutions (above certain levels). The deductions phased in beginning in 2015 and were fully phased in as of January 1, 2019.

 

Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, one of several risk weights is applied to different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of the counterparty. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

The new rules also place restrictions on the payment of capital distributions, including dividends, and certain discretionary bonus payments to executive officers if the banking organization does not hold a capital conservation buffer of greater than 2.5 percent composed of common equity tier 1 capital above its minimum risk-based capital requirements, or if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5 percent at the beginning of the quarter. The capital conservation buffer began to phase in starting on January 1, 2016, at 0.625% of risk-weighted assets, and was increased by that amount each year until fully phased in effective January 1, 2019, at 2.5%.

 

In September 2019, the FRB, along with other federal bank regulatory agencies, issued a final rule, effective January 1, 2020, that gives community banks, including the Company, the option to calculate a simple leverage ratio to measure capital adequacy if the community banks meet certain requirements. Under the rule, a community bank is eligible to elect the Community Bank Leverage Ratio (“CBLR”) framework if it has less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a leverage ratio greater than 9.0%. Qualifying institutions that elect to use the CBLR framework and that maintain a leverage ratio of greater than 9.0% will be considered to have satisfied the risk-based and leverage capital requirements in the regulatory agencies’ generally applicable capital rules and to have met the well-capitalized ratio requirements. It is the Company’s intent to opt out of the simplified framework and continue to follow existing capital rules.

 

In December 2018, the federal banking agencies issued a final rule to address regulatory capital treatment of credit loss allowances under the current expected credit loss (“CECL”) model (accounting standard). The rule revises the federal banking agencies’ regulatory capital rules to identify which credit loss allowances under the CECL model are eligible for inclusion in regulatory capital and to provide banking organizations the option to phase in over three years the day-one adverse effects on regulatory capital that may result from the adoption of the CECL model. The Company currently anticipates recording a one-time cumulative effect adjustment upon adoption, and does not anticipate utilizing the three year phase in. The Company expects to maintain risk-based capital ratios in excess of “well-capitalized” after the impact of the one-time cumulative effect adjustment.

 

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At December 31, 2019, State Bank was in compliance with all of the regulatory capital requirements to which it was subject. For State Bank’s capital ratios, see Note 15 to the Consolidated Financial Statements under Item of 8 of this report (the “Consolidated Financial Statements”).

 

The FRB has adopted regulations governing prompt corrective action to resolve the problems of capital deficient and otherwise troubled state-chartered member banks. At each successively lower defined capital category, a bank is subject to more restrictive and numerous mandatory or discretionary regulatory actions or limits, and the FRB has less flexibility in determining how to resolve the problems of the institution. In addition, the FRB generally can downgrade a bank’s capital category, notwithstanding its capital level, if, after notice and opportunity for hearings, the bank is deemed to be engaged in an unsafe or unsound practice, because it has not corrected deficiencies that resulted in it receiving a less than satisfactory examination rating on matters other than capital or it is deemed to be in an unsafe or unsound condition. State Bank’s capital at December 31, 2019, met the standards for the highest capital category, a “well-capitalized” bank.

 

In April 2015, the FRB issued a final rule which increased the size limitation for qualifying bank holding companies under the FRB’s Small Bank Holding Company Policy Statement from $500 million to $1 billion of total consolidated assets. In August 2018, the FRB issued an interim final rule, as required by the Economic Growth Regulatory Relief, and consumer Protection Act of 2018, to further increase size limitations under the Small Bank Holding Company Policy Statement to $3 billion of total consolidated assets. The Company continues to qualify under the Small Bank Holding Company Policy Statement for exemption from the Federal Reserve Board’s consolidated risk-based capital and leverage rules at the holding company level.

 

Federal Deposit Insurance Corporation

 

The Federal Deposit Insurance Corporation (“FDIC”) is an independent federal agency, which insures the deposits of federally insured banks and savings associations up to certain prescribed limits and safeguards the safety and soundness of financial institutions. The general insurance limit is $250,000 per separately insured depositor. This insurance is backed by the full faith and credit of the United States Government.

 

As insurer, the FDIC is authorized to conduct examinations of and to require reporting by insured institutions, including State Bank, to prohibit any insured institution from engaging in any activity the FDIC determines to pose a threat to the Deposit Insurance Fund (“DIF”), and to take enforcement actions against insured institutions. The FDIC may terminate insurance of deposits of any institution if the FDIC finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or other regulatory agency.

 

The FDIC assesses a quarterly deposit insurance premium on each insured institution based on risk characteristics of the institution and may also impose special assessments in emergency situations, which fund the DIF. Pursuant to the Dodd-Frank Act, the FDIC has established 2 percent as the Designated Reserve Ratio (“DRR”), which is the amount in the DIF as a percentage of all DIF insured deposits. In March 2016, the FDIC adopted final rules designed to meet the statutory minimum DRR of 1.35 percent by September 30, 2020, the deadline imposed by the Dodd-Frank Act. As of September 30, 2018, the DRR met the statutory minimum of 1.35%. As a result, the previous surcharge imposed on banks with assets of $10 billion or more was lifted. In addition, preliminary assessment credits have been determined by the FDIC for banks with assets of less than $10 billion, which had previously contributed to the increase of the DRR to 1.35%. These credits may be redeemed beginning in the quarterly assessment period in which the DRR reaches a minimum of 1.38%, and is not to exceed the total quarterly assessment due.

 

In addition, all FDIC-insured institutions are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, which was established by the government to recapitalize a predecessor to the DIF. These assessments continued until the Financing Corporation bonds matured in September 2019. The final assessment was collected on the March 2019 FDIC invoice.

 

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The FDIC is authorized to prohibit any insured institution from engaging in any activity that poses a serious threat to the insurance fund and may initiate enforcement actions against a bank, after first giving the institution’s primary regulatory authority an opportunity to take such action. The FDIC may also terminate the deposit insurance of any institution that has engaged in or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, order or condition imposed by the FDIC.

 

Community Reinvestment Act

 

The Community Reinvestment Act (“CRA”) requires State Bank’s primary federal regulatory agency, the FRB, to assess State Bank’s record in meeting the credit needs of the communities served by State Bank. The FRB assigns one of four ratings: outstanding, satisfactory; needs to improve or substantial noncompliance. The rating assigned to a financial institution is considered in connection with various applications submitted by the financial institution or its holding company to its banking regulators, including applications to acquire another financial institution or to open or close a branch office. In addition, all subsidiary banks of a financial holding company must maintain a satisfactory or outstanding rating in order for the financial holding company to avoid limitations on its activities. State Bank currently maintains a satisfactory CRA rating.

 

SEC and NASDAQ Regulation

 

The Company is subject to the jurisdiction of the Securities and Exchange Commission (the “SEC”) and certain state securities authorities relating to the offering and sale of its securities. The Company is subject to the registration, reporting and other regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the rules adopted by the SEC under those acts. The Company’s common shares are listed on The NASDAQ Capital Market (“NASDAQ”) under the symbol “SBFG”. As a result, the Company is subject to NASDAQ rules and regulations applicable to listed companies.

 

The SEC has adopted rules and regulations governing, among other matters, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. The SEC has also approved corporate governance rules promulgated by NASDAQ. The Company has adopted and implemented a Code of Conduct and Ethics and a copy of that policy can be found on the Company’s website at www.YourSBFinancial.com by first clicking “Corporate Governance” and then “Code of Conduct”. The Company has also adopted charters of the Audit Committee, the Compensation Committee and the Governance and Nominating Committee, which charters are available on the Company’s website at www.YourSBFinancial.com by first clicking “Corporate Governance” and then “Supplementary Info”.

 

USA Patriot Act

 

The Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) gives the United States Government greater powers over financial institutions to combat money laundering and terrorist access to the financial system in our country. The Patriot Act requires regulated financial institutions to establish programs for obtaining identifying information from customers seeking to open new accounts and establish enhanced due diligence policies, procedures and controls designed to detect and report suspicious activity.

 

Office of Foreign Assets Control Regulation

 

The U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws, including designated foreign countries, nationals and others. OFAC publishes lists of specially designated targets and countries. State Bank is responsible for, among other things, blocking accounts of, and transactions with, such targets and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious financial, legal and reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required. Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions found to be violating these obligations.

 

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Executive and Incentive Compensation

 

In June 2010, the Federal Reserve Board, the Office of the Controller of the Currency (“OCC”) and the FDIC issued joint interagency guidance on incentive compensation policies (the “Joint Guidance”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. This principles-based guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (a) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (b) be compatible with effective internal controls and risk management and (c) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

 

In 2011, federal banking regulatory agencies jointly issued proposed rules on incentive-based compensation arrangements under applicable provisions of the Dodd-Frank Act (the “First Proposed Rules”). The First Proposed Rules generally would have applied to financial institutions with $1 billion or more in assets that maintain incentive-based compensation arrangements for certain covered employees. In May 2016, the federal bank regulatory agencies approved a second joint notice of proposed rules (the “Second Proposed Joint Rules”) designed to prohibit incentive-based compensation arrangements that encourage inappropriate risks at financial institutions. The Second Proposed Joint Rules would apply to covered financial institutions with total assets of $1 billion or more, and are still in proposed rule status. The requirements of the Second Proposed Joint Rules would differ for each of three categories of financial institutions:

 

Level 1 consists of institutions with assets of $250 billion or more;
Level 2 consists of institutions with assets of at least $50 billion and less than $250 billion; and
Level 3 consists of institutions with assets of at least $1 billion and less than $50 billion.

 

Some of the requirements would apply only to Level 1 and Level 2 institutions. For all covered institutions, including Level 3 institutions like us, the Second Proposed Rules would:

 

prohibit incentive-based compensation arrangements that are “excessive” or “could lead to material financial loss”;
require incentive-based compensation that is consistent with a balance of risk and reward, effective management and control of risk, and effective governance; and
require board oversight, recordkeeping and disclosure to the appropriate regulatory agency.

 

Level 1 and Level 2 institutions would have additional requirements, including deferrals of awards to certain covered persons; potential downward adjustments, forfeitures or clawbacks; and additional risk-management and control standards, policies and procedures. In addition, certain practices and types of incentive compensation would be prohibited.

 

Public company compensation committee members must meet heightened independence requirements and consider the independence of compensation consultants, legal counsel and other advisors to the compensation committee. A compensation committee must have the authority to hire advisors and to have the public company fund reasonable compensation of such advisors.

 

SEC regulations require public companies to provide various disclosures about executive compensation in annual reports and proxy statements and to present to their shareholders a non-binding vote on the approval of executive compensation.

 

Public companies will be required, once stock exchanges impose additional listing requirements under the Dodd-Frank Act, to implement “clawback” procedures for incentive compensation payments and to disclose the details of the procedures which allow recovery of incentive compensation that was paid on the basis of erroneous financial information necessitating a restatement due to material noncompliance with financial reporting requirements. This clawback policy is intended to apply to compensation paid within a three-year look-back window of the restatement and would cover all executives who received incentive awards.

 

8

 

 

Consumer Protection Laws and Regulations

 

Banks are subject to regular examination to ensure compliance with federal consumer protection statutes and regulations, including, but not limited to, the following:

 

The Equal Credit Opportunity Act (prohibiting discrimination in any credit transaction on the basis of any of various criteria);
The Truth in Lending Act (requiring that credit terms are disclosed in a manner that permits a consumer to understand and compare credit terms more readily and knowledgeably);
The Fair Housing Act (making it unlawful for a lender to discriminate in housing-related lending activities against any person on the basis of certain criteria);
The Home Mortgage Disclosure Act (requiring financial institutions to collect data that enables regulatory agencies to determine whether financial institutions are serving the housing credit needs of the communities in which they are located); and
The Real Estate Settlement Procedures Act (requiring that lenders provide borrowers with disclosures regarding the nature and cost of real estate settlements and prohibits abusive practices that increase borrowers’ costs);
Privacy provisions of the Gramm-Leach-Bliley Act (requiring financial institutions to establish policies and procedures to restrict the sharing of non-public customer data with non-affiliated parties and to protect customer information from unauthorized access).

 

The banking regulators also use their authority under the Federal Trade Commission Act to take supervisory or enforcement action with respect to unfair or deceptive acts or practices by banks that may not necessarily fall within the scope of a specific banking or consumer finance law.

 

In October 2017, the CFPB issued a final rule (the “Payday Rule”) to establish regulations for payday loans, vehicle title loans, and certain high-cost installment loans. The Payday Rule addressed two discrete topics. First, it contained a set of provisions with respect to the underwriting of certain covered loans and related reporting and recordkeeping requirements (the “Mandatory Underwriting Provisions”). Second, it contained a set of provisions establishing certain requirements and limitations with respect to attempts to withdraw payments from consumers’ checking or other accounts and related recordkeeping requirements (the “Payment Provisions”). The Payday Rule became effective on January 16, 2018. However, most provisions had a compliance date of August 19, 2019.

 

On February 6, 2019, the CFPB proposed delaying the August 19, 2019, compliance date for the Mandatory Underwriting Provisions to November 19, 2020. The CFPB proposed in a separate notice to rescind the Mandatory Underwriting Provisions.

 

On June 6, 2019, the CFPB issued a final rule delaying the compliance date for most Mandatory Underwriting Provisions until November 19, 2020. However, the final rule did not delay the compliance date for the Payment Provisions.

 

The Company does not currently expect the Payday Rule to have a material effect on the Company’s financial condition or results of operations on a consolidated basis.

 

Cybersecurity

 

In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish several lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing Internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the financial institution’s operations after a cyber attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the financial institution or its critical service providers fall victim to this type of cyber-attack. If State Bank fails to observe the regulatory guidance, it could be subject to various regulatory sanctions, including financial penalties.

 

9

 

 

In February 2018, the SEC published interpretive guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents. These SEC guidelines, and any other regulatory guidance, are in addition to notification and disclosure requirements under state and federal banking law and regulations.

 

State regulators have also been increasingly active in implementing privacy and cybersecurity standards and regulations. Recently, several states have adopted regulations requiring certain financial institutions to implement cybersecurity programs and providing detailed requirements with respect to these programs, including data encryption requirements. Many states have also recently implemented or modified their data breach notification and data privacy requirements. The Company expects this trend of state-level activity in those areas to continue, and is continually monitoring developments in the states in which our customers are located.

 

In the ordinary course of business, the Company relies on electronic communications and information systems to conduct its operations and to store sensitive data. The Company employs an in-depth, layered, defensive approach that leverages people, processes and technology to manage and maintain cybersecurity controls. The Company employs a variety of preventative and detective tools to monitor, block, and provide alerts regarding suspicious activity, as well as to report on any suspected advanced persistent threats. The Company has also invested over the last eighteen months to further enhance these tools and mechanisms. Notwithstanding the strength of the Company’s defensive measures, the threat from cyber-attacks is severe, attacks are sophisticated and increasing in volume, and attackers respond rapidly to changes in defensive measures. While to date, the Company has not detected a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, Company’s systems and those of its customers and third-party service providers are under constant threat and it is possible that the Company could experience a significant event in the future. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by us and our customers.

 

Effect of Environmental Regulation

 

Compliance with federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had a material effect upon the capital expenditures, earnings or competitive position of the Company and its subsidiaries. The Company believes that the nature of the operations of its subsidiaries has little, if any, environmental impact. The Company, therefore, anticipates no material capital expenditures for environmental control facilities for its current fiscal year or for the near future. The Company’s subsidiaries may be required to make capital expenditures for environmental control facilities related to properties which they may acquire through foreclosure proceedings in the future; however, the amount of such capital expenditures, if any, is not currently determinable.

 

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I.DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL

 

The following are the condensed average balance sheets of the Company for the years ending December 31 and includes the interest earned or paid, and the average interest rate, on each asset and liability:

 

   2019   2018   2017 
  Average       Average   Average       Average   Average       Average 
($ in thousands)  Balance   Interest   Rate   Balance   Interest   Rate   Balance   Interest   Rate 
Assets                                    
Taxable securities  $95,216   $3,226    3.39%  $85,238   $2,618    3.07%  $84,918   $2,076    2.44%
Non-taxable securities   10,108    345    3.41%   11,379    439    3.86%   14,088    527    3.74%
Loans, net1   809,651    40,829    5.04%   749,055    36,422    4.86%   660,675    29,877    4.52%
Total earning assets   914,975    44,400    4.85%   845,672    39,479    4.67%   759,681    32,480    4.28%
Cash and due from banks   47,135              38,990              35,337           
Allowance for loan losses   (8,370)             (8,361)             (7,828)          
Premises and equipment   23,779              21,795              21,084           
Other assets   50,413              49,170              46,295           
Total assets  $1,027,932             $947,266             $854,569           
                                              
Liabilities                                             
Savings and interest-bearing demand deposits  $427,858   $2,846    0.67%  $401,577   $1,754    0.44%  $369,114   $795    0.22%
Time deposits   262,040    5,814    2.22%   225,467    3,560    1.58%   214,639    2,661    1.24%
Repurchase agreements & other   15,288    82    0.54%   16,458    37    0.22%   12,350    15    0.12%
Advances from FHLB   16,066    402    2.50%   22,108    460    2.08%   20,000    320    1.60%
Trust preferred securities   10,310    430    4.17%   10,310    401    3.89%   10,310    303    2.94%
Total interest-bearing liabilities   731,562    9,574    1.31%   675,920    6,212    0.92%   626,413    4,094    0.65%
                                              
Demand deposits   146,401              137,253              127,747           
Other liabilities   16,779              12,999              10,871           
Total liabilities   894,742              826,172              765,031           
Shareholders’ equity   133,190              121,094              89,538           
                                              
Total liabilities and shareholders’ equity  $1,027,932             $947,266             $854,569           
                                              
Net interest income (tax equivalent basis)       $34,826             $33,267             $28,386      
                                              
Net interest income as a percent of average interest-earning assets - GAAP measure             3.81%             3.93%             3.74%
Net interest income as a percent of average interest-earning assets - Non-GAAP measure 2,3             3.82%             3.95%             3.78%

 

-- Computed on a fully tax equivalent basis (FTE)

 

1Nonaccruing loans and loans held for sale are included in the average balances.
2Interest on tax exempt securities is computed on a tax equivalent basis using a 21 (2019/2018) and 34 percent (2017) statutory tax rate, and added to the net interest income. The tax equivalent adjustment was $0.07, $0.17 and $0.27 million in 2019, 2018 and 2017, respectively.
3Interest on tax exempt loans is computed on a tax equivalent basis using a 21 (2019/2018) and 34 percent (2017) statutory tax rate, and added to the net interest income. The tax equivalent adjustment was $0.06, $0.03 and $0.04 million in 2019, 2018 and 2017, respectively.

 

The following tables set forth the effect of volume and rate changes on interest income and expense for the periods indicated. For purposes of these tables, changes in interest due to volume and rate were determined as follows:

 

Volume variance - change in volume multiplied by the previous year’s rate.
Rate variance - change in rate multiplied by the previous year’s volume.
Rate/volume variance - change in volume multiplied by the change in rate. This variance allocates the volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each.

 

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   Total         
   Variance   Variance Attributable To 
($ in thousands)  2019/2018   Volume   Rate 
Interest income    
Taxable securities  $608   $306   $302 
Non-taxable securities1   (94)   (49)   (45)
Loans, net of unearned income and deferred fees1   4,407    2,946    1,461 
Total interest income   4,921    3,204    1,717 
                
Interest expense               
Savings and interest-bearing demand deposits  $1,092   $115   $977 
Time deposits   2,254    577    1,677 
Repurchase agreements & other   45    (3)   48 
Advances from FHLB   (58)   (126)   68 
Trust preferred securities   29    -    29 
Total interest expense   3,362    564    2,798 
                
Net interest income  $1,559   $2,640   $(1,081)

 

1Interest on non-taxable securities and loans has been adjusted to fully tax equivalent

 

II.INVESTMENT PORTFOLIO

 

A.The fair value of securities available-for-sale as of December 31 in each of the following years are summarized as follows:

 

($ in thousands)  2019   2018   2017 
U.S. Treasury and government agencies  $12,202   $18,670   $12,708 
Mortgage-backed securities   78,182    60,943    56,762 
State and political subdivisions   10,564    11,356    13,250 
Equity securities   -    -    70 
                
Totals  $100,948   $90,969   $82,790 

  

B.The maturity distribution and weighted-average interest rates of securities available-for-sale at December 31, 2019, are set forth in the table below. The weighted-average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount:

 

   Maturing 
($ in thousands)  Within
One Year
   After One Year but within Five Years   After Five Years but within Ten Years   After
Ten Years
   Total 
U.S. Treasury and government agencies  $2,843   $4,866   $4,493   $-   $12,202 
Mortgage-backed securities   -    5,065    12,038    61,079    78,182 
State and political subdivisions   728    2,474    1,461    5,901    10,564 
                          
Total securities by maturity  $3,571   $12,405   $17,992   $66,980   $100,948 
                          
Weighted-average yield by maturity1   1.87%   2.63%   2.65%   2.52%   2.53%

 

1Yields are presented on a tax-equivalent basis.

 

C.Excluding those holdings of the investment portfolio in U.S. Treasury securities and other agencies of the U.S. Government, there were no other securities of any one issuer, which exceeded 10 percent of the shareholders’ equity of the Company at December 31, 2019.

 

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III.LOAN PORTFOLIO

 

A.Types of Loans: Total loans on the balance sheet were comprised of the following classifications at December 31 for the years indicated:

 

($ in thousands)  2019   2018   2017   2016   2015 
Loans held for investment (HFI)                    
Commercial Business & Agricultural  $202,041   $179,053   $153,501   $161,227   $130,377 
Commercial RE & Construction   366,782    340,791    332,154    284,084    242,208 
Residential Real Estate   193,159    187,104    150,854    142,452    130,806 
Consumer & Other   62,808    64,336    59,619    56,335    54,224 
                          
Total Loans   824,790    771,284    696,128    644,098    557,615 
                          
Unearned Income   720    599    487    335    44 
Total Loans, net of unearned income  $825,510   $771,883   $696,615   $644,433   $557,659 

 

Concentrations of Credit Risk: The Company makes commercial, real estate and installment loans to customers located mainly in the Tri-State region of Ohio, Indiana and Michigan. Commercial loans include loans collateralized by commercial real estate, business assets and, in the case of agricultural loans, crops and farm equipment and the loans are expected to be repaid from cash flow from operations of businesses. As of December 31, 2019, commercial business and agricultural loans made up approximately 24.5 percent of the loans held for investment (“HFI”) loan portfolio while commercial real estate loans accounted for approximately 44.5 percent of the HFI loan portfolio. As of December 31, 2019, residential first mortgage loans made up approximately 23.4 percent of the HFI loan portfolio and are secured by first mortgages on residential real estate, while consumer loans to individuals made up approximately 7.6 percent of the HFI loan portfolio and are primarily secured by consumer assets.

 

B.Maturities and Sensitivities of Loans to Changes in Interest Rates: The following tables shows the amounts of commercial, business and agricultural loans and commercial real estate loans outstanding as of December 31, 2019, which, based on remaining scheduled repayments of principal, are due in the periods indicated. Also, the amounts have been classified according to sensitivity to changes in interest rates for loans due after one year (variable-rate loans are those loans with floating or adjustable interest rates).

 

   Maturing 
  Commercial   Commercial     
($ in thousands)  Business & Ag.   Real Estate   Total 
Within one year  $28,781   $30,029   $58,810 
After one year but within five years   64,859    105,908    170,767 
After five years   108,401    230,845    339,246 
                
Totals  $202,041   $366,782   $568,823 

 

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   Interest Sensitivity 
($ in thousands)  Fixed   Variable     
   Rate   Rate   Total 
Commercial Business & Agricultural            
Within one year  $12,363   $16,418   $28,781 
Due after one year but within five years   23,541    41,318    64,859 
Due after five years   15,866    92,535    108,401 
                
Totals   51,770    150,271    202,041 
                
Commercial RE & Construction               
Within one year   13,078    16,952    30,030 
Due after one year but within five years   45,373    60,535    105,908 
Due after five years   53,700    177,144    230,844 
                
Totals   112,151    254,631    366,782 
                
Total               
Within one year   25,441    33,370    58,811 
Due after one year but within five years   68,914    101,853    170,767 
Due after five years   69,566    269,679    339,245 
                
Totals  $163,921   $404,902   $568,823 

 

C.Risk Elements:

 

1.The accrual of interest income is discontinued when the collection of a loan or interest, in whole or in part, is doubtful. When interest accruals are discontinued, interest income accrued in the current period is reversed. Loans that are past due 90 days or more as to interest or principal payments are considered for nonaccrual status. The following schedule summarizes nonaccrual, past due, and troubled debt restructured (TDR) loans at December 31 for the years indicated:

 

($ in thousands)  2019   2018   2017   2016   2015 
     
Loans accounted for on a nonaccrual basis  $5,500   $2,906   $2,704   $2,737   $6,646 
Accruing troubled debt restructurings   874    928    1,129    1,590    1,500 
                          
Total nonperforming loans and TDRs  $6,374   $3,834   $3,833   $4,327   $8,146 

 

Listed below is the interest income on impaired and nonaccrual loans greater than $100,000 at December 31 for the years indicated:

 

($ in thousands)  2019   2018 
         
Cash basis interest income recognized on impaired loans outstanding  $340   $192 
Interest income actually recorded on impaired loans and included in net income for the period   361    188 
Unrecorded interest income on nonaccrual loans   76    87 

 

2.As of December 31, 2019, in addition to the $6.4 million of nonperforming loans reported under Item III.C above (whose amount includes all loans classified by management as doubtful or loss), there were approximately $3.7 million in other outstanding loans where known information about possible credit problems of the borrowers caused management to have concerns as to the ability of such borrowers to comply with the present loan repayment terms (loans classified as substandard by management) and which may result in disclosure of such loans pursuant to Item III.C.1. at some future date. In regard to loans classified as substandard, management believes that such potential problem loans have been adequately evaluated in the allowance for loan losses.

 

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3.Foreign Loans Outstanding

 

None

 

4.Loan Concentrations

 

At December 31, 2019, loans outstanding related to agricultural operations or collateralized by agricultural real estate and equipment aggregated approximately $51.0 million, or 6.2 percent of total HFI loans.

 

D.Other Interest-Bearing Assets

 

There were no other interest-bearing assets as of December 31, 2019, which would be required to be disclosed under Item III.C.1 or Item III.C.2. if such assets were loans.

 

Management believes the allowance for loan losses at December 31, 2019 was adequate to absorb any losses on nonperforming loans, as the allowance balance is maintained by management at a level considered adequate to cover losses that are probable based on past loss experience, general economic conditions, information about specific borrower situations, including their financial position and collateral values, and other factors and estimates which are subject to change over time.

 

IV.SUMMARY OF LOAN LOSS EXPERIENCE

 

A.The following schedule presents an analysis of the allowance for loan losses, average loan data and related ratios at December 31 for the years indicated:

 

($ in thousands)  2019   2018   2017   2016   2015 
Loans                    
Loans outstanding at end of period  $825,510   $771,883   $696,615   $644,433   $557,659 
                          
Average loans outstanding during period  $809,651   $749,055   $660,675   $603,875   $531,614 
                          
Allowance for loan losses                         
Balance at beginning of period  $8,167   $7,930   $7,725   $6,990   $6,771 
                          
Loans charged off:                         
Commercial business and agricultural   (143)   (227)   (50)   (135)   (497)
Commercial real estate   -    (42)   (26)   (241)   (303)
Residential real estate   (53)   (30)   (61)   (20)   (56)
Consumer & other loans   (63)   (108)   (94)   (105)   (96)
    (259)   (407)   (231)   (501)   (952)
Recoveries of loans previously charged off:                         
Commercial business and agricultural   9    1    10    420    29 
Commercial real estate   1    28    2    5    3 
Residential real estate   14    2    6    2    29 
Consumer & other loans   23    13    18    59    10 
    47    44    36    486    71 
Net loans charged off   (212)   (363)   (195)   (15)   (881)
Provision for loan losses   800    600    400    750    1,100 
                          
Balance at end of period  $8,755   $8,167   $7,930   $7,725   $6,990 
                          
Ratio of net charge offs to average loans   0.03%   0.05%   0.03%   0.00%   0.17%

 

The allowance for loan losses balance and the provision for loan losses are determined by management based upon periodic reviews of the loan portfolio. In addition, management considers the level of charge offs on loans, as well as the fluctuations of charge offs and recoveries on loans, in the factors which caused these changes. Estimating the risk of loss and the amount of loss is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover losses that are currently anticipated based on past loss experience, economic conditions, information about specific borrower situations, including their financial position and collateral values, and other factors and estimates which are subject to change over time.

 

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B.The following schedule provides a breakdown of the allowance for loan losses allocated by type of loan and related ratios at December 31 for the years indicated:

 

   Allowance Amount   Percentage of Loans In Each Category to Total Loans   Allowance Amount   Percentage of Loans In Each Category to Total Loans   Allowance Amount   Percentage of Loans In Each Category to Total Loans   Allowance Amount   Percentage of Loans In Each Category to Total Loans   Allowance Amount   Percentage of Loans In Each Category to Total Loans 
($ in thousands)  2019   2018   2017   2016   2015 
Commercial and agricultural  $2,317    24.6%  $1,917    23.3%  $1,328    22.1%  $1,551    25.1%  $1,118    23.4%
Commercial real estate   3,602    44.4%   2,923    44.2%   3,779    47.7%   3,321    44.1%   3,886    43.4%
Residential real estate   2,203    23.4%   2,567    24.2%   2,129    21.7%   1,963    22.1%   1,312    23.5%
Consumer & other loans   633    7.6%   760    8.3%   694    8.6%   890    8.7%   674    9.7%
Totals  $8,755    100.0%  $8,167    100.0%  $7,930    100.0%  $7,725    100.0%  $6,990    100.0%

 

While management’s periodic analysis of the adequacy of the allowance for loan losses may allocate portions of the allowance for specific problem loan situations, the entire allowance is available for any loan charge offs that occur.

 

V.DEPOSITS

 

The average amount of deposits and average rates paid are summarized as follows for the years ended December 31:

 

   2019   2018   2017 
   Average   Average   Average   Average   Average   Average 
($ in thousands)  Amount   Rate   Amount   Rate   Amount   Rate 
Savings and interest-bearing demand deposits  $427,858    0.67%  $401,577    0.44%  $369,114    0.22%
Time deposits   262,040    2.22%   225,467    1.58%   214,639    1.24%
Demand deposits (non interest bearing)   146,401    -    137,253    -    127,747    - 
Totals  $836,299        $764,297        $711,500      

 

Maturities of time certificates of deposit and other time deposits of $100,000 or more outstanding at December 31, 2019, are summarized as follows:

 

($ in thousands)  Amount 
Three months or less  $32,362 
Over three months through six months   21,998 
Over six months and through twelve months   53,568 
Over twelve months   55,365 
      
Total  $163,293 

 

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VI.RETURN ON EQUITY AND ASSETS

 

The ratio of net income to average shareholders’ equity and average total assets and certain other ratios are as follows for the periods ended December 31:

 

($ in thousands)  2019   2018   2017 
     
Average total assets  $1,027,932   $947,266   $854,569 
                
Average shareholders’ equity  $133,190   $121,094   $89,538 
                
Net income  $11,973   $11,638   $11,065 
                
Net income available to common shareholders  $11,023   $10,663   $10,090 
                
Cash dividends declared  $0.36   $0.32   $0.28 
                
Return on average total assets   1.16%   1.23%   1.29%
                
Return on average shareholders’ equity   8.99%   9.61%   12.36%
                
Dividend payout ratio 1   23.84%   19.60%   13.50%
                
Average shareholders’ equity to average assets   12.96%   12.78%   10.48%

 

1Cash dividends declared on common shares divided by net income available to common.

 

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VII.SHORT-TERM BORROWINGS

 

The following information is reported for short-term borrowings, which are comprised of retail repurchase agreements for the periods noted:

 

($ in thousands)  2019   2018   2017 
     
Amount outstanding at end of year  $12,945   $15,184   $15,082 
                
Weighted-average interest rate at end of year   0.51%   0.49%   0.10%
                
Maximum amount outstanding at any month end  $22,675   $18,312   $18,444 
                
Average amount outstanding during the year  $15,288   $16,458   $12,350 
                
Weighted-average interest rate during the year   0.54%   0.22%   0.12%

 

Item 1A. Risk Factors.

 

Cautionary Statement Regarding Forward-Looking Information

 

Certain statements contained in this Annual Report on Form 10-K, and in other statements that we make from time to time in filings by the Company with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include: (a) projections of income or expense, earnings per share, the payment or non-payment of dividends, capital structure and other financial items; (b) statements of plans and objectives of the Company or our Board of Directors or management, including those relating to products and services; (c) statements of future economic performance; (d) statements of future customer attraction or retention; and (d) statements of assumptions underlying these statements. Forward-looking statements reflect our expectations, estimates or projections concerning future results or events. These statements are generally identified by the use of forward-looking words or phrases such as “anticipates”, “believes”, “estimates”, “expects”, “intends”, “may”, “plans”, “projects”, “should”, “will allow”, “will continue”, “will likely result”, “will remain”, “would be”, or similar expressions.

 

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the forward-looking statements. We desire to take advantage of the “safe harbor” provisions of the Act.

 

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Forward-looking statements involve risks and uncertainties. Actual results may differ materially from those predicted by the forward-looking statements because of various factors and possible events, including those risk factors identified below. These risks and uncertainties include, but are not limited to, risks and uncertainties inherent in the national and regional banking industry, changes in economic and political conditions in the market areas in which the Company and its subsidiaries operate, changes in laws, regulations or policies by regulatory agencies, changes in accounting standards and policies, changes in tax laws, fluctuations in interest rates, demand for loans in the market areas in which the Company and its subsidiaries operate, increases in FDIC insurance premiums, changes in the competitive environment, losses of significant customers, geopolitical events, unanticipated litigation, the loss of key personnel and certain other factors discussed in the Risk Factors below. There is also the risk that the Company’s management or Board of Directors incorrectly analyzes these risks and forces, or that the strategies the Company develops to address them are unsuccessful.

 

Forward-looking statements speak only as of that date on which they are made. Except as may be required by law, the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made. All forward-looking statements attributable to the Company or any person acting on our behalf are qualified in their entirety by the following cautionary statements.

 

Changes in economic and political conditions could adversely affect our earnings through declines in deposits, loan demand, the ability of our customers to repay loans and the value of collateral securing our loans.

 

Our success depends to a large extent upon local and national economic conditions, as well as governmental fiscal and monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, fiscal and monetary policy, tariffs, a U.S. withdrawal from or significant renegotiation of trade agreements, trade wars, the election of a new U.S. President in 2020, and other factors beyond our control may adversely affect our deposit levels and composition, the quality of investment securities available for purchase, demand for loans, the ability of our borrowers to repay their loans, and the value of the collateral securing loans made by us. Recent political developments have resulted in substantial changes in economic and political conditions for the U.S. and the remainder of the world. Disruptions in U.S. and global financial markets, and changes in oil production in the Middle East also affect the economy and stock prices in the U.S., which can affect our earnings capital, as well as the ability of our customers to repay loans. The potential effects of the United Kingdom leaving the European Union (Brexit) on the United States are still unknown. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral and our ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings and cash flows. In addition, our lending and deposit gathering activities are concentrated primarily in Northwest Ohio. As a result, our success depends in large part on the general economic conditions of these areas, particularly given that a significant portion of our lending relates to real estate located in this region. Therefore, adverse changes in the economic conditions in these areas could adversely impact our earnings and cash flows.

 

Our earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies.

 

The policies of the Federal Reserve Board impact us significantly. The Federal Reserve Board regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits, and can also affect the value of financial instruments we hold. Those policies determine to a significant extent our cost of funds for lending and investing. Changes in those policies are beyond our control and are difficult to predict. Federal Reserve Board policies can also affect our borrowers, potentially increasing the risk that they may fail to repay their loans. For example, a tightening of the money supply by the Federal Reserve Board could reduce the demand for a borrower’s products and services. This could adversely affect the borrower’s earnings and ability to repay its loan, which could have a material adverse effect on our financial condition and results of operations.

 

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We may be unable to manage interest rate risks, which could reduce our net interest income.

 

Our results of operations are affected principally by net interest income, which is the difference between interest earned on loans and investments and interest expense paid on deposits and other borrowings. The spread between the yield on our interest-earning assets and our overall cost of funds may be compressed, and our net interest income may continue to be adversely impacted by changing rates. We cannot predict or control changes in interest rates. National, regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve Board, affect the movement of interest rates and our interest income and interest expense. If the interest rates paid on deposits and other borrowed funds increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest paid for deposits rises more quickly than the interest received on loans and other investments.

 

In addition, certain assets and liabilities may react in different degrees to changes in market interest rates. For example, interest rates on some types of assets and liabilities may fluctuate prior to changes in broader market interest rates, while interest rates on other types may lag behind. While the bulk of our variable rate commercial assets have interest rate floors, some of our assets, such as adjustable rate mortgages, have features that restrict changes in their interest rates, including rate caps.

 

Interest rates are highly sensitive to many factors that are beyond our control. Some of these factors include: inflation, recession, unemployment, money supply, international disorders, and instability in domestic and foreign financial markets. Changes in interest rates may affect the level of voluntary prepayments on our loans and may also affect the level of financing or refinancing by customers. We believe that the impact on our cost of funds will depend on a number of factors, including but not limited to, the competitive environment in the banking sector for deposit pricing, opportunities for clients to invest in other markets such as fixed income and equity markets, and the propensity of customers to invest in their businesses. The effect on our net interest income from a change in interest rates will ultimately depend on the extent to which the aggregate impact of loan re-pricings exceeds the impact of increases in our cost of funds.

 

If our actual loan losses exceed our allowance for loan losses, our net income will decrease.

 

Our loan customers may not repay their loans according to their terms, and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. We may experience significant loan losses, which could have a material adverse effect on our operating results. In accordance with accounting principles generally accepted in the United States, we maintain an allowance for loan losses to provide for loan defaults and non-performance, which when combined, we refer to as the allowance for loan losses. Our allowance for loan losses may not be adequate to cover actual credit losses, and future provisions for credit losses could have a material adverse effect on our operating results. Our allowance for loan losses is based on prior experience, as well as an evaluation of the risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses. We cannot guarantee that we will not further increase the allowance for loan losses or that regulators will not require us to increase this allowance. Either of these occurrences could have a material adverse effect on our financial condition and results of operations.

 

Moreover, the Financial Accounting Standards Board (“FASB”) has changed its requirements for establishing the allowance for loan losses.

 

20

 

 

On June 16, 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-13 “Financial Instruments - Credit Losses”, which replaces the incurred loss model with an expected loss model, and is referred to as the current expected credit loss (“CECL”) model. Under the incurred loss model, loans are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. The new accounting guidance is effective for annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2019. Under the CECL model, financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will bring with it significantly greater data requirements and changes to methodologies to accurately account for expected losses under the new parameters. If the methodologies and assumptions that we use in the CECL model are proven to be incorrect or inadequate, the allowance for credit losses may not be sufficient, resulting in the need for additional allowance for credit losses to be established, which could have a material adverse impact on our financial condition and results of operations.

 

Any significant increase in the allowance for loan losses or loan charge offs, as required by these regulatory authorities, might have a material adverse effect on the Company’s financial condition and results of operations.

 

FDIC insurance premiums may increase materially, which could negatively affect our profitability.

 

The FDIC insures deposits at FDIC insured financial institutions, including State Bank. The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level. During 2008 and 2009, there were higher levels of bank failures which dramatically increased resolution costs of the FDIC and depleted the deposit insurance fund. The FDIC collected a special assessment in 2009 to replenish the Deposit Insurance Fund and also required a prepayment of an estimated amount of future deposit insurance premiums. The FDIC recently adopted rules revising the assessments in a manner benefiting banks with assets totaling less than $10 billion. There can be no assurance, however, that assessments will not be changed in the future.

 

A transition away from London Inter-Bank Offered Rate (“LIBOR”) as a reference rate for financial contracts could negatively affect our income and expenses and the value of various financial contracts.

 

LIBOR is used extensively in the U.S. and globally as a benchmark for various commercial and financial contracts, including adjustable rate mortgages, corporate debt, interest rate swaps and other derivatives. LIBOR is set based on interest rate information reported by certain banks, which may stop reporting such information after 2021. It is uncertain at this time whether LIBOR will change or cease to exist or the extent to which those entering into financial contracts will transition to any other particular benchmark. Benchmarks that are used in place of LIBOR, such as the Secured Overnight Finance Rate, may perform differently than LIBOR, and such alternative benchmarks may also perform differently in the future than they have in the past. The use of alternative benchmarks may also have other consequences that cannot currently be anticipated. It is also uncertain what will happen with instruments that rely on LIBOR for future interest rate adjustments and which remain outstanding if LIBOR ceases to exist.

 

The Company’s primary exposure to LIBOR relates to its promissory notes with borrowers, swap contracts with clients, offsetting swap contracts with third parties related to the swap contracts with clients, and the Company’s LIBOR-based borrowings (if any). The Company’s contracts generally include a LIBOR term (for example, one month, three month, or one year) plus an incremental margin rate. The Company is working through this transition via a multi-disciplinary project team.

 

A default by another larger financial institution could adversely affect financial markets generally.

 

The commercial soundness of many financial institutions may be closely interrelated as a result of relationships between and among the institutions. As a result, concerns about, or a default or threatened default by, one institution could lead to significant market wide liquidity and credit problems, losses or defaults by other institutions. This is sometimes referred to as “systemic risk” and may adversely affect our business.

 

21

 

 

We operate in a highly regulated industry, and the laws and regulations that govern our operations, corporate governance, executive compensation and financial accounting, or reporting, including changes in, or failure to comply with the same, may adversely affect the Company.

 

The banking industry is highly regulated. We are subject to supervision, regulation and examination by various federal and state regulators, including the FRB, the SEC, the CFPB, the FDIC, Financial Industry Regulatory Authority, Inc. (“FINRA”), and various state regulatory agencies. The statutory and regulatory framework that governs the Company is generally designed to protect depositors and customers, the Deposit Insurance Fund, the U.S. banking and financial system, and financial markets as a whole and not to protect shareholders. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on our business activities (including foreclosure and collection practices), limit the dividends or distributions that we can pay, and impose certain specific accounting requirements that may be more restrictive and may result in greater or earlier charges to earnings or reductions in capital than would otherwise be required under generally accepted accounting principles in the United States of America. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional compliance costs. Both the scope of the laws and regulations and the intensity of the supervision to which we are subject have increased in recent years in response to the perceived state of the financial services industry, as well as other factors such as technological and market changes. Such regulation and supervision may increase our costs and limit our ability to pursue business opportunities. Further, our failure to comply with these laws and regulations, even if the failure was inadvertent or reflects a difference in interpretation, could subject the Company to restrictions on business activities, fines, and other penalties, any of which could adversely affect results of operations, the capital base, and the price of our common shares. Further, any new laws, rules, or regulations could make compliance more difficult or expensive or otherwise adversely affect our business and financial condition.

 

Legislative or regulatory changes or actions could adversely impact our business.

 

The financial services industry is extensively regulated. We are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our operations. These laws and regulations are primarily intended for the protection of consumers, depositors, borrowers and the deposit insurance fund, not to benefit our shareholders. Changes to laws and regulations or other actions by regulatory agencies may negatively impact us, possibly limiting the services we provide, increasing the ability of non-banks to compete with us or requiring us to change the way we operate. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on the operation of an institution and the ability to determine the adequacy of an institution’s allowance for loan losses. Failure to comply with applicable laws, regulations and policies could result in sanctions being imposed by the regulatory agencies, including the imposition of civil money penalties, which could have a material adverse effect on our operations and financial condition. Even the reduction of regulatory restrictions could have an adverse impact on us if such lessening of restrictions increases competition within our industry or market areas.

 

In light of conditions in the global financial markets and the global economy that occurred in the last decade, regulators have increased their focus on the regulation of the financial services industry. In the last several years, Congress and the federal bank regulators have acted on an unprecedented scale in responding to the stresses experienced in the global financial markets. Some of the laws enacted by Congress and regulations promulgated by federal bank regulators subject us and other financial institutions to additional restrictions, oversight and costs that may have an adverse impact on our business and results of operations.

 

Changes in tax laws could adversely affect our performance.

 

We are subject to extensive federal, state and local taxes, including income, excise, sales/use, payroll, franchise, withholding and ad valorem taxes. Changes to tax laws could have a material adverse effect on our results of operations; fair values of net deferred tax assets and obligations of state and political subdivisions held in our investment securities portfolio. In addition, our customers are subject to a wide variety of federal, state and local taxes. Changes in taxes paid by our customers may adversely affect their ability to purchase homes or consumer products, which could adversely affect their demand for our loans and deposit products. In addition, such negative effects on our customers could result in defaults on the loans we have made.

 

Our success depends upon our ability to attract and retain key personnel.

 

Our success depends upon the continued service of our senior management team and upon our ability to attract and retain qualified financial services personnel. Competition for qualified employees is intense. We cannot guarantee that we will be able to retain our existing key personnel or attract additional qualified personnel. If we lose the services of our key personnel, or are unable to attract additional qualified personnel, our business, financial condition and results of operations could be adversely affected.

 

22

 

 

We depend upon the accuracy and completeness of information about customers.

 

In deciding whether to extend credit or enter into other transactions with customers, we may rely on information provided to us by customers, including financial statements and other financial information. We may also rely on representations of customers as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to a business, we may assume that the customer’s audited financial statements conform to generally accepted accounting principles and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer, and we may also rely on the audit report covering those financial statements. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with generally accepted accounting principles or that are materially misleading.  

 

Our ability to pay cash dividends is limited, and we may be unable to pay cash dividends in the future even if we elect to do so.

 

We are dependent primarily upon the earnings of our operating subsidiaries for funds to pay dividends on our common and depositary shares. The payment of dividends by us is also subject to regulatory restrictions. As a result, any payment of dividends in the future will be dependent, in large part, on our ability to satisfy these regulatory restrictions and our subsidiaries’ earnings, capital requirements, financial condition and other factors. There can be no assurance as to if or when the Company may pay dividends or as to the amount of any dividends which may be declared and paid to shareholders in future periods. Failure to pay dividends on our shares could have a material adverse effect on the market price of our shares.

 

We may not be able to grow, and if we do, we may have difficulty managing that growth.

 

Our business strategy is to continue to grow our assets and expand our operations, including through potential strategic acquisitions. Our ability to grow depends, in part, upon our ability to expand our market share, successfully attract core deposits, and to identify loan and investment opportunities as well as opportunities to generate fee-based income. We can provide no assurance that we will be successful in increasing the volume of our loans and deposits at acceptable levels and upon terms acceptable to us. We also can provide no assurance that we will be successful in expanding our operations organically or through strategic acquisitions while managing the costs and implementation risks associated with this growth strategy.

 

We expect to continue to experience growth in the number of our employees and customers and the scope of our operations, but we may not be able to sustain our historical rate of growth or continue to grow our business at all. Our success will depend upon the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships, and to hire, train and manage our employees. In the event that we are unable to perform all these tasks and meet these challenges effectively, including continuing to attract core deposits, our operations, and consequently our earnings, could be adversely impacted.

 

Any future acquisitions will be subject to a variety of risks, including execution risks, failure to realize anticipated transaction benefits, and failure to overcome integration risks, which could adversely affect our growth and profitability.

 

Although we do not currently have any plans, arrangements or understandings to make any acquisitions in the near-term, from time to time in the future we may consider acquisition opportunities that we believe support our businesses and enhance our profitability. In the event that we do pursue acquisitions, we may have difficulty executing on acquisitions and may not realize the anticipated benefits of any transactions we complete.

 

Generally, any acquisition of target financial institutions, branches or other banking assets by us will require approval by, and cooperation from, a number of governmental regulatory agencies, possibly including the FRB, the FDIC and the regulatory authorities in a state in which an acquisition is consummated. Such regulators could deny our application, which would restrict our growth, or the regulatory approvals may not be granted on terms that are acceptable to us. For example, we could be required to sell branches as a condition to receiving regulatory approvals, and such a condition may not be acceptable to us or may reduce the benefit of an acquisition.

 

23

 

 

A limited trading market exists for our common shares, which could lead to price volatility.

 

The ability to sell our common shares depends upon the existence of an active trading market for those shares. While our shares are listed for trading on the NASDAQ Capital Market, there is moderate trading volume in these shares. As a result, shareholders may be unable to sell our shares at the volume, price and time desired. The limited trading market for our shares may cause fluctuations in the market value of our shares to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market. In addition, even if a more active market of our shares should develop, we cannot guarantee that such a market will continue.

 

The market price of our common shares may be subject to fluctuations and volatility.

 

The market price of our common shares may fluctuate significantly due to, among other things, changes in market sentiment regarding our operations, financial results or business prospects, the banking industry generally or the macroeconomic outlook. Certain events or changes in the market or banking industry generally are beyond our control. In addition to the other risk factors contained or incorporated by reference herein, factors that could affect our trading price:

 

our actual or anticipated operating and financial results, including how those results vary from the expectations of management, securities analysts and investors;
changes in financial estimates or publications of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to us or other financial institution;
failure to declare dividends on our common shares from time to time;
reports in the press or investment community generally or relating to our reputation or the financial services industry;
developments in our business or operations or in the financial sector generally;
any future offerings by us of our common shares;
any future offerings by us of debt or preferred shares, which would be senior to our common shares upon liquidation and for purposes of dividend distributions;
legislative or regulatory changes affecting our industry generally or our business and operations specifically;
the operating and share price performance of companies that investors consider to be comparable to us;
announcements of strategic developments, acquisitions, restructurings, dispositions, financings and other material events by us or our competitors;
actions by our current shareholders, including future sales of common shares by existing shareholders, including our directors and executive officers;
proposed or final regulatory changes or developments;
anticipated or pending regulatory investigations, proceedings, or litigation that may involve or affect us; and
other changes in U.S. or global financial markets, global economies and general market conditions, such as interest or foreign exchange rates, stock, commodity, credit or asset valuations or volatility.

 

24

 

 

Equity markets in general and our shares have experienced volatility over the past few years. The market price of our shares may continue to be subject to volatility unrelated to our operating performance or business prospects, which could result in a decline in the market price of our shares.

 

Investors could become subject to regulatory restrictions upon ownership of our common shares.

 

Under the Federal Change in Bank Control Act, a person may be required to obtain prior approval from the Federal Reserve before acquiring 10 percent or more of our common shares or the power to directly or indirectly control our management, operations, or policies.

 

We have implemented anti-takeover devices that could make it more difficult for another company to purchase us, even though such a purchase may increase shareholder value.

 

In many cases, shareholders may receive a premium for their shares if we were purchased by another company. Ohio law and our Articles and Amended and Restated Regulations, as amended (“Regulations”), make it difficult for anyone to purchase us without the approval of our Board of Directors. Consequently, a takeover attempt may prove difficult, and shareholders may not realize the highest possible price for their securities.

 

The preparation of our financial statements requires the use of estimates that may vary from actual results.

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make significant estimates that affect the financial statements. Two of our most critical estimates are the level of the allowance for loan losses and the accounting for goodwill and other intangibles. Because of the inherent nature of these estimates, we cannot provide complete assurance that we will not be required to adjust earnings for significant unexpected loan losses, nor that we will not recognize a material provision for impairment of our goodwill. For additional information regarding these critical estimates, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on page 35 of this Annual Report on Form 10-K.

 

Changes in accounting standards could influence our results of operations.

 

The accounting standard setters, including the FASB, the SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. These changes can be difficult to predict and can materially affect how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, which would result in the restatement of our financial statements for prior periods.

 

The preparation of consolidated financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) requires management to make significant estimates that affect the financial statements. Due to the inherent nature of these estimates, actual results may vary materially from management’s estimates. In June 2016, FASB issued a new accounting standard for recognizing current expected credit losses, commonly referred to as CECL. CECL will result in earlier recognition of credit losses and requires consideration of not only past and current events but also reasonable and supportable forecasts that affect collectability. The Company will be required to comply with the new standard in the first quarter of 2023. Upon adoption of CECL, credit loss allowances may increase, which would decrease retained earnings and regulatory capital. The federal banking regulators have adopted a regulation that will allow banks to phase in the day-one impact of CECL on regulatory capital over three years. CECL implementation poses operational risk, including the failure to properly transition internal processes or systems, which could lead to call report errors, financial misstatements, or operational losses.

 

25

 

 

Our information systems may experience an interruption or security breach.

 

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the possible failure, interruption or security breach of our information systems, there can be no assurance that any such failure, interruption or security breach will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failure, interruption or security breach of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability.

 

Unauthorized disclosure of sensitive or confidential client information, or breaches in security of our systems, could severely harm our business.

 

We collect, process and store sensitive consumer data by utilizing computer systems and telecommunications networks operated by both third-party service providers and us. State Bank’s necessary dependence upon automated systems to record and process State Bank’s transactions poses the risk that technical system flaws, employee errors, tampering or manipulation of those systems, or attacks by third parties will result in losses and may be difficult to detect. We have security and backup and recovery systems in place, as well as a business continuity plan, to ensure the computer systems will not be inoperable, to the extent possible. We also routinely review documentation of such controls and backups related to third party service providers. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations. In recent years, some banks have experienced denial of service attacks in which individuals or organizations flood the bank’s website with extraordinarily high volumes of traffic, with the goal and effect of disrupting the ability of the bank to process transactions.

 

We could be adversely affected if one of our employees causes a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. State Bank is further exposed to the risk that the third-party service providers may be unable to fulfill their contractual obligations (or will be subject to the same risks as we are). These disruptions may interfere with service to our customers, cause additional regulatory scrutiny and result in a financial loss or liability.

 

Misconduct by employees could include fraudulent, improper or unauthorized activities on behalf of clients or improper use of confidential information. We may not be able to prevent employee errors or misconduct, and the precautions we take to detect this type of activity might not be effective in all cases. Employee errors or misconduct could subject us to civil claims for negligence or regulatory enforcement actions, including fines and restrictions on our business.

 

In addition, there have been instances where financial institutions have been victims of fraudulent activity in which criminals pose as customers to initiate wire and automated clearinghouse transactions out of customer accounts. Although we have policies and procedures in place to verify the authenticity of our customers, we cannot assure that such policies and procedures will prevent all fraudulent transfers. Such activity can result in financial liability and harm to our reputation.

 

We have implemented security controls to prevent unauthorized access to the computer systems and require our third-party service providers to maintain similar controls. However, management cannot be certain that these measures will be successful. A security breach of the computer systems and loss of confidential information, such as customer account numbers and related information could result in a loss of customers’ confidence and, thus, loss of business. In addition, unauthorized access to or use of sensitive data could subject us to litigation, liability, and costs to prevent further such occurrences.

 

Further, we may be affected by data breaches at retailers and other third parties who participate in data interchanges with us and our customers that involve the theft of customer credit and debit card data, which may include the theft of our debit card PIN numbers and commercial card information used to make purchases at such retailers and other third parties. Such data breaches could result in us incurring significant expenses to reissue debit cards and cover losses, which could result in a material adverse effect on our results of operations. To date, we have not experienced any material losses relating to cyber-attacks or other information security breaches, but there can be no assurance that we will not suffer such attacks or attempted breaches, or incur resulting losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, and our plans to continue to implement internet and mobile banking capabilities to meet customer demand. As cyber and other data security threats continue to evolve, we may be required to expend significant additional resources to continue to modify and enhance its protective measures or to investigate and remediate any security vulnerabilities.

 

26

 

 

Our assets at risk for cyber-attacks include financial assets and non-public information belonging to customers. We use several third-party vendors who have access to our assets via electronic media. Certain cyber security risks arise due to this access, including cyber espionage, blackmail, ransom, and theft. As cyber and other data security threats continue to evolve, we may be required to expend significant additional resources to continue to modify and enhance our protective measures or to investigate and remediate any security vulnerabilities.

 

Noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations could cause a material financial loss.

 

The Bank Secrecy Act and the USA Patriot Act contain anti-money laundering and financial transparency provisions intended to detect and prevent the use of the U.S. financial system for money laundering and terrorist financing activities. The Bank Secrecy Act, as amended by the USA Patriot Act, requires depository institutions and their holding companies to undertake activities including maintaining an anti-money laundering program, verifying the identity of clients, monitoring for and reporting suspicious transactions, reporting on cash transactions exceeding specified thresholds, and responding to requests for information by regulatory authorities and law enforcement agencies. Financial Crimes Enforcement Network (“FinCEN”), a unit of the Treasury Department that administers the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the federal bank regulatory agencies, as well as the U.S. Department of Justice, Drug Enforcement Administration, and Internal Revenue Service.

 

There is also increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control (“OFAC”). If the Company’s policies, procedures, and systems are deemed deficient, or if the policies, procedures, and systems of the financial institutions that the Company has already acquired or may acquire in the future are deficient, the Company may be subject to liability, including fines and regulatory actions such as restrictions on State Bank’s ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain planned business activities, including acquisition plans, which could negatively impact our business, financial condition, and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for the Company.

 

We are at risk of increased losses from fraud.

 

Criminals are committing fraud at an increasing rate and are using more sophisticated techniques. In some cases, these individuals are part of larger criminal rings, which allow them to be more effective. Such fraudulent activity has taken many forms, ranging from debit card fraud, check fraud, mechanical devices attached to ATM machines, social engineering and phishing attacks to obtain personal information, or impersonation of clients through the use of falsified or stolen credentials. Additionally, an individual or business entity may properly identify itself, yet seek to establish a business relationship for the purpose of perpetrating fraud. An emerging type of fraud even involves the creation of synthetic identification in which fraudsters “create” individuals for the purpose of perpetrating fraud. Further, in addition to fraud committed directly against the Company, the Company may suffer losses as a result of fraudulent activity committed against third parties. Increased deployment of technologies, such as chip card technology, defray and reduce certain aspects of fraud; however, criminals are turning to other sources to steal personally identifiable information, such as unaffiliated healthcare providers and government entities, in order to impersonate the consumer and thereby commit fraud.

 

27

 

 

Our business could be adversely affected through third parties who perform significant operational services on our behalf.

 

The third parties performing operational services for the Company are subject to risks similar to those faced by the Company relating to cybersecurity, breakdowns or failures of their own systems, or misconduct of their employees. Like many other community banks, State Bank also relies, in significant part, on a single vendor for the systems which allow State Bank to provide banking services to State Bank’s customers.

 

One or more of the third parties utilized by us may experience a cybersecurity event or operational disruption and, if any such event does occur, it may not be adequately addressed, either operationally or financially, by such third party. Certain of these third parties may have limited indemnification obligations to us in the event of a cybersecurity event or operational disruption, or may not have the financial capacity to satisfy their indemnification obligations.

 

Financial or operational difficulties of a third party provider could also impair our operations if those difficulties interfere with such third party’s ability to serve the Company. If a critical third-party provider is unable to meet the needs of the Company in a timely manner, or if the services or products provided by such third party are terminated or otherwise delayed and if the Company is not able to develop alternative sources for these services and products quickly and cost-effectively, our business could be materially adversely effected.

 

Additionally, regulatory guidance adopted by federal banking regulators addressing how banks select, engage and manage their third-party relationships, affects the circumstances and conditions under which we work with third parties and the cost of managing such relationships.

 

We may be compelled to seek additional capital in the future, but capital may not be available when needed.

 

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. In addition, federal banking agencies have proposed extensive changes to their capital requirements; including raising required amounts and eliminating the inclusion of certain instruments from the calculation of capital. In addition, we may elect to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect to raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects.

 

Strong competition within our market area may reduce our ability to attract and retain deposits and originate loans.

 

We face competition both in originating loans and in attracting deposits within our market area. We compete for clients by offering personal service and competitive rates on our loans and deposit products. The type of institutions we compete with include large regional financial institutions, community banks, thrifts and credit unions operating within our market areas. Nontraditional sources of competition for loan and deposit dollars come from captive auto finance companies, mortgage banking companies, internet banks, brokerage companies, insurance companies and direct mutual funds. As a result of their size and ability to achieve economies of scale, certain of our competitors offer a broader range of products and services than we offer. We expect competition to remain intense in the future due to legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. In addition, to stay competitive in our markets we may need to adjust the interest rates on our products to match the rates offered by our competitors, which could adversely affect our net interest margin. As a result, our profitability depends upon our continued ability to successfully compete in our market areas while achieving our investment objectives.

 

28

 

 

We may be the subject of litigation, which could result in legal liability and damage to our business and reputation.

 

From time to time, we may be subject to claims or legal action from customers, employees or others. Financial institutions like the Company and State Bank are facing a growing number of significant class actions, including those based on the manner of calculation of interest on loans and the assessment of overdraft fees. Future litigation could include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. We are also involved from time to time in other reviews, investigations and proceedings (both formal and informal) by governmental and other agencies regarding our business. These matters also could result in adverse judgments, settlements, fines, penalties, injunctions or other relief. Like other large financial institutions, we are also subject to risk from potential employee misconduct, including non-compliance with policies and improper use or disclosure of confidential information.

 

Our insurance may not cover all claims that may be asserted against us, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Should the ultimate judgments or settlements in any litigation exceed our insurance coverage, they could have a material adverse effect on our financial condition and results of operations. In addition, we may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms, if at all.

 

We could face legal and regulatory risk arising out of our residential mortgage business.

 

Numerous federal and state governmental, legislative and regulatory authorities are investigating practices in the business of mortgage and home equity lending and servicing and in the mortgage-related insurance and reinsurance industries. We could face the risk of class actions, other litigation and claims from: the owners of or purchasers of such loans originated or serviced by us, homeowners involved in foreclosure proceedings or various mortgage-related insurance programs, downstream purchasers of homes sold after foreclosure, title insurers, and other potential claimants. Included among these claims are claims from purchasers of mortgage and home equity loans seeking the repurchase of loans where the loans allegedly breached origination covenants, representations, and warranties made to the purchasers in the purchase and sale agreements. The CFPB has issued new rules for mortgage origination and mortgage servicing. Both the origination and servicing rules create new private rights of action for consumers against lenders and servicers in the event of certain violations.

 

We may be required to repurchase loans we have sold or indemnify loan purchasers under the terms of the sale agreements, which could adversely affect our liquidity, results of operations and financial statements.

 

When State Bank sells a mortgage loan, it agrees to repurchase or substitute a mortgage loan if it is later found to have breached any representation or warranty State Bank made about the loan or if the borrower is later found to have committed fraud in connection with the origination of the loan. While we have underwriting policies and procedures designed to avoid breaches of representations and warranties as well as borrower fraud, there can be no assurance that no breach or fraud will ever occur. Required repurchases, substitutions or indemnifications could have an adverse impact on our liquidity, results of operations and financial statements.

 

We need to constantly update our technology in order to compete and meet customer demands.

 

The financial services market, including banking services, is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and may enable us to reduce costs. Our future success will depend, in part, on our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in our operations. Some of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological changes affecting the financial services industry could negatively affect our growth, revenue and profit.

 

29

 

 

Climate change, severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact our business.

 

Natural disasters, including severe weather events of increasing strength and frequency due to climate change, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business or upon third parties who perform operational services for us or our customers. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in lost revenue or cause us to incur additional expenses.

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2. Properties.

 

The Company’s principal executive offices are located at 401 Clinton Street, Defiance, Ohio. State Bank owns this facility, with a portion of the facility utilized as a retail banking center. In addition, State Bank owns the land and buildings occupied by nineteen of its banking centers and leases one other property used as a banking center. The Company also occupies office space from various parties for loan production and other business purposes on varying lease terms. There is no outstanding mortgage debt on any of the properties which are owned by State Bank.

 

Listed below are the banking centers, loan production offices and service facilities of the Company and their addresses, all of which are located in Allen, Cuyahoga, Defiance, Delaware, Fulton, Franklin, Hancock, Lucas, Paulding, Seneca, Williams and Wood counties of Ohio; Allen, Hamilton and Steuben counties of Indiana; and Monroe county of Michigan:

 

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SB Financial Group, Inc. Property List as of December 31, 2019

 

($ in thousands)  Description/Address  Leased/
Owned
  Total Deposits 12/31/19 
           
Main Banking Center & Corporate Office        
401  Clinton Street, Defiance, OH  Owned  $231,979 
            
Banking Centers/Drive-Thru’s        
1419  West High Street, Bryan, OH  Owned   42,597 
510  Third Street, Defiance, OH (Drive-thru)  Owned    N/A 
1600  North Clinton Street, Defiance, OH  Leased   35,929 
312  Main Street, Delta, OH  Owned   17,533 
4080  West Dublin Granville Road, Dublin, OH  Owned   53,665 
201  East Lincoln Street, Findlay, OH  Owned   13,536 
12832  Coldwater Road, Fort Wayne, IN  Owned   30,456 
1232  North Main Street, Bowling Green, OH  Owned   9,959 
235  Main Street, Luckey, OH  Owned   29,555 
133  East Morenci Street, Lyons, OH  Owned   20,008 
930  West Market Street, Lima, OH  Owned   54,248 
1201  East Main Street, Montpelier, OH  Owned   41,770 
218  North First Street, Oakwood, OH  Owned   22,109 
220  North Main Street, Paulding, OH  Owned   56,276 
610  East South Boundary Street, Perrysburg, OH  Owned   16,125 
119  South State Street, Pioneer, OH  Owned   29,470 
6401  Monroe Street, Sylvania, OH  Owned   56,354 
311  Main Street, Walbridge, OH  Owned   31,229 
515  Parkview, Wauseon, OH  Owned   47,421 
            
Loan Production Offices        
307  North Wayne Street, Angola, IN  Owned    N/A 
10100  Lantern Road, Suite 240, Fishers, IN  Leased    N/A 
94  Granville Street, Gahanna, OH  Owned    N/A 
206  South Washington Street, Tiffin, OH  Leased    N/A 
8194  Secor Road, Lambertville, MI  Leased    N/A 
1900  Monroe Street, Suite 108, Toledo, OH  Leased    N/A 
29580  Center Ridge Road, Westlake, OH  Leased    N/A 
            
Service Facilities (SBT/SBFG TITLE)        
112  East Jackson Street, West Unity, OH  Owned    N/A 
104  Depot Street, Archbold, OH  Leased    N/A 
105  East Holland Street, Archbold, OH  Leased    N/A 
1911  Baltimore Road, Defiance, OH  Leased    N/A 
573  Carle Avenue Office C, Lewis Center, OH  Leased    N/A 
1379  North Shoop Avenue, Wauseon, OH  Owned    N/A 
9101  Antares Avenue, Columbus, OH  Owned   N/A 
   Total deposits     $840,219 

 

The SB Captive, Inc. operates from office space located at 101 Convention Center Dr., Suite 850, Las Vegas, NV 89109.

 

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The Company’s subsidiaries have several noncancellable leases for business use that expire over the next five years. Aggregate rental expense for these leases was $0.19 and $0.15 million for the years ended December 31, 2019 and 2018, respectively.

 

Future minimum lease payments under operating leases are:

 

($ in thousands)    
2020  $171 
2021   55 
2022   18 
2023   4 
2024   - 
Thereafter   - 
Total minimum lease payments  $248 

 

Item 3. Legal Proceedings.

 

In the ordinary course of our business, the Company and its subsidiaries are parties to various legal actions, which we believe are incidental to the operation of our business. Although the ultimate outcome and amount of liability, if any, with respect to these legal actions cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is not likely to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

Item 4. Mine Safety Disclosures.

 

Not Applicable

 

Supplemental Item: Information about our Executive Officers

 

The following table lists the names and ages of the executive officers of the Company as of February 21, 2020, the positions presently held by each executive officer, and the business experience of each executive officer during their employment at the Company. Unless otherwise indicated, each person has held his or her principal occupation(s) for more than five years.

 

Name  Age  Position(s) Held with the Company and
its Subsidiaries and Principal Occupation(s)
Mark A. Klein  65  Chairman of the Company since April 2015; Director of the Company since February 2010; President and Chief Executive Officer of the Company since January 2010 and of State Bank since January 2006; Director of State Bank since 2006; President of RDSI since October 2011; Member of State Bank Trust Investment Review Committee since March 2007.
Anthony V. Cosentino  58  Executive Vice President and Chief Financial Officer of the Company and State Bank since March 2010; Chief Financial Officer of RDSI since October 2011; Member of State Bank Trust Investment Review Committee since June 2010.
Ernesto Gaytan  48  Executive Vice President and Chief Technology Innovation and Operations Officer of the Company since July 2018; Chief Technology Innovation Officer since November 2017.
Jonathan R. Gathman  46  Executive Vice President and Senior Lending Officer of the Company since October 2005; Senior Vice President and Commercial Lending Manager from June 2005 through October 2005; Vice President and Commercial Lender from February 2003 through June 2005. Began working for State Bank in May 1996.
Keeta J. Diller  63  Executive Vice President and Chief Risk Officer of the Company since July 2019; Senior Vice President and Chief Enterprise Risk Management Officer from August 2018 through July 2019; Senior Vice President and Audit Coordinator and Director of Operations from December 2011 through August 2018; Vice President and Internal Auditor from January 2010 through December 2011; Corporate Secretary for the Company since 1996; Began working for State Bank in February 1990 as the Accounting Supervisor.

 

32

 

PART II

 

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

 

Market Information

 

Our common shares are traded on the NASDAQ Capital Market under the symbol “SBFG”. There were 7,806,668 common shares outstanding as of December 31, 2019, which were held by approximately 1,257 record holders.

 

The Company paid quarterly dividends on its common shares in the aggregate amounts of $0.36 per share and $0.32 per share in 2019 and 2018, respectively. The Company presently anticipates continuing to pay quarterly dividends in the future at similar levels. However, there is no guarantee that dividends on our common shares will continue in the future.

 

Payment of dividends by State Bank may be restricted at any time at the discretion of the regulatory authorities, if they deem such dividends to constitute an unsafe and/or unsound banking practice. These provisions could have the effect of limiting the Company’s ability to pay dividends on its outstanding shares. Moreover, the Federal Reserve Board expects the Company to serve as a source of strength to its subsidiary banks, which may require it to retain capital for further investment in State Bank, rather than for dividends to shareholders of the Company.

 

 

 

   Period Ending 
Index  12/31/14   12/31/15   12/31/16   12/31/17   12/31/18   12/31/19 
SB Financial Group, Inc.   100.00    120.76    177.77    208.08    188.29    230.06 
NASDAQ Composite Index   100.00    106.96    116.45    150.96    146.67    200.49 
SNL U.S. Bank NASDAQ Index   100.00    107.95    149.68    157.58    132.82    166.75 

 

Source: S&P Global Market Intelligence

© 2020

 

The table below reflects the common shares repurchased by the Company during the three months ended December 31, 2019. The Company has no shares remaining under the existing approved share repurchase program, which expired on December 31, 2019.

 

   (a)   (b)   (c)   (d) 
Period  Total Number of Shares Purchased   Weighted 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 
10/01/19 - 10/31/19   26,315   $16.56    26,315    199,365 
11/01/19 - 11/30/19   5,898    18.00    5,898    193,467 
12/01/19 - 12/31/19   8,601    18.95    4,096    - 
Totals   40,814   $17.27    36,309    - 

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Item 6. Selected Financial Data.

 

Financial Highlights

Year Ended December 31,

 

($ in thousands, except per share data)                    
   2019   2018   2017   2016   2015 
Earnings                    
Interest income  $44,400   $39,479   $32,480   $29,051   $25,927 
Interest expense   9,574    6,212    4,094    3,198    2,584 
Net interest income   34,826    33,267    28,386    25,853    23,343 
Provision for loan losses   800    600    400    750    1,100 
Noninterest income   18,016    16,624    17,217    17,889    15,707 
Noninterest expense   37,410    34,847    31,578    30,091    26,927 
Provision for income taxes   2,659    2,806    2,560    4,117    3,404 
Net income   11,973    11,638    11,065    8,784    7,619 
Preferred stock dividends   950    975    975    975    956 
Net income available to common   11,023    10,663    10,090    7,809    6,663 
                          
Per Common Share Data                         
Basic earnings  $1.71   $1.72   $2.10   $1.60   $1.36 
Diluted earnings   1.51    1.51    1.74    1.38    1.19 
Cash dividends declared   0.36    0.32    0.28    0.24    0.20 
Total equity per share   17.53    16.36    15.03    13.75    12.81 
Total tangible equity per share   15.23    15.39    13.27    11.59    10.39 
                          
Average Balances                         
Average total assets  $1,027,932   $947,266   $854,569   $789,045   $719,586 
Average equity   133,190    121,094    89,538    84,540    78,618 
                          
Ratios                         
Return on average total assets   1.16%   1.23%   1.29%   1.11%   1.06%
Return on average equity   8.99    9.61    12.36    10.39    9.69 
Cash dividend payout ratio1   23.84    19.60    13.50    15.11    14.71 
Average equity to average assets   12.96    12.78    10.48    10.71    10.93 
                          
Period End Totals                         
Total assets  $1,038,577   $986,828   $876,627   $816,005   $733,071 
Total investments; fed funds sold   100,948    90,969    82,790    90,128    89,789 
Total loans & leases   825,510    771,883    696,615    644,433    557,659 
Loans held for sale   7,258    4,445    3,940    4,434    7,516 
Allowance for loan losses   8,755    8,167    7,930    7,725    6,990 
Total deposits   840,219    802,552    729,600    673,073    586,453 
Advances from FHLB   16,000    16,000    18,500    26,500    35,000 
Trust preferred securities   10,310    10,310    10,310    10,310    10,310 
Total equity   136,094    130,435    94,000    86,548    81,241 

 

1Cash dividends on common shares divided by net income available to common.

 

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

 

SB Financial Group, Inc. (“SB Financial”), is a financial holding company registered with the Federal Reserve Board and subject to regulation under the Bank Holding Company Act of 1956, as amended. Through its direct and indirect subsidiaries, SB Financial is engaged in commercial and retail banking, wealth management and private client financial services.

 

The following discussion provides a review of the consolidated financial condition and results of operations of SB Financial and its subsidiaries (collectively, the “Company”). This discussion should be read in conjunction with the Company’s consolidated financial statements and related footnotes as of and for the years ended December 31, 2019 and 2018.

 

Strategic Discussion

 

The focus and strategic goal of the Company is to grow into and remain a top decile (>90th percentile) independent financial services company. The Company intends to achieve and maintain that goal by executing our five key initiatives.

 

Increase profitability through ongoing diversification of revenue streams: For the twelve months ended December 31, 2019, the Company generated $18.0 million in noninterest income, or 34.1 percent of total operating revenue from fee-based products. These revenue sources include fees generated from saleable residential mortgage loans, retail deposit products, wealth management services, saleable business-based loans (small business and farm service) and title agency revenue. For the twelve months ended December 31, 2018, the Company generated $16.6 million in revenue from fee-based products, or 33.3 percent of total operating revenue.

 

Strengthen our penetration in all markets served: Over our 117-year history of continuous operation in Northwest Ohio, we have established a significant presence in our traditional markets in Defiance, Fulton, Paulding and Williams counties in Ohio. In our newer markets of Bowling Green, Columbus, Findlay, Toledo (Ohio) and Ft. Wayne (Indiana), our current market penetration is minimal but we believe our potential for growth is significant. We continue to seek to expand this presence and penetration in all of our markets.

 

Expand product utilization by new and existing customers: As of December 31, 2019, we served 30,377 households and provided 91,154 products and services (3.00 products & services per household) to these households. Our strategy is to continue to expand the scope of our relationship with each household via our dynamic “on-boarding” process. Proactively identifying client needs is a key ingredient of our value proposition. As of December 31, 2018, we served 29,562 households and provided 87,202 products and services (2.95 products & services per household) to these households.

 

Deliver gains in operational excellence: Our management team believes that becoming and remaining a high-performance financial services company will depend upon seamlessly and consistently delivering operational excellence, as demonstrated by the Company’s leadership in the origination and servicing of residential mortgage loans. As of December 31, 2019, the Company serviced 8,155 residential mortgage loans with a principal balance of $1.2 billion. As of December 31, 2018, the Company serviced 7,586 loans with a principal balance of $1.1 billion.

 

Sustain asset quality: As of December 31, 2019, the Company’s asset quality metrics remained strong. Specifically, total nonperforming assets were $5.3 million, or 0.51 percent of total assets. Total delinquent loans at December 31, 2019 were 0.28 percent of total loans. As of December 31, 2018, the Company had total nonperforming assets of $4.0 million, or 0.40 percent of total assets. Total delinquent loans at December 31, 2018 were 0.65 percent of total loans.

 

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Critical Accounting Policies

 

The accounting and reporting policies of the Company are in accordance with generally accepted accounting principles in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the Company’s consolidated financial statements for the years ended December 31, 2019 and 2018. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The Company’s financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective or complex.

 

Allowance for Loan Losses: The allowance for loan losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for loan losses each quarter based on changes, if any, in the nature and amount of problem assets and associated collateral, underwriting activities, loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge offs.

 

The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on each impaired loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.

 

Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent, but undetected, losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the subjective nature of individual loan valuations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are also factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of imprecise risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.

 

Goodwill and Other Intangibles: The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required. Goodwill is subject, at a minimum, to annual tests for impairment. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods, and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial goodwill and other intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry conditions and changes in competition.

 

Deferred Tax Liability: The Company has evaluated its deferred tax liability to determine if it is more likely than not that the liability will be realized in the future. The Company’s most recent evaluation has determined that the Company will more likely than not be able to realize the remaining deferred tax liability.

 

Income Tax Accounting: The Company files a consolidated federal income tax return. The provision for income taxes is based upon income in the consolidated financial statements, rather than amounts reported on our income tax return. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in rates on the deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.

 

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Changes in Financial Condition

 

Total assets at December 31, 2019, were $1.04 billion, compared to $986.8 million at December 31, 2018. Loans (excluding loans held for sale) were $825.5 million at December 31, 2019, compared to $771.9 million at December 31, 2018. Total deposits were $840.2 million at December 31, 2019, compared to $802.6 million at December 31, 2018.

 

Total equity was $136.1 million at December 31, 2019, up 4.4 percent from $130.4 million at December 31, 2018. Net income less dividends increase retained earnings by $8.7 million for 2019.

 

Total loans  Years Ended December 31, 
($ in thousands)  2019   2018   % Change 
Commercial business & agriculture  $202,761   $179,652    12.9%
Commercial real estate   366,782    340,791    7.6%
Residential real estate   193,159    187,104    3.2%
Consumer & other   62,808    64,336    -2.4%
Loans held for investment  $825,510   $771,883    6.9%
Loans held for sale  $7,258   $4,445    63.3%

 

Total deposits  2019   2018   % Change 
Noninterest bearing demand  $158,357   $144,592    9.5%
Interest-bearing demand   131,084    130,628    0.3%
Savings & money market   293,025    285,870    2.5%
Time deposits   257,753    241,462    6.7%
                
Total deposits  $840,219   $802,552    4.7%
                
Total shareholders’ equity  $136,094   $130,435    4.3%

 

Loans held for investment increased $53.6 million, or 7.0 percent, to $825.5 million at December 31, 2019. The largest component of this increase was in commercial real estate loans, which rose $26.0 million, followed by commercial business and agriculture loans, which rose $23.1 million.

 

Deposits increased $37.7 million, or 4.7 percent, to $840.2 million at December 31, 2019. Deposit growth for the year included $13.8 million in noninterest demand deposits and $16.3 million in time deposits.

 

Stockholders’ equity at December 31, 2019, was $136.1 million or 13.1 percent of total assets compared to $130.4 million or 13.2 percent of total assets at December 31, 2018.

 

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Asset Quality  Years Ended December 31, 
($ in thousands)  2019   2018   % Change 
Nonaccruing loans  $5,500   $2,906    89.3%
Accruing restructured loans (TDRs)   874    928    -5.8%
OREO & repossessed assets   305    131    132.8%
Nonperforming assets   6,679    3,965    68.4%
Net charge offs   212    362    -41.4%
Loan loss provision   800    600    33.3%
Allowance for loan losses   8,755    8,167    7.2%
                
Nonperforming assets/total assets   0.64%   0.40%   59.9%
Net charge offs/average loans   0.02%   0.05%   -60.0%
Allowance/loans   1.06%   1.06%   0.2%
Allowance/nonperforming loans   137.35%   213.02%   -35.5%

 

Nonperforming assets consisting of loans, Other Real Estate Owned (“OREO”) and accruing TDRs totaled $6.7 million, or 0.64 percent of total assets at December 31, 2019, an increase of $2.7 million or 68.4 percent from 2018. Net charge offs were down during 2019, at $0.21 million, which was a $0.15 million decrease compared to 2018. The Company’s loan loss allowance at December 31, 2019, now covers nonperforming loans at 137 percent, down from 213 percent at December 31, 2018.

 

Regulatory capital reporting is required for State Bank only, as the Company is now exempt from quarterly regulatory capital level measurement pursuant to the Small Bank Holding Company Policy Statement. As of December 31, 2019, State Bank met all regulatory capital levels required to be considered well-capitalized (See Note 15 to the Consolidated Financial Statements).

 

Earnings Summary – 2019 vs. 2018

 

Net income for 2019 was $12.0 million, and net income available to common shareholders was $11.0 million, or $1.51 per diluted share, compared with net income of $11.6 million and net income available to common of $10.7 million, or $1.51 per diluted share, for 2018. State Bank reported net income for 2019 of $12.5 million, which was down from the $12.9 million in net income in 2018. SBFG Title reported net income for 2019 of $0.3 million.

 

Positive results for 2019 included loan growth of $53.6 million, and deposit growth of $37.7 million. The mortgage banking business line continues to contribute significant revenues, with residential real estate loan production of $445.3 million for the year, resulting in $8.4 million of revenue from gains on sale. The level of mortgage origination was up from the $342.1 million in 2018. The Company’s loans serviced for others ended the year at $1.2 billion, up from $1.1 billion at December 31, 2018.

 

Operating revenue was up compared to the prior year by $3.0 million, or 5.9 percent, which is impacted by a $1.1 million temporary OMSR impairment. Our 2019 results include the impact from our two new subsidiaries: SBFG Title with net income of $0.3 million and SB Captive with net income of $0.9 million. Net interest margin on a fully tax equivalent basis (“FTE”) for 2019 was 3.82 percent, down 13 basis points from 2018.

 

Operating expense was up compared to the prior year by $2.6 million, or 7.4 percent, due to compensation and fringe benefit cost increases as a result of higher mortgage commission levels.

 

Net charge offs for 2019 of $0.21 million resulted in a loan loss provision of $0.8 million, compared to net charge offs of $0.36 million and a $0.6 million loan loss provision in 2018.

 

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Results of Operations

 

   Years Ended December 31, 
($ in thousands, except per share data)  2019   2018   % Change 
Total assets  $1,038,577   $986,828    5.2%
Total investments   100,948    90,969    11.0%
Loans held for sale   7,258    4,445    63.3%
Loans, net of unearned income   825,510    771,883    6.9%
Allowance for loan losses   8,755    8,167    7.2%
Total deposits   840,219    802,552    4.7%
                
Total operating revenue1  $52,842   $49,891    5.9%
Net interest income   34,826    33,267    4.7%
Loan loss provision   800    600    33.3%
Noninterest income   18,016    16,624    8.4%
Noninterest expense   37,410    34,847    7.4%
Net income   11,973    11,638    2.9%
Net income available to common shareholders   11,023    10,663    3.4%
Diluted earnings per share   1.51    1.51    0.0%

 

1Operating revenue equals net interest income plus noninterest income.

 

Net Interest Income  Years Ended December 31, 
($ in thousands)  2019   2018   % Change 
Total net interest income  $34,826   $33,267    4.7%

 

Net interest income was $34.8 million for 2019 compared to $33.3 million for 2018, an increase of $1.6 million or 4.7 percent. Average earning assets increased to $915.0 million in 2019, compared to $845.7 million in 2018, an increase of $69.3 million or 8.2 percent due to higher loan volume. The consolidated 2019 full year net interest margin on an FTE basis decreased 12 basis points to 3.83 percent compared to 3.95 percent for the full year of 2018.

 

Provision for loan losses of $0.8 million was taken in 2019 compared to $0.6 million taken for 2018. For 2019, net charge offs totaled $0.21 million, or 0.03 percent of average loans. This charge off level was lower than 2018, in which net charge offs were $0.36 million or 0.06 percent of average loans.

 

Noninterest Income  Years Ended December 31, 
($ in thousands)  2019   2018   % Change 
Wealth management fees  $3,093   $2,871    7.7%
Customer service fees   2,761    2,670    3.4%
Gains on sale of residential loans & OMSR’s   8,413    6,870    22.5%
Mortgage loan servicing fees, net   (397)   1,296    -130.6%
Gain on sale of non-mortgage loans   1,255    1,230    2.0%
Title Insurance income   1,120    -    N/A 
Net gain on sale of securities   206    70    194.3%
Gain (loss) on sale/disposal of assets   (5)   35    -114.3%
Other   1,570    1,582    -0.8%
Total noninterest income  $18,016   $16,624    8.4%

 

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Total noninterest income was $18.0 million for 2019 compared to $16.6 million for 2018, representing an increase of $1.4 million, or 8.4 percent, year-over-year. This increase was driven by a 22.5 percent increase in gains on sale of residential real estate loans and the addition of our title agency. The Company sold $367.3 million of originated mortgages into the secondary market, which allowed our serviced loan portfolio to grow to $1.2 billion at December 31, 2019 from $1.1 billion at December 31, 2018. The higher servicing balance of the portfolio led to the 9.1 percent increase in mortgage loan servicing income. The sale of non-mortgage loans (small business and farm credits) was flat to the prior year. The Company continued to expand its Wealth management assets under care, which resulted in a 7.7 percent increase in wealth fee income.

 

Noninterest Expense  Years Ended December 31, 
($ in thousands)  2019   2018   % Change 
Salaries & employee benefits  $22,064   $20,620    7.0%
Net occupancy expense   2,603    2,397    8.6%
Equipment expense   2,828    2,889    -2.1%
Data processing fees   1,973    1,811    8.9%
Professional fees   2,476    1,848    34.0%
Marketing expense   895    884    1.2%
Telephone and communications   466    495    -5.9%
Postage and delivery expense   340    286    18.9%
State, local and other taxes   1,092    719    51.9%
Employee expense   795    912    -12.8%
Other expense   1,878    1,986    (5.4)%
Total noninterest expense  $37,410   $34,847    7.4%

 

Total noninterest expense was $37.4 million for 2019 compared to $34.8 million for 2018, representing a $2.6 million, or 7.4 percent, increase year-over-year. Total full-time equivalent employees ended 2019 at 252, which was up 2 from year end 2018.

 

Salaries and benefits were driven by higher compensation costs in the mortgage division. Professional fees were higher due to higher spending on legal in connection with acquisition activities. The addition of our title agency added $0.9 million in operating expense for the year. The addition of capital from our common raise drove the higher level of franchise taxes in 2019.

 

Earnings Summary – 2018 vs. 2017

 

Net income for 2018 was $11.6 million, and net income available to common shareholders was $10.7 million, or $1.51 per diluted share, compared with net income of $11.1 million and net income available to common of $10.1 million, or $1.74 per diluted share, for 2017. The Company’s 2018 results reflect the issuance of 1.66 million new common shares in the first quarter. The Company’s 2017 results included a $1.7 million one-time reduction in tax expense due to the enactment in December 2017 of the “Tax Cuts and Jobs Act” (“TCJA”). State Bank reported net income for 2018 of $12.9 million, which was up from the $12.3 million in net income in 2017. RDSI reported net income for 2018 of $0.1 million, compared to a net loss of $0.2 million reported for 2017 due to the sale of the RDSI assets in January 2018.

 

Positive results for 2018 included loan growth of $75.3 million, and deposit growth of $73.0 million. The mortgage banking business line continues to contribute significant revenues, with residential real estate loan production of $342.1 million for the year, resulting in $6.9 million of revenue from gains on sale. The level of mortgage origination was up from the $315.8 million in 2017. The Company’s loans serviced for others ended the year at $1.1 billion, up from $994.9 million at December 31, 2017.

 

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Operating revenue in 2018 was up compared to the prior year by $4.3 million, or 9.4 percent, due to higher margin income due to $75.3 million in balance sheet loan growth, in addition to the sale of our item processing business, which netted $0.4 million in revenue. Net interest margin on an FTE basis for 2018 was 3.95 percent, up 17 basis points from 2017.

 

Operating expense was up compared to the prior year by $3.3 million, or 10.4 percent, due to compensation and fringe benefit cost increases as a result of higher staffing levels. Net charge offs for 2018 of $0.4 million resulted in a loan loss provision of $0.6 million, which was up from the $0.2 million of charge offs and $0.4 million of loan loss provision in 2017.

 

Goodwill, Intangibles and Capital Purchases

 

The Company completed its most recent annual goodwill impairment test as of December 31, 2019. At December 31, 2019, the Company’s reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment.

 

Management plans to continue from time to time to purchase additional premises and equipment and improve current facilities to meet the current and future needs of the Company’s customers. These purchases will include buildings, leasehold improvements, furniture and equipment. Management expects that cash on hand and cash generated from current operations will fund these capital expenditures and purchases.

 

Liquidity

 

Liquidity relates primarily to the Company’s ability to fund loan demand, meet deposit customers’ withdrawal requirements and provide for operating expenses. Sources used to satisfy these needs consist of cash and due from banks, interest-bearing deposits in other financial institutions, securities available-for-sale, loans held for sale and borrowings from various sources. These assets, excluding the borrowings, are commonly referred to as liquid assets. Liquid assets were $135.3 million at December 31, 2019, compared to $143.8 million at December 31, 2018.

 

The Company’s commercial real estate, first mortgage residential, agricultural and multi-family mortgage portfolio of $610.9 million at December 31, 2019, can and is readily used to collateralize borrowings, which is an additional source of liquidity. Management believes the Company’s current liquidity level, without these borrowings, is sufficient to meet its current and anticipated liquidity needs. At December 31, 2019, all eligible commercial real estate, residential first, multi-family mortgage and agricultural loans were pledged under a Federal Home Loan Bank (“FHLB”) blanket lien.

 

Significant additional off-balance-sheet liquidity is available in the form of FHLB advances, unused federal funds lines from correspondent banks and the national certificate of deposit market. Management expects the risk of changes in off-balance-sheet arrangements to be immaterial to earnings. Based on the current collateralization requirements of the FHLB, approximately $117.4 million of additional borrowing capacity existed at December 31, 2019.

 

At December 31, 2019 and 2018, the Company had $41.0 million in federal funds lines available. The Company also had $45.6 million in unpledged securities at December 31, 2019 available for additional borrowings.

 

The cash flow statements for the periods presented provide an indication of the Company’s sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. A discussion of the cash flow statements for 2019 and 2018 follows:

 

The Company experienced positive cash flows from operating activities in 2019 and 2018. Net cash from operating activities was $18.8 and $13.9 million for the years ended December 31, 2019 and 2018, respectively. Significant operating items for 2019 included gain on sale of loans of $9.7 million and net income of $12.0 million. Cash provided by the sale of loans held for sale were $368.2 million. Cash used in the origination of loans held for sale were $364.5 million.

 

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The Company experienced negative cash flows from investing activities in 2019 and 2018. Net cash used in investing activities was $67.6 and $87.6 million for the years ended December 31, 2019 and 2018, respectively. The changes for 2019 include the purchase of available-for-sale securities of $38.5 million, and net increase in loans of $65.5 million. The changes for 2018 include the purchase of available-for-sale securities of $29.3 million and net increase in loans of $76.5 million. The Company had proceeds from repayments, maturities, sales and calls of securities of $29.9 and $20.2 million in 2019 and 2018, respectively.

 

The Company experienced positive cash flows from financing activities in 2019 and 2018. Net cash from financing activities was $27.5 and $95.5 million for the years ended December 31, 2019 and 2018, respectively. Positive cash flows of $37.7 and $72.9 million is attributable to the change in deposits for 2019 and 2018, respectively.

 

The Company uses an Economic Value of Equity (“EVE”) analysis to measure risk in the balance sheet incorporating all cash flows over the estimated remaining life of all balance sheet positions. The EVE analysis calculates the net present value of the Company’s assets and liabilities in rate shock environments that range from -400 basis points to +400 basis points. The likelihood of a decrease in rates is remote given the current interest rate environment and therefore, only the -100 basis points and -200 basis points rate changes were included in the EVE analysis for 2019 and 2018. The results of this analysis are reflected in the following table.

 

Economic Value of Equity

December 31, 2019

($ in thousands)

 

Change in rates  $ Amount   $ Change   % Change 
+400 basis points  $222,686   $26,861    13.72%
+300 basis points   218,252    22,427    11.45%
+200 basis points   212,838    17,013    8.69%
+100 basis points   205,405    9,580    4.89%
Base Case   195,825    -    - 
-100 basis points   180,152    (15,673)   -8.00%
-200 basis points   156,430    (39,395)   -20.12%

 

Economic Value of Equity

December 31, 2018

($ in thousands)

 

Change in rates  $ Amount   $ Change   % Change 
+400 basis points  $213,477   $19,568    10.09%
+300 basis points   210,068    16,158    8.33%
+200 basis points   205,673    11,763    6.07%
+100 basis points   200,400    6,490    3.35%
Base Case   193,910    -    - 
-100 basis points   184,172    (9,738)   -5.02%
-200 basis points   170,293    (23,617)   -12.18%

 

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Tabular Disclosure of Contractual Obligations

 

The following table details the Company’s contractual obligations as of December 31, 2019, which were comprised of long-term debt obligations, other debt obligations, operating lease obligations and other long-term liabilities. Long-term debt obligations are comprised of FHLB Advances of $16.0 million. Other debt obligations are comprised of Trust Preferred securities of $10.3 million and operating leases of $0.3 million. The other long-term liabilities include time deposits of $257.8 million.

 

   Payment due by period 
($ in thousands)      Less than   1 - 3   3 - 5   More than 
Contractual obligations  Total   1 year   years   years   5 years 
                     
Long-term debt obligations  $16,000   $8,000   $8,000   $-   $- 
                          
Other debt obligations   10,310    -    -    -    10,310 
                          
Operating lease obligations   248    171    73    4    - 
                          
Other long-term liabilities                         
Reflected on the registrant’s balance sheet under GAAP   257,753    154,391    91,078    12,102    182 
Totals  $284,311   $162,562   $99,151   $12,106   $10,492 

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

 

Asset liability management involves developing, executing and monitoring strategies to maintain appropriate liquidity, maximize net interest income and minimize the impact that significant fluctuations in market interest rates would have on current and future earnings. The business of the Company and the composition of its balance sheet consist of investments in interest-earning assets (primarily loans, mortgage-backed securities, and securities available-for-sale) which are primarily funded by interest-bearing liabilities (deposits and borrowings). With the exception of specific loans which are originated and held for sale, all of the financial instruments of the Company are for other than trading purposes. All of the Company’s transactions are denominated in U.S. dollars with no specific foreign exchange exposure. In addition, the Company has limited exposure to commodity prices related to agricultural loans. The impact of changes in foreign exchange rates and commodity prices on interest rates are assumed to be insignificant. The Company’s financial instruments have varying levels of sensitivity to changes in market interest rates resulting in market risk. Interest rate risk is the Company’s primary market risk exposure; to a lesser extent, liquidity risk also impacts market risk exposure.

 

Interest rate risk is the exposure of a banking institution’s financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to the Company’s earnings and capital base. Accordingly, effective risk management that maintains interest rate risks at prudent levels is essential to the Company’s safety and soundness.

 

Evaluating a financial institution’s exposure to changes in interest rates includes assessing both the adequacy of the management process used to control interest rate risk and the organization’s quantitative level of exposure. When assessing the interest rate risk management process, the Company seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain interest rate risks at prudent levels of consistency and continuity. Evaluating the quantitative level of interest rate risk exposure requires the Company to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity and asset quality (when appropriate).

 

The FRB together with the OCC and the FDIC adopted a Joint Agency Policy Statement on interest rate risk effective June 26, 1996. The policy statement provides guidance to examiners and bankers on sound practices for managing interest rate risk, which will form the basis for ongoing evaluation of the adequacy of interest rate risk management at supervised institutions. The policy statement also outlines fundamental elements of sound management that have been identified in prior Federal Reserve guidance and discusses the importance of these elements in the context of managing interest rate risk. Specifically, the guidance emphasizes the need for active board of director and senior management oversight and a comprehensive risk management process that effectively identifies, measures and controls interest rate risk.

 

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Financial institutions derive their income primarily from the excess of interest collected over interest paid. The rates of interest an institution earns on its assets and owes on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, an institution is exposed to lower profit margins (or losses) if it cannot adapt to interest rate changes. For example, assume that an institution’s assets carry intermediate or long-term fixed rates and that those assets are funded with short-term liabilities. If market interest rates rise by the time the short-term liabilities must be refinanced, the increase in the institution’s interest expense on its liabilities may not be sufficiently offset if assets continue to earn at the long-term fixed rates. Accordingly, an institution’s profits could decrease on existing assets because the institution will either have lower net interest income or possibly, net interest expense. Similar risks exist when assets are subject to contractual interest rate ceilings, or rate-sensitive assets are funded by longer-term, fixed-rate liabilities in a declining rate environment.

 

There are several ways an institution can manage interest rate risk including: 1) matching repricing periods for new assets and liabilities, for example, by shortening or lengthening terms of new loans, investments, or liabilities; 2) selling existing assets or repaying certain liabilities; and 3) hedging existing assets, liabilities, or anticipated transactions. An institution might also invest in more complex financial instruments intended to hedge or otherwise change interest rate risk. Interest rate swaps, futures contracts, options on futures contracts, and other such derivative financial instruments can be used for this purpose. Because these instruments are sensitive to interest rate changes, they require management’s expertise to be effective. The Company has not purchased derivative financial instruments in the past, but during 2019 and 2018 the Company entered into interest rate swap agreements as an accommodation to certain loan customers (see Note 6 to the Consolidated Financial Statements). The Company may purchase such instruments in the future if market conditions are favorable.

 

The following table details quantitative disclosures of market risk and provides information about the Company’s financial instruments used for purposes other than trading that are sensitive to changes in interest rates as of December 31, 2019. The table does not present when these items may actually reprice. For loans receivable, securities, and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities as well as the historical impact of interest rate fluctuations on the prepayment of loans and mortgage backed securities. For core deposits (demand deposits, interest-bearing checking, savings, and money market deposits) that have no contractual maturity, the table presents principal cash flows and applicable related weighted-average interest rates based upon the Company’s historical experience, management’s judgment and statistical analysis, as applicable, concerning their most likely withdrawal behaviors. The current historical interest rates for core deposits have been assumed to apply for future periods in this table as the actual interest rates that will need to be paid to maintain these deposits are not currently known. Weighted-average variable rates are based upon contractual rates existing at the reporting date.

 

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Principal/Notional Amount Maturing or Assumed to be Withdrawn in:

 

($ in thousands)  2020   2021   2022   2023   2024   Thereafter   Total 
Rate sensitive assets                            
Variable rate loans  $70,328   $29,505   $15,487   $8,416   $8,405   $72,257   $204,398 
Average interest rate   5.23%   5.06%   4.98%   4.80%   4.51%   4.15%   4.76%
Adjustable rate loans   32,228    32,690    31,719    25,528    25,201    243,914    391,280 
Average interest rate   4.70%   4.62%   4.60%   4.53%   4.48%   4.37%   4.45%
Fixed rate loans   39,100    23,433    30,724    19,830    12,036    104,710    229,832 
Average interest rate   5.10%   4.60%   4.40%   4.57%   4.81%   4.58%   4.66%
Total loans   141,656    85,628    77,929    53,774    45,642    420,881    825,510 
Average interest rate   5.07%   4.77%   4.60%   4.59%   4.57%   4.38%   4.58%
Fixed rate investment securities   22,685    14,564    7,585    7,909    6,695    40,722    100,160 
Average interest rate   1.62%   2.41%   2.39%   2.34%   2.63%   2.62%   2.32%
Variable rate investment securities   395    182    144    151    152    4,412    5,436 
Average interest rate   3.81%   3.39%   3.07%   3.07%   3.07%   2.75%   2.87%
Fed funds sold & other   -    -    -    -    -    -    - 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Total rate sensitive assets  $164,736   $100,374   $85,658   $61,834   $52,493   $466,010   $931,105 
Average interest rate   4.59%   4.42%   4.40%   4.30%   4.32%   4.21%   4.33%
                                    
Rate sensitive liabilities                                   
Demand - noninterest bearing  $22,352   $19,197   $16,486   $14,160   $12,162   $74,000   $158,357 
Demand - interest-bearing   15,594    13,740    12,105    10,665    9,396    69,584    131,084 
Average interest rate   0.05%   0.05%   0.05%   0.05%   0.05%   0.05%   0.05%
Money market accounts   21,771    19,042    16,655    14,567    12,741    88,890    173,666 
Average interest rate   0.89%   0.89%   0.89%   0.89%   0.89%   0.89%   0.89%
Savings   52,110    8,714    7,587    6,602    5,747    38,599    119,359 
Average interest rate   0.51%   0.51%   0.51%   0.51%   0.51%   0.51%   0.51%
Certificates of deposit   154,185    65,257    26,027    9,005    3,095    184    257,753 
Average interest rate   2.11%   2.00%   2.21%   2.67%   1.38%   1.48%   2.10%
Fixed rate FHLB advances   8,000    2,500    3,000    2,500    -    -    16,000 
Average interest rate   2.14%   2.77%   2.88%   2.93%   0.00%   0.00%   2.50%
Variable rate FHLB advances   -    -    -    -    -    -    - 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Fixed rate notes payable   -    -    -    -    -    -    - 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Variable rate notes payable   -    -    -    -    -    10,310    10,310 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   3.69%   3.69%
Fed funds purchased, repos & other   12,945    -    -    -    -    -    12,945 
Average interest rate   0.51%   0.00%   0.00%   0.00%   0.00%   0.00%   0.51%
Total rate sensitive liabilities  $286,957   $128,450   $81,860   $57,499   $43,141   $281,567   $879,474 
Average interest rate   1.38%   1.24%   1.04%   0.84%   0.44%   0.50%   0.96%

 

Comparison of 2019 to 2018

 

   First   Years         
($ in thousands)  Year   2 - 5   Thereafter   Total 
Total rate sensitive assets:                    
December 31, 2019  $164,736   $300,359   $466,010   $931,105 
December 31, 2018   146,554    304,681    415,810    867,045 
Increase (decrease)  $18,182   $(4,322)  $50,200   $64,060 
                     
Total rate sensitive liabilities:                    
December 31, 2019  $286,957   $310,950   $281,567   $879,474 
December 31, 2018   267,723    297,636    278,687    844,046 
Increase (decrease)  $19,234   $13,314   $2,880   $35,428 

 

45

 

 

The above table reflects expected maturities, not expected repricing. The contractual maturities adjusted for anticipated prepayments and anticipated renewals at current interest rates, as shown in the preceding table, are only part of the Company’s interest rate risk profile. Other important factors include the ratio of rate-sensitive assets to rate-sensitive liabilities (which takes into consideration loan repricing frequency but not when deposits may be repriced) and the general level and direction of market interest rates. For core deposits, the repricing frequency is assumed to be longer than when such deposits actually reprice. For some rate-sensitive liabilities, their repricing frequency is the same as their contractual maturity. For variable-rate loans receivable, repricing frequency can be daily or monthly. For adjustable-rate loans receivable, repricing can be as frequent as annually for loans whose contractual maturities range from one to thirty years.

 

The Company manages its interest rate risk by the employment of strategies to assure that desired levels of both interest-earning assets and interest-bearing liabilities mature or reprice with similar time frames. Such strategies include: 1) loans receivable which are renewed (and repriced) annually, 2) variable rate loans, 3) certificates of deposit with terms from one month to six years, 4) securities available-for-sale which mature at various times primarily from one through ten years, 5) federal funds borrowings with terms of one day to 90 days, and 6) FHLB borrowings with terms of one day to ten years.

 

The majority of assets and liabilities of the Company are monetary in nature, and therefore the Company differs greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation significantly affects noninterest expense, which tends to rise during periods of general inflation.

 

Management believes the most significant impact on financial results is the Company’s ability to react to changes in interest rates. Management seeks to maintain an essentially balanced position between interest sensitive assets and liabilities and actively manages loan, security, and liability maturities in order to protect against the effects of wide interest rate fluctuations on net income and shareholders’ equity.

 

Item 8. Financial Statements and Supplementary Data.

 

Our Consolidated Financial Statements and notes thereto and other supplementary data begin on the following page.

 

46

 

 

SB Financial Group, Inc.

Consolidated Balance Sheets

at December 31,

 

($ in thousands)        
   2019   2018 
Assets        
Cash and due from banks  $27,064   $48,363 
Available-for-sale securities   100,948    90,969 
Loans held for sale   7,258    4,445 
Loans, net of unearned income   825,510    771,883 
Allowance for loan losses   (8,755)   (8,167)
Premises and equipment, net   23,385    22,084 
Federal Reserve and Federal Home Loan Bank Stock, at cost   4,648    4,123 
Foreclosed assets held for sale, net   305    131 
Interest receivable   3,106    2,822 
Goodwill and other intangibles   17,832    16,401 
Cash value of life insurance   17,221    16,834 
Mortgage servicing rights   11,017    11,365 
Other assets   9,038    5,575 
Total assets  $1,038,577   $986,828 
           
Liabilities and shareholders’ equity          
Liabilities          
Deposits          
Non interest bearing demand  $158,357   $144,592 
Interest bearing demand   131,084    130,628 
Savings   119,359    104,444 
Money market   173,666    181,426 
Time deposits   257,753    241,462 
Total deposits   840,219    802,552 
           
Repurchase agreements   12,945    15,184 
Federal Home Loan Bank advances   16,000    16,000 
Trust preferred securities   10,310    10,310 
Interest payable   1,191    909 
Other liabilities   21,818    11,438 
Total liabilities   902,483    856,393 
           
Commitments & Contingent Liabilities   -    - 
           
Shareholders’ Equity          
Preferred stock, no par value; authorized 200,000 shares; 2019 - 0 shares outstanding, 2018 - 14,995 shares outstanding   -    13,979 
Common stock, no par value; authorized 10,000,000 shares; 2019 - 8,180,712 shares issued, 2018 - 6,694,598 shares issued   54,463    40,485 
Additional paid-in capital   15,023    15,226 
Retained earnings   72,704    64,012 
Accumulated other comprehensive income (loss)   659    (552)
Treasury stock, at cost; (2019 - 417,785 common shares, 2018 - 191,348 common shares)   (6,755)   (2,715)
Total shareholders’ equity   136,094    130,435 
Total liabilities and shareholders’ equity  $1,038,577   $986,828 

 

See Notes to Consolidated Financial Statements

 

F-1 

 

 

SB Financial Group, Inc.

Consolidated Statements of Income

Years Ended December 31,

 

($ in thousands, except per share data)  2019   2018 
Interest Income        
Loans        
Taxable  $40,529   $36,268 
Tax exempt   300    154 
Securities          
Taxable   3,226    2,618 
Tax exempt   345    439 
Total interest income   44,400    39,479 
           
Interest Expense          
Deposits   8,660    5,314 
Repurchase agreements & other   82    37 
Federal Home Loan Bank advance expense   402    460 
Trust preferred securities expense   430    401 
Total interest expense   9,574    6,212 
           
Net Interest Income   34,826    33,267 
Provision for loan losses   800    600 
           
Net interest income after provision for loan losses   34,026    32,667 
           
Noninterest Income          
Wealth management fees   3,093    2,871 
Customer service fees   2,761    2,670 
Gain on sale of mortgage loans & OMSR   8,413    6,870 
Mortgage loan servicing fees, net   (397)   1,296 
Gain on sale of non-mortgage loans   1,255    1,230 
Title insurance income   1,120    - 
Net gain on sale of securities   206    70 
Gain (loss) on sale/disposal of assets   (5)   35 
Other income   1,570    1,582 
Total noninterest income   18,016    16,624 
           
Noninterest Expense          
Salaries and employee benefits   22,064    20,620 
Net occupancy expense   2,603    2,397 
Equipment expense   2,828    2,889 
Data processing fees   1,973    1,811 
Professional fees   2,476    1,848 
Marketing expense   895    884 
Telephone and communications   466    495 
Postage and delivery expense   340    286 
State, local and other taxes   1,092    719 
Employee expense   795    912 
Other expense   1,878    1,986 
Total noninterest expense   37,410    34,847 
           
Income before income tax   14,632    14,444 
           
Provision for income taxes   2,659    2,806 
           
Net Income  $11,973   $11,638 
           
Preferred share dividends   950    975 
           
Net income available to common shareholders  $11,023   $10,663 
           
Basic earnings per common share  $1.71   $1.72 
           
Diluted earnings per common share  $1.51   $1.51 

 

See Notes to Consolidated Financial Statements

F-2 

 

 

SB Financial Group, Inc.

Consolidated Statements of Comprehensive Income

Years Ended December 31,

 

($ in thousands)  2019   2018 
         
Net income  $11,973   $11,638 
Other comprehensive income:          
Available for sale investment securities:          
Gross unrealized holding gain (loss) arising in the period   1,327    (590)
Related tax (expense) benefit   (279)   124 
Less: reclassification adjustment for gain realized in income   206    70 
Related tax expense   (43)   (15)
Net effect on other comprehensive income   1,211    (411)
Total comprehensive income  $13,184   $11,227 

 

See Notes to Consolidated Financial Statements

 

F-3 

 

 

SB Financial Group, Inc.

Consolidated Statements of Stockholders’ Equity

Years Ended December 31,

 

   Preferred   Common   Additional
Paid-in
   Retained   Accumulated
Other
Comprehensive
   Treasury     
($ in thousands, except per share data)  Stock   Stock   Capital   Earnings   Income (Loss)   Stock   Total 
January 1, 2019  $13,979   $40,485   $15,226   $64,012   $(552)  $(2,715)  $130,435 
Net income                  11,973              11,973 
Other comprehensive income                       1,211         1,211 
Conversion of preferred to common   (13,979)   13,978                        (1)
Stock reissue for purchase of Peak Title             22              117    139 
Dividends on common, $0.36 per share                  (2,331)             (2,331)
Dividends on preferred, $0.65 per share                  (950)             (950)
Restricted stock vesting             (321)             321    - 
Stock options exercised             (321)             572    251 
Repurchased stock                            (5,050)   (5,050)
Stock based compensation expense             417                   417 
December 31, 2019  $-    $54,463   $15,023   $72,704   $659   $(6,755)  $136,094 

 

   Preferred   Common   Additional
Paid-in
   Retained   Accumulated
Other
Comprehensive
   Treasury     
($ in thousands, except per share data)  Stock   Stock   Capital   Earnings   Income (Loss)   Stock   Total 
January 1, 2018  $13,983   $12,569   $15,405   $55,439   $(141)  $(3,255)  $94,000 
Net income                  11,638              11,638 
Other comprehensive loss                       (411)        (411)
Common stock issuance (1,666,666 shares)        27,912                        27,912 
Conversion of preferred to common   (4)   4                        - 
Dividends on common, $0.32 per share                  (2,090)             (2,090)
Dividends on preferred, $0.65 per share                  (975)             (975)
Restricted stock vesting             (257)             257    - 
Stock options exercised             (200)             392    192 
Repurchased stock                            (109)   (109)
Stock based compensation expense             278                   278 
Balance, December 31, 2018  $13,979   $40,485   $15,226   $64,012   $(552)  $(2,715)  $130,435 

 

See Notes to Consolidated Financial Statements

 

F-4 

 

 

SB Financial Group, Inc.

Consolidated Statements of Cash Flows

Years Ended December 31,

 

($ in thousands)  2019   2018 
Operating Activities          
Net Income  $11,973   $11,638 
Items not requiring (providing) cash          
Depreciation and amortization   1,879    1,693 
Provision for loan losses   800    600 
Expense of share-based compensation plan   417    278 
Amortization of premiums and discounts on securities   314    355 
Amortization of intangible assets   8    10 
Amortization of originated mortgage servicing rights   2,126    1,230 
Impairment of mortgage servicing rights   1,094    61 
Deferred income taxes   (279)   324 
Proceeds from sale of loans held for sale   368,154    275,604 
Originations of loans held for sale   (364,472)   (271,067)
Gain from sale of loans   (9,668)   (8,100)
Loss (gain) on sales of assets   5    (35)
Net gains on sales of securities   (206)   (70)
Changes in          
Interest receivable   (284)   (997)
Other assets   (3,680)   (562)
Interest payable & other liabilities   10,648    2,888 
Net cash provided by operating activities   18,829    13,850 
Investing Activities          
Purchases of available-for-sale securities   (38,455)   (29,281)
Proceeds from maturities of available-for-sale securities   22,527    18,042 
Proceeds from sales of available-for-sale securities   7,375    2,185 
Proceeds from sales of portfolio loans   11,265    - 
Net change in loans   (65,504)   (76,503)
Purchase of premises, equipment   (2,043)   (1,999)
Proceeds from sales of premises, equipment   24    134 
Purchase of bank owned life insurance   (50)   - 
Purchase of Federal Reserve and Federal Home Loan Bank Stock   (525)   (375)
Proceeds from sale of foreclosed assets   372    210 
Acquisition, net of cash acquired   (2,600)   - 
Net cash used in investing activities   (67,614)   (87,587)
           
Financing Activities          
           
Net increase in demand deposits, money market, interest checking & savings accounts   21,376    49,308 
Net increase in certificates of deposit   16,291    23,644 
Net increase (decrease) in securities sold under agreements to repurchase   (2,239)   102 
Proceeds from Federal Home Loan Bank advances   -    13,000 
Repayment of Federal Home Loan Bank advances   -    (15,500)
Net proceeds from share-based compensation plans   251    192 
Stock repurchase plan   (5,050)   (109)
Issuance of common shares   139    27,912 
Conversion of preferred stock   (1)   - 
Dividends on common shares   (2,331)   (2,090)
Dividends on preferred shares   (950)   (975)
Net cash provided by financing activities   27,486    95,484 
Increase (decrease) in cash and cash equivalents   (21,299)   21,747 
Cash and cash equivalents, beginning of year   48,363    26,616 
Cash and cash equivalents, end of year  $27,064   $48,363 
Supplemental cash flow information          
Interest paid  $9,292   $5,895 
Income taxes paid  $3,084   $1,870 
Fair value of assets acquired - premises and equipment  $1,161   $- 
Supplemental non-cash disclosure          
Initial recognition of right-of-use lease assets  $293   $- 
Transfer of loans to loans held for sale  $11,114   $- 
Transfer of loans to foreclosed assets  $551   $201 
Transfer of loans to premises and equipment  $-   $670 

 

See Notes to Consolidated Financial Statements

F-5 

 

 

SB Financial Group, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2019 and 2018

 

Note 1: Organization and Summary of Significant Accounting Policies

 

Organization and Nature of Operations

 

SB Financial Group, Inc. (the “Company”) is a financial holding company whose principal activity is the ownership and management of its wholly-owned subsidiaries, The State Bank and Trust Company (“State Bank”), SBFG Title, LLC dba Peak Title Agency (“SBFG Title”), SB Captive, Inc. (“SB Captive”), RFCBC, Inc. (“RFCBC”), Rurbanc Data Services, Inc. dba RDSI Banking Systems (“RDSI”), and Rurban Statutory Trust II (“RST II”). State Bank owns all the outstanding stock of Rurban Mortgage Company (“RMC”), and State Bank Insurance, LLC (“SBI”). The Company is primarily engaged in providing a full range of banking and wealth management services to individual and corporate customers primarily located in Ohio, Indiana, and Michigan. The Company is subject to competition from other financial institutions, and regulated by certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.

 

Principles of Consolidation

 

The Consolidated Financial Statements include the accounts of the Company, State Bank, SBFG Title, SB Captive, RFCBC, RDSI, RMC, RST II, and SBI. All significant intercompany accounts and transactions were eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, loan servicing rights, and fair value of financial instruments.

 

Cash Equivalents

 

The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2019 and 2018, cash equivalents consisted primarily of interest-bearing and noninterest bearing demand deposit balances held by correspondent banks.

 

At December 31, 2019, the Company’s correspondent cash accounts exceeded federally insured limits by $2.9 million. Additionally, the Company had approximately $9.5 million of cash held by the FRB and the FHLB, which is not federally insured.

 

Securities

 

Available-for-sale securities, which include any debt security for which the Company has no immediate plan to sell but which may be sold in the future, are carried at fair value. Unrealized gains and losses are recorded, net of related income tax effects, in other comprehensive income.

 

Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses on sales of securities are determined on the specific-identification method.

 

For debt securities with fair value below carrying value when the Company does not intend to sell the debt security, and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, the Company recognizes the credit component of an other-than-temporary impairment of the debt security in earnings and the remaining portion in other comprehensive income.

 

F-6 

 

 

Mortgage Loans Held for Sale

 

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to noninterest income. Gains and losses on loan sales are recorded in noninterest income. The Company utilizes third-party hedges to minimize the impact of interest rate risk fluctuations, and their impact is realized through noninterest income.

 

Loans

 

Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoffs, are reported at their outstanding principal balances adjusted for any charge offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Generally, loans are placed on nonaccrual status not later than 90 days past due. Past due status is based on the contractual terms of the loan. All interest accrued, but not collected for loans that are placed on nonaccrual or charged off, is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Allowance for Loan Losses

 

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the non-collectability of a loan balance is probable. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as new information becomes available.

 

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical charge off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected on the historical loss or risk rating data.

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration each of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial, agricultural, and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.

 

F-7 

 

 

When a loan moves to nonaccrual status, total unpaid interest accrued to date is reversed from income. Subsequent payments are applied to the outstanding principal balance with the interest portion of the payment recorded on the balance sheet as a contra-loan. Interest received on impaired loans may be realized once all contractual principal amounts are received or when a borrower establishes a history of six consecutive timely principal and interest payments. It is at the discretion of management to determine when a loan is placed back on accrual status upon receipt of six consecutive timely payments.

 

Large groups of smaller balance homogenous loans are collectively evaluated for impairment. Accordingly, individual consumer and residential loans are not separately identified for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

 

Premises and Equipment

 

Depreciable assets are stated at cost less accumulated depreciation. Depreciation is charged to expense using the straight-line method for buildings and equipment over the estimated useful lives of the assets. Leasehold improvements are capitalized and depreciated using the straight-line method over the terms of the respective leases.

 

Long-lived Asset Impairment

 

The Company evaluates the recoverability of the carrying value of long-lived assets whenever events or circumstances indicate the carrying amount may not be recoverable. If a long-lived asset is tested for recoverability and the undiscounted estimated future cash flows expected to result from the use and eventual disposition of the asset is less than the carrying amount of the asset, the asset’s cost is adjusted to fair value and an impairment loss is recognized as the amount by which the carrying amount of a long-lived asset exceeds its fair value.

 

Federal Reserve Bank and Federal Home Loan Bank Stock

 

FRB and FHLB stock are required investments for institutions that are members of the FRB and FHLB systems. The required investment in the common stock is based on a predetermined formula, carried at cost and evaluated for impairment.

 

Foreclosed Assets Held for Sale

 

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the carrying amount or the fair value less cost to sell. Revenue and expenses from operations related to foreclosed assets and changes in the valuation allowance are included in net income or expense from foreclosed assets.

 

Goodwill

 

Goodwill is tested for impairment annually. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value.

 

Core Deposits and Other Intangibles

 

Intangible assets are being amortized on a straight-line basis over weighted-average periods ranging from one to fifteen years. Such assets are periodically evaluated as to the recoverability of their carrying value. Purchased software is being amortized using the straight-line method over periods ranging from one to three years.

 

Derivatives

 

The Company utilizes derivative financial instruments to help manage exposure to interest rate risk and the effects that changes in interest rates may have on net income and the fair value of assets and liabilities. The Company enters into interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. Additionally, the Company enters into forward contracts for the future delivery of mortgage loans to third-party investors and enters into interest rate lock commitments (“IRLCs”) with potential borrowers to fund specific mortgage loans that will be sold into the secondary market. The forward contracts are entered into in order to economically hedge the effect of changes in interest rates resulting from the Company’s commitment to fund the loans.

 

F-8 

 

 

The IRLCs and forward contracts are not designated as accounting hedges and are recorded at fair value with the changes in fair value reflected in noninterest income on the consolidated statements of income. The fair value of derivative instruments with a positive fair value are reported in accrued income and other assets in the consolidated balance sheets, while the derivative instruments with a negative fair value are reported in accrued expenses and other liabilities in the consolidated balance sheets.

 

For exchange-traded contracts, fair value is based on quoted market prices. For non-exchange traded contracts, fair value is based on dealer quotes, pricing models, discounted cash flow methodologies or similar techniques for which the determination of fair value may require significant management judgment or estimation.

 

Mortgage Servicing Rights

 

Mortgage servicing assets are recognized separately when rights are acquired through purchase or through sale of financial assets. Under the servicing assets and liabilities accounting guidance, (Accounting Standards Codification “ASC” 806-50), servicing rights from the sale or securitization of loans originated by the Company are initially measured at fair value at the date of transfer. The Company subsequently measures each class of servicing asset using the amortization method. Under the amortization method, servicing rights are amortized in proportion to and over the period of estimated net servicing income. The amortized assets are assessed for impairment based on fair value at each reporting date.

 

Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost of service, the discount rate, the custodial earning rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. These variables change from quarter to quarter as market conditions and projected interest rates change, and may have an adverse impact on the value of the mortgage servicing right and may result in a reduction to noninterest income.

 

Each class of separately recognized servicing assets subsequently measured using the amortization method is evaluated and measured for impairment. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the carrying amount of the servicing assets for that tranche. The valuation allowance is adjusted to reflect changes in the measurement of impairment after the initial measurement of impairment. Changes in valuation allowances are reported with “Mortgage loan servicing fees, net” in the income statement. Fair value in excess of the carrying amount of servicing assets for that stratum is not recognized.

 

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.

 

Share-Based Employee Compensation Plan

 

At December 31, 2019 and 2018, the Company had a share-based employee compensation plan (see Note 17 to the Consolidated Financial Statements).

 

Transfers of Financial Assets 

 

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company – put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before the maturity or the ability to unilaterally cause the holder to return specific assets.

 

F-9 

 

 

Income Taxes 

 

The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

 

Uncertain tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the term “upon examination” also includes resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment.

 

The Company recognizes interest and penalties on income taxes as a component of income tax expense.

 

The Company files consolidated income tax returns with its subsidiaries. With a few exceptions, the Company is no longer subject to U.S. Federal, State and Local examinations by tax authorities for the years before 2016. As of December 31, 2019, the Company had no uncertain income tax positions.

 

The Company uses the specific identification (or portfolio) method for reclassifying material stranded tax effects in Accumulated Other Consolidated Income (“AOCI”) to earnings.

 

Treasury Shares

 

Treasury stock is stated at cost. Cost is determined by the weighted-average cost method.

 

Earnings Per Share

 

Earnings per common share is computed using the two-class method. Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during each period. Diluted earnings per share reflect additional potential common shares and convertible preferred shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options which are determined using the treasury stock method and convertible preferred shares which are determined using the converted method. Treasury stock shares are not deemed outstanding for earnings per share calculations.

 

Comprehensive Income

 

Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes. Other comprehensive income includes unrealized appreciation (depreciation) on available-for-sale securities, and unrealized and realized gains and losses in derivative financial instruments that qualify for hedge accounting. AOCI consists solely of the cumulative unrealized gains and losses on available-for-sale securities net of income tax.

 

F-10 

 

 

Revenue Recognition

 

The Company recognizes revenues as they are earned based on contractual terms, as transactions occur, or services are provided and collectability is reasonably assured. The Company’s principal source of revenue is interest income from loans and leases and investment securities. The Company also earns noninterest income from various banking and financial services offered through State Bank.

 

Interest income is the largest source of revenue for the Company which is primarily recognized on an accrual basis.

 

Noninterest income is earned through a variety of financial and transaction services provided to corporate and consumer clients such as trust and wealth advisory, deposit account, debit card, mortgage banking and insurance.

 

New and applicable accounting pronouncements:

 

ASU No. 2018-07: Compensation – Stock Compensation (Topic 718)

 

This ASU expands the scope of Topic 718, to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. This ASU supersedes Subtopic 505-50, Equity-Based Payments to Non-Employees. The amendments in this ASU became effective for periods beginning after December 15, 2018. At this time, the Company does not have any share-based payments to nonemployees.

 

ASU No. 2017-12: Derivatives and Hedging (Topic 815)

 

This ASU improves the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. The ASU also makes targeted improvements to simplify the application of the hedge accounting guidance. The amendments in this ASU became effective for fiscal years after December 15, 2018 and the Company adopted these amendments. The impact of these amendments was immaterial to the Company’s financial statements.

 

ASU No. 2016-02: Leases (Topic 842)

 

FASB issued ASU 2016-02, Leases. The new standard establishes a right-of-use asset model that requires a lessee to record an asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. As the Company owns most of its branch locations, the impact of adoption of this ASU resulted in a $0.2 million right-of-use asset and a corresponding lease obligation liability of $0.2 million. The right-of-use asset is included in other assets and the lease obligation liability is included in other liabilities in the Company’s December 31, 2019 consolidated balance sheet. The Company has given consideration to the materiality of their leases and has determined that the additional required disclosures for leases is immaterial to the consolidated financial statements.

 

F-11 

 

 

Accounting standards not yet adopted:

 

ASU No. 2018-13: Fair Value Measurement - Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820)

 

The updated guidance improves the disclosure requirements for fair value measurements. The ASU removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements. The ASU modifies certain disclosures required by Topic 820 related to disclosure of transfers into and out of Level 3 of the fair value hierarchy; the requirement to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly for investments in certain entities that calculate net asset value; and clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The ASU adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted-average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted- average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update become effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the impact of adopting the new guidance on its consolidated financial statements, but it is not expected to have a material impact.

 

ASU No. 2017-04: Intangibles – Goodwill and Other (Topic 350)

 

This ASU simplifies the test for goodwill impairment. Specifically, these amendments eliminate Step 2 from the goodwill impairment test, and also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The amendments in this ASU are effective for annual goodwill impairment tests in fiscal years beginning after December 15, 2019, and management does not believe the changes will have a material effect on the Company’s accounting and disclosures.

 

ASU No. 2016-13: Financial Instruments – Credit Losses (Topic 326)

 

This ASU, which is commonly known as CECL, replaces the current GAAP incurred impairment methodology regarding credit losses with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this update affect an entity to varying degrees depending on the credit quality of the assets held by the entity, their duration, and how the entity applies current GAAP.

 

The adoption of ASU 2016-13 is likely to result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. Furthermore, ASU 2016-13 will necessitate that we establish an allowance for expected credit losses on debt securities.

 

In December 2018, the OCC, the Federal Reserve Board, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard.

 

On November 15, 2019, the FASB delayed the effective date for certain small public companies and other private companies. As the Company is currently a smaller reporting company, the amendment will delay the effective date of ASU No. 2016-13 to the fiscal year beginning after December 15, 2022.

 

While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date. The Company implemented a process to track required data by utilizing accounting software in preparation for compliance. We anticipate being fully prepared for implementation by January 1, 2023. 

 

Reclassifications:

 

Certain reclassifications have been made to prior period financial statements to conform to the current financial statement presentation. These reclassifications had no effect on net income.

 

F-12 

 

 

Note 2: Earnings Per Share

 

Earnings per common share (“EPS”) is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the applicable period, excluding participating securities. Participating securities include non-vested restricted stock awards. Non-vested restricted stock awards are considered participating securities to the extent the holders of these securities receive non-forfeitable dividends at the same rate as holders of common shares. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share plus the convertible impact of preferred shares and the dilutive effect of stock compensation using the treasury stock method. EPS for the years ended December 31, 2019 and 2018 is computed as follows: 

 

   Twelve Months Ended Dec. 31, 
($ and outstanding shares in thousands - except per share data)  2019   2018 
         
Distributed earnings allocated to common shares  $2,331   $2,090 
Undistributed earnings allocated to common shares   8,675    8,558 
           
Net earnings allocated to common shares   11,006    10,648 
Net earnings allocated to participating securities   17    15 
Dividends on convertible preferred shares   950    975 
           
Net Income allocated to common shares and participating securities  $11,973   $11,638 
           
Weighted average shares outstanding for basic earnings per share   6,456    6,198 
Dilutive effect of stock compensation   46    61 
Dilutive effect of preferred convertible shares   1,433    1,460 
           
Weighted average shares outstanding for diluted earnings per share   7,935    7,719 
           
Basic earnings per common share  $1.71   $1.72 
           
Diluted earnings per common share  $1.51   $1.51 

 

There were no anti-dilutive shares in 2019 or 2018.

 

F-13 

 

 

Note 3: Available-for-Sale Securities

 

The amortized cost and appropriate fair values, together with gross unrealized gains and losses, of available-for-sale securities are as follows: 

 

  Amortized   Gross Unrealized   Gross Unrealized     
($ in thousands)  Cost   Gains   Losses   Fair Value 
December 31, 2019:                    
U.S. Treasury and Government agencies  $12,023   $181   $(2)  $12,202 
Mortgage-backed securities   77,892    492    (202)   78,182 
State and political subdivisions   10,199    366    (1)   10,564 
                     
Totals  $100,114   $1,039   $(205)  $100,948 

  

       Gross   Gross     
   Amortized   Unrealized   Unrealized     
   Cost   Gains   Losses   Fair Value 
December 31, 2018: