UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended |
or
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from ___________ to ___________ . |
Commission file number
Middlefield Banc Corp. |
(Exact Name of Registrant as Specified in its Charter) |
| | |
State or Other Jurisdiction of | I.R.S. Employer Identification No. | |
Incorporation or Organization | ||
| | |
Address of Principal Executive Offices | Zip Code |
| ||
Registrant’s Telephone Number, Including Area Code |
Securities Registered Pursuant To Section 12(b) Of The Act:
Title of Each Class | | Name of Each Exchange on Which Registered | ||
| Trading Symbol | The (NASDAQ Capital Market) |
Securities registered pursuant to Section 12(g) of the Act: None |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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.
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).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ | Accelerated filer ☐ | |
| Smaller reporting company | |
Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements.
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
The aggregate market value on June 30, 2023 of common stock held by non-affiliates of the registrant was approximately $
As of March 28, 2024, there were
Documents Incorporated by Reference Portions of the registrant’s definitive proxy statement for the 2024 Annual Meeting of Shareholders are incorporated by reference in Part III of this report. Portions of the Annual Report to Shareholders for the year ended December 31, 2023 are incorporated by reference into Part I and Part II of this report. |
MIDDLEFIELD BANC CORP.
YEAR ENDED December 31, 2023
Part I
Forward-looking Statements This document contains forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) about the Company and its subsidiaries. The information incorporated in this document by reference, future filings by the Company on Form 10-Q and Form 8-K, and future oral and written statements by the Company and its management may also contain forward-looking statements. Forward-looking statements include statements about anticipated operating and financial performance, such as loan originations, operating efficiencies, loan sales, charge-offs and loan loss provisions, growth opportunities, interest rates, and deposit growth. Words such as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “project,” “plan,” and similar expressions are intended to identify these forward-looking statements.
Forward-looking statements are subject to many assumptions, risks, and uncertainties. Several factors could cause actual results to differ materially from those indicated by the forward-looking statements. These include the factors we discuss immediately below, those addressed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” other factors discussed elsewhere in this document or identified in our filings with the Securities and Exchange Commission (the “SEC”), and those presented elsewhere by our management from time to time. Many of the risks and uncertainties are beyond our control. The following factors could cause our operating and financial performance to differ materially from the plans, objectives, assumptions, expectations, estimates, and intentions expressed in forward-looking statements:
• the strength of the United States economy in general and the strength of the local economies in which we conduct our operations; general economic conditions, either nationally or regionally, may be less favorable than we expect, resulting in a deterioration in the credit quality of our loans, among other things
• the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board
• credit losses as a result of declining real estate values, increasing interest rates, increasing unemployment, changes in payment behavior or other factors
• changes in the amount of our loan portfolio collateralized by real estate and weaknesses in the real estate market
• increased cybersecurity risk, including potential business disruptions or financial losses
• changes in accounting standards, rules and interpretations and the related impact on our financial statements, including the effects from our adoption of the current expected credit losses (“CECL”) model on January 1, 2023
• inflation, interest rate, market, and monetary fluctuations
• the development and acceptance of new products and services of the Company and subsidiaries and the perceived overall value of these products and services by customers, including the features, pricing, and quality compared to competitors’ products and services
• the willingness of customers to substitute our products and services for those of competitors
• the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities, and insurance)
• changes in consumer spending and saving habits
• the potential effects of events beyond our control that may have a destabilizing effect on financial markets and the economy, such as epidemics and pandemics, war or terrorist activities, disruptions in our customers’ supply chains, disruptions in transportation, essential utility outages or trade disputes and related tariffs
• the concentration of large deposits from certain customers, who have balances above current FDIC insurance limits;
• the effects of recent developments and events in the financial services industry, including the large-scale deposit withdrawals over a short period of time at Silicon Valley Bank, Signature Bank and First Republic Bank that resulted in failure of those institutions.
• other risks and uncertainties detailed in this Annual Report on Form 10-K and, from time to time, in our other filings with the Securities and Exchange Commission (“SEC”)
Forward-looking statements are based on our beliefs, plans, objectives, goals, assumptions, expectations, estimates, and intentions as of the date the statements are made. Investors should exercise caution because the Company cannot give any assurance that its beliefs, plans, objectives, goals, assumptions, expectations, estimates, and intentions will be realized. The Company disclaims any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information, or otherwise.
Middlefield Banc Corp. Incorporated in 1988 under the Ohio General Corporation Law, Middlefield Banc Corp. (“Company”) is a bank holding company registered under the Bank Holding Company Act of 1956. The Company’s subsidiaries are:
1. The Middlefield Banking Company (“MBC”, or the “Bank”), an Ohio-chartered commercial bank that began operations in 1901. MBC engages in a general commercial banking business in northeastern, central, and western Ohio. MBC’s principal executive office is located at 15985 East High Street, Middlefield, Ohio 44062-0035, and the telephone number is (440) 632-1666.
2. EMORECO Inc., an Ohio asset resolution corporation headquartered in Middlefield, Ohio. EMORECO exists to resolve and dispose of troubled assets. EMORECO’s principal executive office is located at 15985 East High Street, Middlefield, Ohio 44062-0035.
The Company makes available free of charge on its internet website, www.middlefieldbank.bank, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC and state the address of that site (https://www.sec.gov/).
The Middlefield Banking Company MBC was chartered under Ohio law in 1901. MBC offers customers a broad range of banking services, including checking, savings, negotiable order of withdrawal (“NOW”) accounts, money market accounts, time deposits, commercial loans, real estate loans, a variety of consumer loans, safe deposit facilities, and travelers’ checks. MBC offers online banking and bill payment services to individuals and online cash management services to business customers through its website at www.middlefieldbank.bank.
On December 1, 2022, the Company completed its merger with Liberty Bancshares, Inc. (“Liberty’), pursuant to a previously announced definitive merger agreement. Under the terms of the merger agreement, Liberty shareholders received 2.752 shares of the Company’s common stock in exchange for each share of Liberty common stock they owned immediately before the merger. The Company issued 2,561,513 shares of its common stock in the merger and the aggregate merger consideration was approximately $73.3 million. Upon closing, Liberty’s bank subsidiary was merged into MBC, and Liberty’s six full-service bank offices, in Ada and Kenton in Hardin County, in Bellefontaine and Bellefontaine South in Logan County, in Marysville in Union County, and in Westerville in Franklin County, became offices of MBC.
Engaged in general commercial banking in northeastern, central, and western Ohio, MBC offers these services principally to small and medium-sized businesses, professionals, small business owners, and retail customers. MBC has developed a marketing program to attract and retain consumer accounts and to match banking services and facilities with the needs of customers.
MBC’s loan products include operational and working capital loans, loans to finance capital purchases, term business loans, residential construction loans, selected guaranteed or subsidized loan programs for small businesses, professional loans, residential and mortgage loans, agricultural loans, and consumer installment loans to make home improvements and to purchase automobiles, boats, and other personal expenditures.
On March 13, 2019, MBC established a wholly-owned subsidiary named Middlefield Investments, Inc. (MI), headquartered in Middlefield, Ohio. This operating subsidiary exists to hold and manage an investment portfolio. At December 31, 2023, MI’s assets consist of a cash account, investments, and related accrued interest accounts. MI may only hold and manage investments and may not engage in any other activity without prior approval of the Ohio Division of Financial Institutions. In the first quarter of 2022, MBC established a wholly-owned subsidiary named MB Insurance Services (MIS). This operating subsidiary exists to offer retail and business customers a variety of insurance services, including home, renters, automobile, pet, identity theft, travel, and professional liability insurance. At December 31, 2023, MIS’s assets consist of a cash account, a prepaid asset, and an accounts receivable. As a result of the bank merger, Middlefield Banc Corp. acquired a 100% ownership interest in LBSI Insurance, LLC (“LBSI”), a wholly-owned financial subsidiary of Liberty National Bank. All significant intercompany items have been eliminated between MBC and these subsidiaries.
EMORECO Organized in 2009 as an Ohio corporation under the name EMORECO, Inc. and wholly owned by the Company, the purpose of the asset resolution subsidiary is to maintain, manage, and dispose of nonperforming loans and other real estate owned (“OREO”) acquired by the subsidiary bank as the result of borrower default on real estate-secured loans. On December 31, 2023, EMORECO’s assets consist of one cash account. According to federal law governing bank holding companies, real estate must be disposed of within two years of acquisition, although limited extensions may be granted by the Federal Reserve Bank. A holding company subsidiary has limited real estate investment powers. EMORECO may only manage and maintain property and may not improve or develop property without the advance approval of the Federal Reserve Bank.
Market Area
MBC’s eleven Northeast Ohio branches are located in Ashtabula, Cuyahoga, Geauga, Portage, Summit, and Trumbull counties. Our four Western Ohio branches are located in Hardin and Logan counties. Our six Central Ohio branches are located in Delaware, Franklin, Madison, and Union counties. We have a loan production office in Mentor located in Lake County. Lake County is contiguous to Ashtabula, Cuyahoga, and Geauga counties in our Northeast Ohio market. The most recent FDIC market share data available from June 30, 2023 shows we had a deposit market share of approximately 19.37% in Geauga County, which represented the second largest market share in Geauga County, 3.03% in Ashtabula County, 0.07% in Cuyahoga County, 0.32% in Delaware County, 0.10% in Franklin County, 37.28% in Hardin County, which represented the largest market share in Hardin County, 9.37% in Logan County, which represented the third largest market share in Logan County, 2.04% in Madison County, 4.90% in Portage County, 0.55% in Summit County, 1.76% in Trumbull County, and 1.88% in Union County. According to the most recent information available from the U.S. Department of Commerce Bureau of Economic Analysis, nine of these twelve counties are ranked in the top half of Ohio counties measured by per capita personal income by county for 2019 through 2022.
The economy of MBC’s Northeast Ohio market is centered around manufacturing and agriculture and includes a large Amish population. MBC’s headquarters, main banking office, and three additional branches are located in Geauga County. Geauga County is the center of the 4th largest Amish population in the world. With a 2022 per capita personal income of $83,249, Geauga County is ranked second highest among Ohio’s 88 counties.
MBC’s market area in Northeast Ohio benefits from the area’s proximity to Cleveland in Cuyahoga County. Cuyahoga County is Ohio’s second most populous county and boasts the second largest economy in Ohio measured by GDP. Cuyahoga County’s 2022 GDP of nearly $104.2 billion is greater than the total GDP of 13 states and ranks 33rd of 3,108 counties nationally. In analysis of county-level GDP data from the U.S. Bureau of Economic Analysis, the Cleveland State University College of Urban Affairs analyzed per capita gross domestic product for the Cleveland metro area (an area covering Cuyahoga, Geauga, Lake, Lorain and Medina Counties) compared to 14 large metro areas including the seven fastest-growing of the large metro areas nationally from 2001 through 2022. Cuyahoga County ranked 88th for annual GDP growth per capita from 2000 to 2018, ahead of the home counties of cities experiencing greater population growth such as Charlotte, Indianapolis, and Phoenix. In that same time period from 2000 to 2018, Cuyahoga County ranked 474th out of the 500 largest counties in the U.S. for population change. Cleveland anchors the Cleveland Metropolitan Area, the 33rd-largest in the U.S. at 2.18 million, as well as the larger Cleveland-Akron-Canton Combined Statistical Area, the most populous statistical area in Ohio and the 17th-largest in the United States with a population of 3.63 million in 2020.
MBC’s market area in Central Ohio benefits from the area’s proximity to Columbus in Franklin County. Franklin County is Ohio’s most populous county and has the largest GDP of Ohio’s 88 counties. Columbus is the state capital, the largest city in Ohio, and the 14th largest city in the U.S. The Columbus metro area has experienced strong population growth in the last decade. According to the U.S. Census Bureau, Columbus saw the eleventh largest numeric population increase between July 1, 2017 and July 1, 2018 in the U.S. – making Columbus the only city in the Midwest on the top 15 list. The employment growth rate for the Columbus metro area has been greater than Ohio’s employment growth rate, responsible for 1 in every 3 new jobs in Ohio. Since 2015, construction has been the fastest-growing sector in the Columbus metro area. Per capita personal income in the Columbus metro area continues to be above the statewide level for Ohio. According to the 2020 U.S. Census, the Columbus metro area accounts for 18% of Ohio’s population and experienced the largest percentage increase of Midwest metro areas with a population of one million people since the 2010 U.S. Census. From 2000 to 2020, the Columbus metro area saw a 25% increase in population relative to Ohio’s 3% increase in the same time period. Among the ten counties that comprise the Columbus metro area are the four Central Ohio counties where MBC has branches (Delaware, Franklin, Madison, and Union counties). Among the 51 metropolitan areas that the U.S. Census Bureau estimated to have more than one million people in 2020, Columbus ranked 17th in population growth since 2010. The population in the ten-county area centered around Franklin County increased by more than 230,000 to reach an estimated 2,138,946 in 2020, an increase of 12.2% over 10 years. Among all 263 metropolitan statistical areas the Census Bureau tracks, Columbus ranked 59th in population growth from 2010 to 2020 and 94th since 2019 (+0.63%). The larger Columbus-Marion-Zanesville Combined Statistical Area had a population of over 2.54 million people in 2020, up from 2.3 million in 2010, the first census to include combined statistical areas.
Based on the most recent data available for 2022, Delaware County had the highest per capita personal income at $88,871 among Ohio’s 88 counties. Union County, which is contiguous to Delaware County, had the 13th fastest-growing housing market in the U.S. according to the U.S. Census Bureau’s data on the nation’s 100 fastest growing counties with 5,000 or more housing units from July 1, 2018 to July 1, 2019. From 2018 to 2019, the number of housing units in Union County jumped 4%, in part due to growth in Dublin, Plain City and Jerome Township, as well as Honda’s facilities in Marysville. From July 1, 2020 to July 1, 2021, Union County remains in the top 100 fastest-growing counties with 5,000 or more housing units as the 37th fastest-growing housing market in the U.S. Union County is the only Ohio county among the nation’s 100 fastest-growing counties with 5,000 or more housing units.
The following table summarizes unemployment percentage rates in the Ohio counties where we operate retail banking centers, Ohio, and the US average on a comparative basis as of December 31, 2022, and December 31, 2023.
Ohio County |
Dec-2022 Unemployment % |
Dec-2023 Unemployment % |
2023-2022 % Change |
Ashtabula County |
4.3 |
3.8 |
-0.5 |
Cuyahoga County |
3.6 |
3.2 |
-0.4 |
Delaware County |
2.6 |
2.4 |
-0.2 |
Franklin County |
3.1 |
2.7 |
-0.4 |
Geauga County |
2.9 |
2.7 |
-0.2 |
Hardin County |
3.3 |
3.2 |
-0.1 |
Logan County |
3.2 |
2.9 |
-0.3 |
Madison County |
2.9 |
2.7 |
-0.2 |
Portage County |
3.7 |
3.2 |
-0.5 |
Summit county |
3.9 |
3.3 |
-0.6 |
Trumbull County |
4.7 |
4.0 |
-0.7 |
Union County |
2.6 |
2.6 |
0.0 |
12 County Average |
3.4 |
3.1 |
-0.3 |
Ohio |
4.2 |
3.4 |
-0.8 |
United States |
3.5 |
3.7 |
0.2 |
Ohio Department of Job and Family Services Bureau of Labor Market Information non-seasonally adjusted unemployment rates as of December 2022 and December 2023. The December 2023 unemployment rate is classified as preliminary as of January 19, 2024.
The average unemployment rate of MBC’s twelve-county market area trends below the state of Ohio’s unemployment rate. As of December 2023, the bank’s market area average unemployment rate is less than the national average, and the State of Ohio also has an unemployment rate that is lower than the national average. Ashtabula and Trumbull are the only counties in MBC’s market area with unemployment rates above the national average as of December 2023. With a 0.7% decrease on a twelve-month basis, Trumbull County experienced the most significant change in the unemployment rate from December 2022 to December 2023.
MBC is not dependent upon any one significant customer or specific industry. Business is not seasonal to any material degree.
Lending — Loan Portfolio Composition and Activity. The Bank makes residential and commercial mortgages, home equity lines of credit, secured and unsecured consumer installment, commercial and industrial, and real estate construction loans for owner-occupied, non-owner occupied, multifamily, and income-producing properties. The Bank’s Credit Policy aspires to a loan composition mix consisting of approximately 25% to 50% consumer-purpose transactions, including residential real estate loans, home equity loans, and other consumer loans. The Policy is also designed to provide for 55% to 70% of total loans as business-purpose commercial loans and business and consumer credit card accounts of up to 5% of total loans.
Lending Limit Although Ohio law imposes no material restrictions on the types of loans the Bank may make, real estate-based lending has historically been the Bank’s primary focus. For prudential reasons, we avoid lending on the security of real estate located outside our market area. Ohio law does restrict the amount of loans an Ohio-chartered bank may make, generally limiting credit to any single borrower to less than 15% of capital. An additional margin of 10% of capital is allowed for loans fully secured by readily marketable collateral. This 15% legal lending limit has not been a material restriction on lending. We can accommodate loan volumes exceeding the legal lending limit by selling loan participations to other banks. As of December 31, 2023, MBC’s 15%-of-capital limit on loans to a single borrower was approximately $30.9 million.
The Bank offers specialized loans for business and commercial customers, including equipment and inventory financing, real estate construction loans, agricultural loans, and Small Business Administration loans for qualified businesses. A portion of the Bank’s commercial loans is designated as real estate loans for regulatory reporting purposes because they are secured by mortgages on real property. Loans of that type may be made for purposes of financing commercial activities, such as accounts receivable, equipment purchases, and leasing. These loans are still secured by real estate to provide the Bank with an extra security measure. Although these loans might be secured in whole or in part by real estate, they are treated in the discussions to follow as commercial and industrial loans. The Bank’s consumer installment loans include secured and unsecured loans to individual borrowers for various purposes, including personal, home improvements, revolving credit lines, autos, boats, and recreational vehicles.
The following table presents maturity information for the loan portfolio. The table does not include prepayments or scheduled principal repayments. All loans are shown as maturing based on contractual maturities.
Due after one |
Due after five |
|||||||||||||||||||
Due in one |
years through |
years through |
Due after |
|||||||||||||||||
year or less |
five years |
fifteen years |
fifteen years |
Total |
||||||||||||||||
(Dollars in thousands) |
||||||||||||||||||||
Commercial real estate: |
||||||||||||||||||||
Owner occupied |
$ | 8,100 | $ | 27,945 | $ | 75,531 | $ | 71,969 | $ | 183,545 | ||||||||||
Non-owner occupied |
34,289 | 100,478 | 183,975 | 82,838 | 401,580 | |||||||||||||||
Multifamily |
737 | 5,394 | 55,013 | 21,362 | 82,506 | |||||||||||||||
Residential real estate |
910 | 5,575 | 52,922 | 269,447 | 328,854 | |||||||||||||||
Commercial and industrial |
20,863 | 72,699 | 72,669 | 55,277 | 221,508 | |||||||||||||||
Home equity lines of credit |
2,253 | 1,275 | 29,932 | 94,358 | 127,818 | |||||||||||||||
Construction and Other |
24,124 | 46,454 | 26,576 | 27,951 | 125,105 | |||||||||||||||
Consumer installment |
140 | 2,815 | 397 | 3,862 | 7,214 | |||||||||||||||
$ | 91,416 | $ | 262,635 | $ | 497,015 | $ | 627,064 | $ | 1,478,130 |
Loans due on demand and overdrafts are included in the amount due in one year or less. The Company has no loans without a stated schedule of repayment or a stated maturity. Accrued interest of $5.5 million is presented in "Accrued interest receivable and other assets" on the Consolidated Balance Sheets and is excluded from the table.
The following table shows the dollar amount of all loans due after December 31, 2024 that have predetermined interest rates and the dollar amount of all loans due after December 31, 2024 that have floating or adjustable rates.
Fixed |
Adjustable |
|||||||||||
Rate |
Rate |
Total |
||||||||||
(Dollars in thousands) |
||||||||||||
Commercial real estate: |
||||||||||||
Owner occupied |
$ | 40,831 | $ | 134,614 | $ | 175,445 | ||||||
Non-owner occupied |
113,656 | 253,635 | 367,291 | |||||||||
Multifamily |
6,064 | 75,705 | 81,769 | |||||||||
Residential real estate |
122,315 | 205,629 | 327,944 | |||||||||
Commercial and industrial |
110,828 | 89,817 | 200,645 | |||||||||
Home equity lines of credit |
60 | 125,505 | 125,565 | |||||||||
Construction and Other |
31,594 | 69,387 | 100,981 | |||||||||
Consumer installment |
3,211 | 3,863 | 7,074 | |||||||||
$ | 428,559 | $ | 958,155 | $ | 1,386,714 |
Residential Real Estate Loans A significant portion of the Bank’s lending consists of origination of residential loans secured by 1-4 family real estate located in Ashtabula, Cuyahoga, Delaware, Franklin, Geauga, Madison, Portage, Summit, and Trumbull counties. Residential real estate loans approximated $328.9 million or 22.2% of the Bank’s total loan portfolio on December 31, 2023.
The Bank makes loans of up to 80% of the value of the real estate and improvements securing a loan (“LTV” ratio) on 1-4 family real estate. The Bank generally does not lend in excess of the lower of 80% of the appraised value or sales price of the property. The Bank offers residential real estate loans with terms of up to 30 years.
Approximately 63.0% of the residential mortgage loan portfolio due after a year has an adjustable rate and is secured by 1-4 family real estate on December 31, 2023. The Bank originates variable-rate and fixed-rate, single-family mortgage loans. Generally, fixed-rate mortgage loans are underwritten according to the Federal Home Loan Mortgage Corporation (“Freddie Mac”) guidelines. In some instances, these loans are sold to the agency. Upon the sale to Freddie Mac, the servicing rights are retained and are done so in furtherance of the Bank’s goal of better matching the maturities and interest rate sensitivity of its assets and liabilities. The Bank generally retains responsibility for collecting and remitting loan payments, inspecting the properties, making certain insurance and tax payments on behalf of borrowers, and otherwise servicing the loans it sells, and receives a fee for performing these services. Sales of loans also provide funds for additional lending and other purposes.
On December 31, 2023, residential real estate loans of approximately $1.2 million were non-accruing, representing 0.4% of the residential real estate loan portfolio. On December 31, 2022, residential real estate loans of approximately $1.4 million were non-accruing, representing 0.5% of the residential real estate loan portfolio.
Home Equity Lines of Credit Home equity lines of credit comprise variable-rate home equity lines of credit as well as closed-end home equity installment loans. The Bank’s home equity credit policy generally allows for a loan of up to 89% of the combined loan-to-value ratio (CLTV) when we have the first lien or the HELOC is in the first position, less the principal balance of the outstanding first mortgage loan. The policy also allows a maximum 80% CLTV for a HELOC, where we do not have the first lien position. The Bank’s home equity loans generally have terms of 20 years. The credit performance of most of the home equity lines of credit portfolio where we hold the first lien position is superior to the portion of the portfolio where we have the second lien position but do not hold the first lien. Lien position information is generally determined at the time of origination and monitored ongoing for risk management purposes.
On December 31, 2023, the Bank had approximately $127.8 million in its home equity lines of credit portfolio, representing 8.6% of total loans. On December 31, 2023, home equity lines of credit of approximately $856,000 were non-accruing and represented 0.7% of the home equity lines of credit portfolio. On December 31, 2022, the Bank had approximately $128.1 million in its home equity lines of credit portfolio, representing 9.5% of total loans. On December 31, 2022, home equity lines of credit of approximately $191,000 were non-accruing and represented 0.1% of the home equity lines of credit portfolio.
Commercial and Commercial Real Estate Loans
The Bank’s commercial and commercial real estate loan services include:
• |
accounts receivable, inventory and working capital loans |
• |
short-term notes |
• |
renewable operating lines of credit |
• | selected guaranteed or subsidized loan programs for small businesses |
• |
loans to finance capital equipment |
• |
loans to professionals |
• |
term business loans |
• |
commercial real estate loans |
• |
demand lines of credit |
• |
agricultural loans |
Commercial real estate loans include commercial properties occupied by the proprietor of the business conducted on the premises, non-owner occupied business properties, multifamily residential properties, income-producing properties, and agricultural properties and businesses that support these sectors. The primary risks of commercial real estate loans are loss of income of the owner or lessee of the property and the inability of the market to sustain rent levels. Although commercial loans generally bear more risk than single-family residential mortgage loans, they tend to be higher-yielding, have shorter terms, and provide for interest-rate adjustments. Accordingly, commercial loans enhance a lender’s interest rate risk management and, in management’s opinion, promote more rapid asset and income growth than a loan portfolio composed strictly of residential real estate mortgage loans.
Although a risk of nonpayment exists for all loans, certain specific risks are associated with various kinds of loans. One of the primary risks associated with commercial loans is the possibility that the commercial borrower will not generate cash flow sufficient to repay the loan. The Bank’s Credit Policy provides that commercial loan applications must be supported by documentation indicating cash flow sufficient for the borrower to service the proposed loan. Financial statements or tax returns for at least three years must be submitted, and annual reviews are required for business purpose relationships of $750,000 or more. Ongoing financial information is generally required for any commercial relationship where the exposure is $250,000 or more.
The fair value of commercial loan collateral must exceed the Bank’s exposure. For this purpose, fair value is determined by independent appraisal or the loan officer’s estimate, employing guidelines established by the Credit Policy. Loans not secured by real estate generally have terms of five years or fewer unless guaranteed by the U.S. Small Business Administration or other governmental agencies, and term loans secured by collateral having a useful life exceeding five years may have longer terms. The Bank’s Credit Policy allows for terms of up to 20 years for loans secured by commercial real estate and one year for business lines of credit. The maximum LTV ratio for commercial real estate loans is 80% of the appraised value or cost, whichever is less.
Real estate is commonly a material component of collateral for the Bank’s loans, including commercial loans. Although the expected source of repayment is generally the operations of the borrower’s business or personal income, real estate collateral provides an additional security measure. Risks associated with loans secured by real estate include fluctuating land values, changing local economic conditions, changes in tax policies, and a concentration of loans within a limited geographic area.
On December 31, 2023, commercial and commercial real estate loans totaled $889.1 million, or 60.2% of the Bank’s total loan portfolio, which include $426,000 in Paycheck Protection Program (“PPP”) loans. On December 31, 2023, commercial and commercial real estate loans of approximately $8.7 million were non-accruing and represented 0.98% of the commercial and commercial real estate loan portfolios. On December 31, 2022, commercial and commercial real estate loans totaled $826.2 million, or 61.1% of the Bank’s total loan portfolio, which include $748,000 in PPP loans. On December 31, 2022, commercial and commercial real estate loans of approximately $255,000 were non-accruing and represented 0.03% of the commercial and commercial real estate loan portfolios.
Construction and Other
The Bank originates several different types of loans that it categorizes as construction loans, including:
• |
residential construction loans to borrowers who will occupy the premises upon completion of construction, |
|
• |
residential construction loans to builders, |
|
• |
commercial construction loans, and |
|
• |
real estate acquisition and development loans. |
Because of the complex nature of construction lending, these loans are generally recognized as having a higher degree of risk than other forms of real estate lending. The Bank’s fixed-rate and adjustable-rate construction loans do not provide for the same interest rate terms on the construction loan and on the permanent mortgage loan that follows the completion of the construction phase of the loan. It is typical for the Bank to make residential construction loans without an existing written commitment for permanent financing. The Bank’s Credit Policy provides that the Bank may make construction loans with terms for up to one year, with a maximum LTV ratio for residential construction of 80%. The Bank also offers residential construction-to-permanent loans with a twelve-month construction period followed by 30 years of permanent financing.
On December 31, 2023, real estate construction loans totaled $125.1 million, or 8.5% of the Bank’s total loan portfolio. There were no loans in the construction and other portfolio that were 90 days delinquent or non-accruing on that date. On December 31, 2022, real estate construction and other loans totaled $94.2 million, or 7.0% of the Bank’s total loan portfolio. On December 31, 2022, real estate construction loans of approximately $68,000 were non-accruing and represented 0.1% of the real estate construction loan portfolio.
Consumer Installment Loans The Bank’s consumer installment loans include secured and unsecured loans to individual borrowers for various purposes, including personal, home improvement, revolving credit lines, automobiles, boats, and recreational vehicles. The Bank does not currently do any indirect lending. Unsecured consumer loans carry significantly higher interest rates than secured loans. The Bank maintains strict credit guidelines when considering consumer loan applications.
According to the Bank’s Credit Policy, consumer loans secured by collateral other than real estate generally may have terms of up to five years, and unsecured consumer loans may have terms up to three years. Real estate security is typically required for consumer loans having terms exceeding five years.
On December 31, 2023, the Bank had approximately $7.2 million in its consumer installment loan portfolio, representing 0.5% of total loans. On December 31, 2023, consumer installment loans of approximately $160,000 were non-accruing and represented 2.2% of the consumer installment loan portfolio. On December 31, 2022, the Bank had approximately $8.1 million in its consumer installment loan portfolio, representing 0.6% of total loans. On December 31, 2022, consumer installment loans of approximately $166,000 were non-accruing and represented 2.0% of the consumer installment loan portfolio.
Loan Solicitation and Processing Loan originations are developed from several sources, including continuing business with depositors, other borrowers, real estate builders, solicitations by Bank personnel, and walk-in customers.
When a loan request is made, the Bank reviews the application, credit bureau reports, property appraisals or evaluations, financial information, verifications of income, and other documentation concerning the borrower's creditworthiness, as applicable to each loan type. The Bank’s underwriting guidelines are set by senior management and approved by the Board of Directors. The Credit Policy specifies each officer’s loan approval authority. Loans exceeding an individual officer’s approval authority are submitted to an Officer’s Loan Committee, which can approve loans up to $6,000,000. The Board of Directors’ Loan Committee acts as approval authority for exposures over $6,000,000 and up to $10,000,000. Loans exceeding $10,000,000 require approval from the entire Board of Directors.
Income from Lending Activities The Bank earns interest and fee income from its lending activities. Net of origination costs, loan origination fees are amortized over the life of a loan. The Bank also receives loan fees related to existing loans, including late charges. Income from loan origination and commitment fees varies with the volume and type of loans and commitments made and with competitive and economic conditions. Note 1 to the Consolidated Financial Statements discusses how loan fees and income are recognized for financial reporting purposes.
Mortgage Banking Activity The Bank originates residential loans secured by first-lien mortgages on one-to-four family residential properties located within its market area for either portfolio or sale into the secondary market. During the year ended December 31, 2023, the Bank recorded gains of $97,000 on the sale of $5.6 million in loans receivable originated for sale. During the year ended December 31, 2022, the Bank recorded gains of $24,000 on the sale of $1.6 million in loans receivable originated for sale. These loans were sold on a servicing-retained basis to Freddie Mac.
In addition to income recognized on the sale of loans, the Bank receives fees for servicing loans that it has sold. Income from these activities will vary from period to period with the volume and type of loans originated and sold, which depends on prevailing mortgage interest rates and their effect on the demand for loans in the Bank’s market area.
Nonperforming Loans Late charges on residential mortgages and consumer loans are assessed if a payment is not received by the due date plus a grace period. When an advanced stage of delinquency appears on a single-family loan and repayment cannot be expected within a reasonable time, or a repayment agreement is not entered into, required notice of foreclosure or repossession proceedings may be prepared by the Bank’s attorney and delivered to the borrower so that foreclosure proceedings may be initiated promptly, if necessary. The Bank also collects late charges on commercial loans.
When the Bank acquires real estate through foreclosure, voluntary deed, or similar means, it is classified as OREO until it is sold. When a property is acquired in this manner, it is recorded at the lower of cost (the unpaid principal balance at the date of acquisition) or fair value, less anticipated cost to sell. If fair value, less cost to sell, is less than the carrying value of the loan, then the carrying value is reduced through the allowance for credit losses (“ACL”) immediately before recording the real estate as OREO. Any subsequent write-down is charged to expense. All costs incurred from the date of acquisition to maintain the property are expensed. OREO is appraised during the foreclosure process, before the acquisition, when possible. Subsequent to the initial appraisal, OREO is appraised at least annually. Losses are recognized for the amount by which the book value of the real estate exceeds the estimated fair value of the property, less anticipated cost to sell.
The Bank undertakes a regular review of the loan portfolio to assess its risks, particularly the risks associated with the commercial loan portfolio.
Classified Assets FDIC regulations governing classification of assets require nonmember commercial banks — including the Bank — to classify their own assets and to establish appropriate allowances for credit losses, subject to FDIC review. The regulations are designed to encourage management to evaluate assets on a case-by-case basis, discouraging automatic classifications. Under this classification system, problem assets of insured institutions are classified as “substandard,” “doubtful,” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Assets classified as “doubtful” have all the weaknesses inherent in those classified substandard, with the added characteristic that the weaknesses make the collection of principal in full — based on currently existing facts, conditions, and values — highly questionable and improbable. Assets classified as “loss” are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the Bank to risk sufficient to warrant classification in one of the above categories but that possess some potential weakness are required to be designated “special mention” by management.
When an FDIC-insured institution classifies assets as either “substandard” or “doubtful,” it may establish allowances for credit losses in an amount deemed prudent by management. When an insured institution classifies assets as “loss,” it is required either to establish an allowance for credit losses equal to 100% of that portion of the assets so classified or to charge off that amount. An Ohio nonmember bank’s determination about the classification of its assets and the amount of its allowances is subject to review by the FDIC and the Ohio Division of Financial Institutions (the “ODFI”), which may order the establishment of additional loss allowances. Management also employs an independent third party to semi-annually review and validate the internal loan review process and loan classifications.
Investment Securities Investment securities provide a return on residual funds after lending activities. Investments may be in corporate securities, U.S. Government and agency obligations, state and local government obligations, government-guaranteed mortgage-backed securities, or subordinated debt of other financial institutions. The Bank generally does not invest in securities rated less than investment grade by a nationally recognized statistical rating organization. Ohio law prescribes the kinds of investments an Ohio-chartered bank may make. Permitted investments include local, state, and federal government securities, mortgage-backed securities, and securities of federal government agencies. An Ohio-chartered bank also may invest up to 10% of its assets in corporate debt and equity securities or a higher percentage in certain circumstances. Ohio law also limits to 15% of capital the amount an Ohio-chartered bank may invest in the securities of any one issuer, other than local, state, and federal government and federal government agency issuers and mortgage-backed securities issuers. These provisions have not been a material constraint upon the Bank’s investment activities.
All securities-related activity is reported to the Bank’s Board of Directors. General changes in investment strategy are required to be reviewed and approved by the Board of Directors. Senior management can purchase and sell securities per the Bank’s stated investment policy.
Management determines the appropriate classification of securities at the time of purchase. At this time, the Bank has no securities classified as held to maturity. Securities to be held for indefinite periods and not intended to be held to maturity or on a long-term basis are classified as available for sale. Available for sale securities are reflected on the Consolidated Balance Sheet at their fair value.
The contractual maturity and average yield of investment securities are as follows:
December 31, 2023 |
||||||||||||||||||||||||||||||||||||||||||||
One year or less |
More than one to five years |
More than five to ten years |
More than ten years |
Total investment securities |
||||||||||||||||||||||||||||||||||||||||
Amortized cost |
Average yield |
Amortized cost |
Average yield |
Amortized cost |
Average yield |
Amortized cost |
Average yield |
Amortized cost |
Average yield |
Fair value |
||||||||||||||||||||||||||||||||||
(Dollar amounts in thousands) |
||||||||||||||||||||||||||||||||||||||||||||
Subordinated debt |
$ | - | - | $ | - | - | $ | 34,300 | 4.98 | % | $ | - | - | $ | 34,300 | 4.98 | % | $ | 31,919 | |||||||||||||||||||||||||
Obligations of states and political subdivisions: |
||||||||||||||||||||||||||||||||||||||||||||
Tax-exempt* |
560 | 3.29 | % | 910 | 4.34 | % | 18,695 | 3.11 | % | 129,716 | 2.50 | % | 149,881 | 2.59 | % | 132,542 | ||||||||||||||||||||||||||||
Mortgage-backed securities in government-sponsored entities |
7 | 2.74 | % | 1,206 | 2.27 | % | 1,820 | 2.59 | % | 3,932 | 2.84 | % | 6,965 | 2.68 | % | 6,318 | ||||||||||||||||||||||||||||
Total |
$ | 567 | 3.28 | % | $ | 2,116 | 3.16 | % | $ | 54,815 | 4.26 | % | $ | 133,648 | 2.51 | % | $ | 191,146 | 3.03 | % | $ | 170,779 |
* Tax-equivalent yield calculated using a 21% tax rate
Expected maturities of investment securities could differ from contractual maturities because the borrower, or issuer, could have the right to call or prepay obligations with or without call or prepayment penalties.
Yields on tax-exempt securities (tax-exempt for federal income tax purposes) are shown on a fully tax-equivalent basis. The average yield is determined based on the current book price and projected yield of each investment category, assuming the yield to call or maturity.
As of December 31, 2023, the Bank held 90,024 shares of $100 par value Federal Home Loan Bank (“FHLB”) of Cincinnati stock, which is a restricted security. FHLB stock represents an equity interest in the FHLB, but it does not have a readily determinable market value. The stock can be sold at its par value only to the FHLB or to another member institution. Member institutions must maintain a minimum stock investment in the FHLB based on total assets, total mortgages, and total mortgage-backed securities. The Bank’s minimum investment in FHLB stock on December 31, 2023, was $9.0 million.
Sources of Funds —Deposit accounts are a significant source of funds for the Bank. At December 31, 2023 and 2022, our deposits totaled $1.43 billion and $1.40 billion, respectively. The Bank offers many deposit products to attract commercial and consumer checking and savings customers, including standard and money market savings accounts, NOW accounts, a variety of fixed-maturity, fixed-rate certificates with maturities ranging from 3 to 60 months, and brokered deposits. These accounts earn interest at rates established by management based on liquidity, competitive market factors, and management’s desire to increase certain types or maturities. The Bank also provides travelers’ checks, official checks, money orders, ATM services, and IRA accounts.
Liquidity is a measure of the ability and ease with which bank assets may be converted to meet financial obligations such as deposits or other funding sources. Banks are required to implement liquidity risk management frameworks that ensure they maintain sufficient liquidity, including a cushion of unencumbered, high quality liquid assets, to withstand a range of stress events. The level and speed of deposit outflows contributing to the failures of Silicon Valley Bank, Signature Bank and First Republic Bank in the first half of 2023 were unprecedented. These events underscore the importance of liquidity risk management and contingency funding planning by insured depository institutions like the Bank.
The primary role of liquidity risk management is to: (i) prospectively assess the need for funds to meet financial obligations, and (ii) ensure the availability of cash or collateral to fulfill those needs at the appropriate time by coordinating the various sources of funds available to the institution under normal and stressed conditions. We review our liquidity risk management policies in light of regulatory requirements and industry developments.
The following table shows on a consolidated basis the amount of uninsured time deposits as of December 31, 2023, including certificates of deposit, by the time remaining until maturity.
(Dollar amounts in thousands) |
Amount |
Percent of Total |
||||||
Within three months |
$ | 16,835 | 14.32 | % | ||||
Beyond three but within six months |
38,403 | 32.66 | % | |||||
Beyond six but within twelve months |
59,625 | 50.71 | % | |||||
Beyond one year |
2,717 | 2.32 | % | |||||
Total |
$ | 117,580 | 100.00 | % |
The Bank participates in the IntraFi® ICS and CDARS reciprocal deposit network, which enables depositors to receive FDIC insurance coverage on deposits otherwise exceeding the maximum insurable amount. We consider these reciprocal deposits to be in-market deposits as distinguished from traditional out-of-market brokered deposits. Time deposits as of December 31, 2023 and 2022, included $28.6 million and $39.1 million, respectively, of reciprocal deposits. Included in total deposits as of December 31, 2023 and 2022, were $88.8 million and $50.4 million, respectively, of reciprocal interest-bearing checking.
Borrowings, deposits, and repayment of loan principal are the Bank’s primary sources of funds for lending activities and other general business purposes. However, when the supply of funds cannot satisfy the demand for loans or general business purposes, the Bank can obtain funds from the FHLB of Cincinnati. Interest and principal are payable monthly, and the line of credit is secured by a pledge collateral agreement on certain investments and loan balances. On December 31, 2023, MBC had $163.0 million in FHLB borrowings outstanding. On December 31, 2022, MBC had $65.0 million in FHLB borrowings outstanding. The Bank also has access to credit through the Federal Reserve Bank of Cleveland and other funding sources.
Competition
The banking and financial services industry is highly competitive. We compete with many financial institutions within our markets, including local, regional, and national commercial banks and credit unions. We also compete with brokerage firms, consumer finance companies, mutual funds, securities firms, insurance companies, fintech companies, and other financial intermediaries for some of our products and services. Some of our competitors are not currently subject to the regulatory restrictions and the level of regulatory supervision applicable to us.
Interest rates on loans and deposits, as well as prices on fee-based services, are typically significant competitive factors within the banking and financial services industry. Many of our competitors are much larger, have more significant resources than we do, and compete aggressively. These competitors attempt to gain market share through their financial product mix, pricing strategies, and banking center locations.
Other important standard competitive factors in our industry and markets include office locations and hours, quality of customer service, community reputation, continuity of personnel and services, capacity and willingness to extend credit, online capabilities, and ability to offer sophisticated banking products and services. While we seek to remain competitive concerning fees charged, interest rates, and pricing, we believe that the Bank’s commitment to personal service, innovation, and involvement in the communities that the Bank serves, are factors that contribute to the Bank’s competitive advantage and will enable us to compete successfully within our markets and enhance our ability to attract and retain customers.
Personnel and Human Capital Resources
We encourage and support the growth and development of our employees and, wherever possible, seek to fill positions by promotion and transfer from within the organization. Continual learning and career development are advanced through ongoing performance and development conversations with employees, internally developed training programs, customized corporate training engagements, and educational reimbursement programs. Reimbursement is available to employees enrolled in a pre-approved degree or certification programs at accredited institutions that teach skills or knowledge relevant to our business, in compliance with Section 127 of the Internal Revenue Code, and for seminars, conferences, and other training events employees attend in connection with their job responsibilities.
The safety, health, and wellness of our employees are a top priority. On an ongoing basis, we further promote the health and wellness of our employees by strongly encouraging work-life balance, offering flexible work schedules, keeping the employee portion of health care premiums to a minimum, and sponsoring various wellness programs.
Employee retention helps us operate efficiently and achieve one of our business objectives, which is being a low-cost provider. We believe our commitment to living out our core values, actively prioritizing concern for our employees’ well-being, supporting our employees’ career goals, offering competitive wages, and providing valuable fringe benefits aids in the retention of our top-performing employees.
As of December 31, 2023, the Bank had 256 full-time equivalent employees. None of the employees are represented by a collective bargaining group.
Supervision and Regulation
The following discussion of bank supervision and regulation is qualified in its entirety by reference to the statutory and regulatory provisions discussed. Changes in applicable law or in the policies of various regulatory authorities could materially affect the business and prospects of the Company.
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956. The Company is subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System, acting primarily through the Federal Reserve Bank of Cleveland. The Company must file annual reports and other information with the Federal Reserve. The bank subsidiary is an Ohio-chartered commercial bank. As a state-chartered, nonmember bank, the bank is primarily regulated by the FDIC and the ODFI.
The Company and the Bank are subject to federal and Ohio banking laws. These federal and state laws are intended to protect depositors, not stockholders. Federal and state laws applicable to holding companies and their financial institution subsidiaries regulate the range of permissible business activities, investments, reserves against deposits, capital levels, lending activities and practices, the nature and amount of collateral for loans, establishment of branches, mergers, dividends, and a variety of other important matters. The Bank is subject to detailed, complex, and sometimes overlapping federal and state statutes and regulations affecting routine banking operations. These statutes and regulations include but are not limited to state usury and consumer credit laws, the Truth in Lending Act and Regulation Z, the Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Truth in Savings Act, and the Community Reinvestment Act. Regulation D, promulgated by the FRB, imposes reserve requirements on all depository institutions, including the Bank, which maintain transaction accounts or nonpersonal time deposits. In March 2020, due to a change in its approach to monetary policy due to the COVID-19 pandemic, the FRB implemented a final rule to amend Regulation D requirements and reduce the reserve requirement ratio to zero. The FRB has indicated that it has no plans to re-impose reserve requirements but may do so in the future if conditions warrant.
The Federal Reserve Board and the FDIC have extensive authority to prevent and remedy unsafe and unsound practices and violations of applicable laws and regulations by institutions and holding companies. The agencies may assess civil money penalties, issue cease-and-desist or removal orders, seek injunctions, and publicly disclose those actions. In addition, the Ohio Division of Financial Institutions possesses enforcement powers to address violations of Ohio banking law by Ohio-chartered banks.
Regulation of Bank Holding Companies - Bank and Bank Holding Company Acquisition. The Bank Holding Company Act and the Federal Reserve Board's Regulation Y require advance approval of the Federal Reserve to acquire "control" of a bank holding company. In evaluating a company's proposed acquisition of control of a bank or bank holding company, the Federal Reserve takes into consideration such factors as the financial condition and future prospects of the applicant, its subsidiaries, any banks related to the applicant through common ownership or management, and the bank or banks to be acquired, the competence, experience, and integrity of the officers, directors, and principal shareholders of the applicant, its subsidiaries, and the banks and bank holding companies concerned, the convenience and needs of the community and the competitive effects of the acquisition.
Under the Bank Holding Company Act, a company proposing to acquire direct or indirect control of a bank or bank holding company must apply for the Federal Reserve's prior approval. A company acquires such direct or indirect control of a bank or bank holding company by acquiring ownership, control, or power to vote twenty five percent or more of the outstanding shares of any class of voting securities of the bank or bank holding company; by controlling in any manner the election of a majority of the directors of the bank or bank holding company; or by exercising the power to exercise, directly or indirectly, a controlling influence over the management or policies of the bank or bank holding company. In January 2020, the Federal Reserve substantially revised its control regulations. Under the revised regulations, if a company acquires less than twenty five percent of the voting securities of a bank or bank holding company, the Federal Reserve provides the following four-tiered approach to determining control based upon a company's ownership percentage in the voting stock of a bank or holding company: (1) less than 5% stock ownership; (2) 5%-9.99% stock ownership; (3) 10%-14.99% stock ownership; and (4) l 5%-24.99% stock ownership. In determining whether a company acquires control of a bank or bank holding company in each of the four tiers, the Federal Reserve takes into account substantive activities, including management agreements, director service, business relationships, business terms, officer and employee interlocks, and limiting contractual right. Additionally, the Federal Reserve will presume that control exists if a company owns one‐third or more of the total equity of a bank or bank holding company.
The Change in Bank Control Act and the Federal Reserve's Regulation Y require any person, acting_ directly or indirectly, or through or in concert with one or more persons, to provide advance notice to the Federal Reserve before acquiring control of a bank or bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of a class of voting securities of the bank or bank holding company. If the holding company has securities registered under Section 12 of the Securities Exchange Act of 1934, as the Company does, or if no other person owns a greater percentage of the class of voting securities, control is presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities. Approval of the ODFI is also necessary to acquire control of an Ohio-chartered bank.
Nonbanking Activities With some exceptions, the Bank Holding Company Act generally prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve nonbank activities that, by statute or by Federal Reserve Board regulation or order, are held to be closely related to the business of banking or of managing or controlling banks. In making its determination that a particular activity is closely associated with the business of banking, the Federal Reserve considers whether the performance of the actions by a bank holding company can be expected to produce benefits to the public — such as greater convenience, increased competition, or gains in efficiency in resources — that will outweigh the risks of possible adverse effects such as decreased or unfair competition, conflicts of interest, or unsound banking practices. Some of the activities determined by Federal Reserve Board regulation to be closely related to the business of banking are: making or servicing loans or leases; engaging in insurance and discount brokerage activities; owning thrift institutions; performing data processing services; acting as a fiduciary or investment or financial advisor; and making investments in corporations or projects designed primarily to promote community welfare.
Financial Holding Companies On November 12, 1999, the Gramm-Leach-Bliley Act became law, repealing much of the 1933 Glass-Steagall Act’s separation of the commercial and investment banking industries. The Gramm-Leach-Bliley Act expands the range of nonbanking activities in which a bank holding company may engage while preserving existing authority for bank holding companies to engage in activities closely related to banking. The legislation creates a new category of holding company called a “financial holding company.” Financial holding companies may engage in any activity that is:
• |
financial in nature or incidental to that financial activity, or |
|
• |
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 include:
• |
acting as principal, agent, or broker for insurance, |
|
• |
underwriting, dealing in, or making a market in securities, and |
|
• |
providing financial and investment advice. |
The Federal Reserve Board and the Secretary of the Treasury have the authority to decide whether other activities are also financial or incidental to financial activity, taking into account, among others, changes in technology, changes in the banking marketplace, and competition for banking services. The Company is engaged solely in activities that were permissible for a bank holding company before the enactment of the Gramm-Leach-Bliley Act. Federal Reserve Board rules require that all depository institution subsidiaries of a financial holding company be and remain well-capitalized and well-managed. If all depository institution subsidiaries of a financial holding company do not remain well-capitalized and well-managed, the financial holding company must enter into an agreement acceptable to the Federal Reserve Board, undertaking to comply with all capital and management requirements within 180 days. In the meantime, the financial holding company may not use its expanded authority to engage in nonbanking activities without Federal Reserve Board approval, and the Federal Reserve may impose other limitations on the holding company’s or affiliates’ activities. If a financial holding company fails to restore the well-capitalized and well-managed status of a depository institution subsidiary, the Federal Reserve may order divestiture of the subsidiary.
The Company has not elected to be a financial holding company
Holding Company Capital and Source of Strength The Federal Reserve considers the adequacy of a bank holding company’s capital on essentially the same risk-adjusted basis as capital adequacy is determined by the FDIC at the bank subsidiary level.
The Federal Reserve has issued regulations under the Bank Holding Company Act requiring a bank holding company to serve as a source of financial and managerial strength to its subsidiary bank. It is the policy of the Federal Reserve that, pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary bank during periods of financial stress or adversity. Under this requirement, we are expected to commit resources to support our Bank, including when we may not be in a financial position to provide such help.
Our Company is a legal entity separate and distinct from its bank subsidiary. As a bank holding company, we are subject to certain restrictions on our ability to pay dividends under applicable banking laws and regulations. Federal bank regulators are authorized to determine, under certain circumstances relating to the financial condition of a bank holding company or a bank, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. Federal Reserve policy provides that a bank holding company should not pay dividends unless (1) the bank holding company’s net income over the last four quarters (net of dividends paid) is sufficient to fund the dividends fully, (2) the prospective rate of earnings retention appears consistent with the capital needs, asset quality, and overall financial condition of the bank holding company and its subsidiaries and (3) the bank holding company will continue to meet minimum required capital adequacy ratios. The policy also provides that a bank holding company should inform the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds earnings for the period for which the dividend is being paid or that could result in a material adverse change to the bank holding company’s capital structure. Bank holding companies also are required to consult with the Federal Reserve before materially increasing dividends. The Federal Reserve could prohibit or limit the payment of dividends by a bank holding company if it determines that payment of the dividend would constitute an unsafe or unsound practice.
Since all of our income comes from dividends from our Bank, which is also the primary source of our liquidity, our ability to pay dividends and repurchase shares depends upon our receipt of dividends from our Bank.
Capital — Risk-Based Capital Requirements The Federal Reserve Board and the FDIC employ similar risk-based capital guidelines in their examination and regulation of bank holding companies and financial institutions. If capital falls below the minimum levels established by the guidelines, the bank holding company or bank may be denied approval to acquire or establish additional banks or nonbank businesses or to open new facilities. Failure to satisfy capital guidelines could subject a banking institution to a variety of restrictions or enforcement actions by federal bank regulatory authorities, including the termination of deposit insurance by the FDIC and a prohibition on the acceptance of brokered deposits.
A bank’s capital hedges its risk exposure, absorbing losses that can be predicted as well as losses that cannot be predicted. According to the Federal Financial Institutions Examination Council’s explanation of the capital component of the Uniform Financial Institutions Rating System, commonly known as the “CAMELS” rating system, a rating system employed by the Federal bank regulatory agencies, a financial institution must “maintain capital commensurate with the nature and extent of risks to the institution and the ability of management to identify, measure, monitor, and control these risks. The effect of credit, market, and other risks on the institution’s financial condition should be considered when evaluating the adequacy of capital.”
Under regulations promulgated by the federal bank regulators, U.S. banking organizations are subject to comprehensive capital standards that require the maintenance of common equity Tier 1 capital, Tier 1 capital, and total capital to risk-weighted assets of at least 4.5%, 6% and 8%, respectively, and a leverage ratio of at least 4% Tier 1 capital. Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and Additional Tier 1 capital. Additional Tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus Additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is composed of capital instruments and related surplus meeting specified requirements. It may include cumulative preferred stock and long-term, perpetual preferred stock, mandatory convertible securities, intermediate preferred stock, and subordinated debt. Also included in Tier 2 capital is the allowance for credit losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale securities). During the first quarter of 2015, the Company exercised the opt-out election regarding the treatment of AOCI. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, a bank’s assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests), are multiplied by a risk-weight factor assigned by the regulations based on perceived risks inherent in the type of asset. Higher capital levels are required for asset categories believed to present more significant risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first-lien one-to-four family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, and a risk weight of 150% is assigned to particular past-due loans and high volatility commercial real estate loans.
In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer", consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. At December 31, 2023, the Bank exceeded the regulatory requirement for the “capital conservation buffer.”
The FDIC also employs a market risk component in calculating capital requirements for nonmember banks. The market risk component could require additional capital for general or specific market risk of trading portfolios of debt and equity securities and other investments or assets. The FDIC’s evaluation of an institution’s capital adequacy takes into account a variety of other factors as well, including interest rate risks to which the institution is subject, the level and quality of an institution’s earnings, loan and investment portfolio characteristics and risks, risks arising from the conduct of nontraditional activities, and a variety of other factors.
Accordingly, the FDIC’s final supervisory judgment concerning an institution’s capital adequacy could differ significantly from the conclusions that might be derived from the absolute level of an institution’s risk-based capital ratios. Therefore, institutions generally are expected to maintain risk-based capital ratios that exceed the minimum ratios discussed above. This is particularly true for institutions contemplating significant expansion plans and institutions that are subject to high or excessive levels of risk. Moreover, although the FDIC does not impose explicit capital requirements on holding companies of institutions regulated by the FDIC, the FDIC can take into account the degree of leverage and risks at the holding company level. If the FDIC determines that the holding company (or another affiliate of the institution regulated by the FDIC) has an excessive degree of leverage or is subject to undue risks, the FDIC may require the subsidiary institution(s) to maintain additional capital or the FDIC may impose limitations on the subsidiary institution’s ability to support its weaker affiliates or holding company.
Prompt Corrective Action. To resolve the problems of undercapitalized financial institutions and to prevent a recurrence of the banking crisis of the 1980s and early 1990s, the Federal Deposit Insurance Corporation Improvement Act of 1991 established a system known as “prompt corrective action.” Under the prompt corrective action provisions and implementing regulations, every institution is classified into one of five categories, depending on its total capital ratio, its Tier 1 capital ratio, its common equity Tier 1 risk-based capital ratio, its leverage ratio, and subjective factors. The categories are “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” To be considered well-capitalized for purposes of the prompt corrective action rules, a bank must maintain total risk-based capital of 10.0% or greater, Tier 1 risk-based capital of 8.0% or greater, common equity Tier 1 capital of 6.5% or greater, and leverage capital of 5.0% or greater. An institution with a capital level that might qualify for well-capitalized or adequately capitalized status may nevertheless be treated as though it were in the next lower capital category if its primary federal banking supervisory authority determines an unsafe or unsound condition or practice warrants that treatment.
A financial institution’s capital classification can significantly affect its operations under the prompt corrective action rules. For example, an institution that is not well-capitalized generally is prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market without advance regulatory approval, which can harm the bank’s liquidity. An insured depository institution is subject to additional restrictions at each successively lower capital category. Undercapitalized institutions are required to take specified actions to increase their capital or otherwise decrease the risks to the federal deposit insurance fund. A bank holding company must guarantee that a subsidiary bank that adopts a capital restoration plan will satisfy its plan obligations. Any capital loans made by a bank holding company to a subsidiary bank are subordinated to the claims of depositors in the bank and certain other indebtedness of the subsidiary bank. If bankruptcy of a bank holding company occurs, any commitment by the bank holding company to a federal banking regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and would be entitled to priority of payment. Bank regulatory agencies generally must appoint a receiver or conservator shortly after an institution becomes critically undercapitalized. For a complete discussion of the Company and the Bank’s actual capital amounts and ratios, refer to Note 19 - Regulatory Capital of the “Notes to Consolidated Financial Statements” of this Annual Report.
Limits on Dividends and Other Payments The Company’s ability to obtain funds for the payment of dividends and for other cash requirements depends on the amount of dividends that may be paid to it by the bank. Ohio bank law and FDIC policy are consistent, providing that banks generally may rely solely on current earnings to pay dividends. Under Ohio Revised Code section 1107.15(B), a dividend may be declared from surplus, meaning additional paid-in capital, with the approval of (x) the Ohio Superintendent of Financial Institutions and (y) the holders of two-thirds of the bank’s outstanding shares. Superintendent approval is also necessary to pay a dividend if the total of all cash dividends in a year exceeds the sum of (x) net income for the year and (y) retained net income for the two preceding years. Relying on 12 U.S.C. 1818(b), the FDIC may restrict a bank’s ability to pay a dividend if the FDIC has reasonable cause to believe that the dividend would constitute an unsafe and unsound practice. The FDIC’s capital maintenance requirements and prompt corrective action rules may also affect a bank's ability to pay dividends. A bank may not pay a dividend if the bank is undercapitalized or if payment would cause the bank to become undercapitalized.
A 1985 policy statement of the Federal Reserve Board declares that a bank holding company should not pay cash dividends on common stock unless the organization’s net income for the past year is sufficient to fund the dividends fully and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition.
Sarbanes-Oxley Act of 2002 The goals of the Sarbanes-Oxley Act enacted in 2002 are to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and protect investors by improving the accuracy and reliability of corporate disclosures made under the securities laws. The changes are intended to allow shareholders to monitor the performance of companies and directors more easily and efficiently.
The Sarbanes-Oxley Act generally applies to all companies that file periodic reports with the SEC under the Exchange Act. The Act has an impact on a wide variety of corporate governance and disclosure issues, including the composition of audit committees, certification of financial statements by the chief executive officer and the chief financial officer, forfeiture of bonuses and profits made by directors and senior officers in the 12 months covered by restated financial statements, a prohibition on insider trading during pension plan black-out periods, disclosure of off-balance-sheet transactions, a prohibition on personal loans to directors and officers (excluding FDIC-insured financial institutions), expedited filing requirements for stock transaction reports by officers and directors, the formation of a public accounting oversight board, auditor independence, and various increased criminal penalties for violations of securities laws.
Deposit Insurance The Deposit Insurance Fund of the FDIC insures deposits at insured depository institutions such as the Bank. Deposit accounts in the Bank are insured by the FDIC generally up to a maximum of $250,000 based upon the ownership rights and capacities in which deposit accounts are maintained at the Bank. Banks' premium for deposit insurance is based upon a risk classification system established by the FDIC.
Effective July 1, 2016, the FDIC changed the way banks are assessed for deposit insurance. The FDIC has eliminated the risk categories for “small banks”, such as the Bank, that have been FDIC insured for at least five years and have less than $10 billion in total assets, and assessments are now based on financial measures and supervisory ratings derived from statistical modeling estimating the probability of failure within three years. In conjunction with the Deposit Insurance Fund reserve ratio achieving 1.15%, the assessment range (inclusive of possible adjustments) for established small banks with CAMELS 1 or 2 ratings has been reduced to 1.5 to 16 basis points and the maximum assessment rate for established small banks with CAMELS 3 through 4 ratings is 40 basis points.
The FDIC has the authority to increase insurance assessments. Effective January 1, 2023, FDIC deposit insurance assessment rates increased two basis points. The FDIC rule aims to return the deposit insurance fund to its statutory minimum of 1.35%. Any significant increases would have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what assessment rates will be in the future.
Interstate Banking and Branching Section 613 of the Dodd Frank Act (“DFA”) amends the interstate branching provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. The expanded de novo branching authority of the DFA authorizes a state or national bank to open a de novo branch in another state if the law of the state where the branch is to be located would permit a state bank chartered by that state to open the branch. Section 607 of the DFA also increases the approval threshold for interstate bank acquisitions, providing that a bank holding company must be well-capitalized and well managed as a condition to approval of an interstate bank acquisition, rather than being merely adequately capitalized and adequately managed, and that an acquiring bank must be and remain well-capitalized and well managed as a condition to approval of an interstate bank merger.
Transactions with Affiliates Transactions between an insured bank, such as the Bank, and any of its affiliates are governed by Sections 23A and 23B of the Federal Reserve Act and implementing regulations. These statutes are intended to protect banks from abuse in financial transactions with affiliates, preventing FDIC-insured deposits from being diverted to support the activities of unregulated entities engaged in nonbanking businesses. An affiliate of a bank includes any company or entity that controls or is under common control with the bank. Generally, section 23A and section 23B of the Federal Reserve Act:
● |
limit the extent to which a bank or its subsidiaries may lend to or engage in various other kinds of transactions with any one affiliate to an amount equal to 10% of the institution’s capital and surplus, limiting the aggregate of covered transactions with all affiliates to 20% of capital and surplus, |
● |
impose restrictions on investments by a subsidiary bank in the stock or securities of its holding company, |
● |
require that affiliate transactions be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate, and |
● |
impost strict collateral requirements on loans or extensions or credit by a bank to an affiliate |
The Bank’s authority to extend credit to insiders — meaning executive officers, directors and greater than 10% stockholders — or to entities those persons control, is subject to section 22(g) and section 22(h) of the Federal Reserve Act and the Federal Reserve’s Regulation O. Among other things, these laws require insider loans to be made on terms substantially similar to those offered to unaffiliated individuals, place limits on the amount of loans a bank may make to insiders based in part on the bank’s capital position and require that specified approval procedures be followed. Loans to an individual insider may not exceed the legal limit on loans to any one borrower, which in general terms is 15% of capital but can be higher in some circumstances. In addition, the aggregate of all loans to all insiders may not exceed the Bank’s unimpaired capital and surplus. Insider loans exceeding the greater of 5% of capital or $25,000 must be approved in advance by a majority of the board of directors, with any “interested” director not participating in the voting. Lastly, loans to executive officers are subject to special limitations. Executive officers may borrow in unlimited amounts to finance their children’s education or to finance the purchase or improvement of their residence, and they may borrow no more than $100,000 for most other purposes. Loans to executive officers exceeding $100,000 may be allowed if the loan is fully secured by government securities or a segregated deposit account. A violation of these restrictions could result in the assessment of substantial civil monetary penalties, the imposition of a cease-and-desist order or other regulatory sanctions.
Banking agency guidance for commercial real estate lending In December 2006 the FDIC and other Federal banking agencies issued final guidance on sound risk management practices for concentrations in commercial real estate lending, including acquisition and development lending, construction lending, and other land loans, which experience has shown can be particularly high-risk lending.
The commercial real estate risk management guidance does not impose rigid limits on commercial real estate lending but does create a much sharper supervisory focus on the risk management practices of banks with concentrations in commercial real estate lending. According to the guidance, an institution that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial real estate, or is approaching or exceeds the following supervisory criteria may be identified for further supervisory analysis of the level and nature of its commercial real estate concentration risk:
● |
total reported loans for construction, land development, and other land represent 100% or more of the institution’s total capital, or |
● |
total commercial real estate loans represent 300% or more of the institution’s total capital and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36 months. |
These measures are intended merely to enable the banking agencies to identify institutions that could have an excessive commercial real estate lending concentration, potentially requiring close supervision to ensure that the institutions have sound risk management practices in place. Conversely, these measures do not imply that banks are authorized by the December 2006 guidance to accumulate a commercial real estate lending concentration up to the 100% and 300% thresholds.
Community Reinvestment Act (CRA) Under the Community Reinvestment Act of 1977 and implementing regulations of the banking agencies, a financial institution has a continuing and affirmative obligation — consistent with safe and sound operations — to address the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services it believes are best suited to its particular community. The CRA requires that bank regulatory agencies conduct regular CRA examinations and provide written evaluations of institutions’ CRA performance. The CRA also requires that an institution’s CRA performance rating be made public. CRA performance evaluations are based on a four-tiered rating system: Outstanding, Satisfactory, Needs to Improve and Substantial Noncompliance.
Although CRA examinations occur on a regular basis, CRA performance evaluations have been used principally in the evaluation of regulatory applications submitted by an institution. CRA performance evaluations are considered in evaluating applications for such things as mergers, acquisitions, and applications to open branches.
MBC’s CRA performance evaluation dated December 12, 2023 states that MBC’s CRA rating is “Satisfactory.”
On October 24, 2023, the federal banking agencies, including the FDIC, issued a final rule designed to strengthen and modernize regulations implementing the CRA. The changes are designed to encourage banks to expand access to credit, investment and banking services in low‐and moderate-income communities, adapt to changes in the banking industry including mobile and internet banking, provide greater clarity and consistency in the application of the CRA regulations and tailor CRA evaluations and data collection to bank size and type. Under the final rule, banks with assets of at least $600 million as of December 31 in both of the prior two calendar years and less than $2 billion as of December 31 in either of the prior two calendar years will be an "intermediate bank," and banks with assets of at least $2 billion as of December 31 in both of the prior two calendar years will be a "large bank." Banks classified as large banks will be subject to significant changes in their CRA compliance efforts. Intermediate banks are subject to more moderate changes to their CRA compliance program. Small banks are expected to see no changes to their CRA compliance activities unless they voluntarily opt in to some of the new requirements.
The agencies will evaluate large banks under four performance tests: the Retail Lending Test, the Retail Services and Products Test, the Community Development Financing Test, and the Community Development Services Test. The agencies will evaluate intermediate banks under the Retail Lending Test and either the current community development test, referred to in the final rule as the Intermediate Bank Community Development Test, or, at the bank's option, the Community Development Financing Test. The applicability date for the majority of the provisions in the final rule is January 1, 2026, and additional data collection and reporting requirements will be applicable on January 1, 2027. Until the January 1, 2026 compliance date, the current CRA regulations continue to apply.
The changes to the CRA regulations will make it more challenging and costly for the Bank to receive a rating of at least "satisfactory" on its CRA exam.
Federal Home Loan Bank The FHLB serves as a credit source for its members. As a member of the FHLB of Cincinnati, MBC is required to maintain an investment in the capital stock of the FHLB of Cincinnati in an amount calculated by reference to the FHLB member bank’s amount of loans, and or “advances,” from the FHLB.
Each FHLB is required to establish standards of community investment or service that its members must maintain for continued access to long-term advances from the FHLB. The criteria consider a member’s performance under the CRA and its record of lending to first-time home buyers.
Cybersecurity and Data Protection Recent statements by federal regulators regarding cybersecurity indicate that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised client credentials, including security measures to reliably authenticate clients accessing internet-based services of the financial institution. Financial institution management is also expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If the Bank fails to observe regulatory guidance regarding appropriate cybersecurity safeguards, we could be subject to various regulatory sanctions, including financial penalties.
The Bank dedicates significant resources to securing its systems and to protecting non-public personal information and other confidential information. These include resources dedicated to intrusion prevention such as firewalls, endpoint protection and behavior analysis tools, among others. The Bank also dedicates resources toward vulnerability identification through the performance of vulnerability scans and penetration tests, among other methods. We also require employees with access to information systems to undertake data protection and cybersecurity training and compliance programs. Compliance with cybersecurity training is tracked and reported to management, and the Audit Committee of the Board. In addition, the Bank conducts quarterly employee phishing tests and provides those results to the Bank’s executives. The Bank has processes in place for assessing, identifying, and managing material risks from potential cybersecurity incidents, including vulnerability identifications, intrusion prevention, encryption, endpoint protection, behavior analysis, mitigation and the processes and protocols set forth in the Bank’s incident response plan. The Bank also employs systems and processes designed to oversee and identify cybersecurity threats associated with third-party vendors, including a risk assessment and rigorous evaluation of each vendor that may access, process or store highly sensitive or proprietary data or that is systematically integrated with the Bank’s systems or network. In addition to our in-house cybersecurity capabilities, we engage assessors, consultants, auditors, and other third parties to assist with assessing, identifying, mitigating and managing cybersecurity risks. See Item 1C. Cybersecurity for additional details regarding cybersecurity and data protection.
In the ordinary course of business, the Bank relies on electronic communications and information systems to conduct its operations and to store sensitive data. The Bank employs an in-depth, layered, defensive approach that incorporates security processes and technology to manage and maintain cybersecurity controls. The Bank 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. Notwithstanding the strength of the Bank’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.
Anti-money laundering and anti-terrorism legislation The Bank Secrecy Act of 1970 requires financial institutions to maintain records and report transactions to prevent the financial institutions from being used to hide money derived from criminal activity and tax evasion. The Bank Secrecy Act establishes (a) record-keeping requirements to assist government enforcement agencies with tracing financial transactions and flow of funds, (b) reporting requirements for Suspicious Activity Reports and Currency Transaction Reports to assist government enforcement agencies with detecting patterns of criminal activity, (c) enforcement provisions authorizing criminal and civil penalties for illegal activities and violations of the Bank Secrecy Act and its implementing regulations, and (d) safe harbor provisions that protect financial institutions from civil liability for their cooperative efforts.
The Treasury’s Office of Foreign Asset Control administers and enforces economic and trade sanctions against targeted foreign countries, entities, and individuals based on U.S. foreign policy and national security goals. As a result, financial institutions must scrutinize transactions to ensure that they do not represent obligations of or ownership interests in entities owned or controlled by sanctioned targets.
Signed into law on October 26, 2001, the USA PATRIOT Act of 2001 is omnibus legislation enhancing the powers of domestic law enforcement organizations to resist the international terrorist threat to United States security. Title III of the legislation, the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001, most directly affects the financial services industry, enhancing the Federal government’s ability to fight money laundering through monitoring of currency transactions and suspicious financial activities. The USA PATRIOT Act has significant implications for depository institutions and other businesses involved in the transfer of money:
- |
a financial institution must establish due diligence policies, procedures, and controls reasonably designed to detect and report money laundering through correspondent accounts and private banking accounts, |
- |
no bank may establish, maintain, administer, or manage a correspondent account in the United States for a foreign shell bank, |
- |
financial institutions must abide by Treasury Department regulations encouraging financial institutions, their regulatory authorities, and law enforcement authorities to share information about individuals, entities, and organizations engaged in or suspected of engaging in terrorist acts or money laundering activities, and |
- |
financial institutions must follow Treasury Department regulations setting forth minimum standards regarding customer identification. These regulations require financial institutions to implement reasonable procedures for verifying the identity of any person seeking to open an account, maintain records of the information used to verify the person’s identity, and consult lists of known or suspected terrorists and terrorist organizations provided to the financial institution by government agencies. Every financial institution must establish anti-money laundering programs, including the development of internal policies and procedures, designation of a compliance officer, employee training, and an independent audit function. |
Consumer protection laws and regulations. The Middlefield Banking Company is subject to regular examination by the FDIC to ensure compliance with statutes and regulations applicable to the bank’s business, including consumer protection statutes and implementing regulations, some of which are discussed below. Violations of any of these laws may result in fines, reimbursements, and other related penalties.
Equal Credit Opportunity Act. The Equal Credit Opportunity Act generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.
Truth in Lending Act. The Truth in Lending Act is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the Truth in Lending Act, all creditors must use the same credit terminology to express rates and payments, including the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule, among other things.
Fair Housing Act. The Fair Housing Act makes it unlawful for a residential mortgage lender to discriminate against any person because of race, color, religion, national origin, sex, handicap, or familial status. A number of lending practices have been held by the courts to be illegal under the Fair Housing Act, including some practices that are not specifically mentioned in the Fair Housing Act.
Home Mortgage Disclosure Act. The Home Mortgage Disclosure Act arose out of public concern over credit shortages in certain urban neighborhoods. The Home Mortgage Disclosure Act requires financial institutions to collect data that enable regulatory agencies to determine whether the financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The Home Mortgage Disclosure Act also requires the collection and disclosure of data about applicant and borrower characteristics as a way to identify possible discriminatory lending patterns. The vast amount of information that financial institutions collect and disclose concerning applicants and borrowers receives attention not only from state and Federal banking supervisory authorities but also from community-oriented organizations and the general public.
Real Estate Settlement Procedures Act. The Real Estate Settlement Procedures Act requires that lenders provide borrowers with disclosures regarding the nature and cost of real estate settlements. The Real Estate Settlement Procedures Act also prohibits abusive practices that increase borrowers’ costs, such as kickbacks and fee splitting without providing settlement services.
Privacy. Under the Gramm-Leach-Bliley Act, all financial institutions are required to establish policies and procedures to restrict the sharing of non-public customer data with non-affiliated parties and to protect customer data from unauthorized access. In addition, the Fair Credit Reporting Act of 1971 includes many provisions concerning national credit reporting standards and permits consumers to opt out of information sharing for marketing purposes among affiliated companies.
In November, 2021, the FDIC, the OCC and the Federal Reserve Board issued a final rule requiring banking organizations that experience a computer-security incident to notify a bank’s primary federal bank regulator. Compliance with the rule began May 1, 2022. A computer-security incident occurs when there is a violation or imminent threat of a violation to banking security policies and procedures, or when actual or potential harm to the confidentiality, integrity, or availability of an information system or the information occurs. The affected bank must notify its respective federal regulator of the computer-security incident as soon as possible and no later than 36 hours after the bank determines a computer-security incident has occurred. These notifications are intended to promote early awareness of threats to banking organizations and will help banks react to those threats before they manifest into bigger incidents. This rule also requires bank service providers to notify their customers of a computer-security incident.
State Banking Regulation As an Ohio-chartered bank, The Middlefield Banking Company is subject to regular examination by the ODFI. State banking regulation affects the internal organization of the bank as well as its savings, lending, investment, and other activities. State banking regulation may contain limitations on an institution’s activities that are in addition to limitations imposed under federal banking law. The ODFI may initiate supervisory measures or formal enforcement actions, and if the grounds provided by law exist, it may take possession and control of an Ohio-chartered bank.
Monetary Policy The earnings of financial institutions are affected by the policies of regulatory authorities, including monetary policy of the Federal Reserve Board. An important function of the Federal Reserve System is regulation of aggregate national credit and money supply. The Federal Reserve Board accomplishes these goals with measures such as open market transactions in securities, establishment of the discount rate on bank borrowings, and changes in reserve requirements against bank deposits. These methods are used in varying combinations to influence overall growth and distribution of financial institutions’ loans, investments and deposits, and they also affect interest rates charged on loans or paid on deposits. Monetary policy is influenced by many factors, including inflation, unemployment, short-term and long-term changes in the international trade balance, and fiscal policies of the United States government. Federal Reserve Board monetary policy has had a significant effect on the operating results of financial institutions in the past, and it can be expected to influence operating results in the future.
Risks Related to the Company’s Business
The Company does not have the financial and other resources that larger competitors have; this could affect its ability to compete for large commercial loan originations and its ability to offer products and services competitors provide to customers. The northeastern Ohio and central Ohio markets in which the Company operates have high concentrations of financial institutions. Many of the financial institutions operating in our markets are branches of significantly larger institutions headquartered in Cleveland or in Columbus, with significantly greater financial resources and higher lending limits. In addition, many of these institutions offer services that the Company does not or cannot provide. For example, the larger competitors’ greater resources offer advantages such as the ability to price services at lower, more attractive levels, and the ability to provide larger credit facilities. The Company accommodates loan volumes in excess of its lending limits from time to time through the sale of loan participations to other banks.
The business of banking is changing rapidly with changes in technology, which poses financial and technological challenges to small and mid-sized institutions. With frequent introductions of new technology-driven products and services, the banking industry is undergoing rapid technological changes. In addition to enhancing customer service, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Financial institutions’ success is increasingly dependent upon use of technology to provide products and services that satisfy customer demands and to create additional operating efficiencies. Many of the Company’s competitors have substantially greater resources to invest in technological improvements, which could enable them to perform various banking functions at lower costs than the Company, or to provide products and services that the Company is not able to economically provide. The Company cannot assure you that we will be able to develop and implement new technology-driven products or services or that the Company will be successful in marketing these products or services to customers. Because of the demand for technology-driven products, banks increasingly rely on unaffiliated vendors to provide data processing services and other core banking functions. The use of technology-related products, services, delivery channels, and processes exposes banks to various risks, particularly transaction, strategic, reputation, and compliance risk. The Company cannot assure you that we will be able to successfully manage the risks associated with our dependence on technology.
Success in the banking industry requires disciplined management of lending risks. There are many risks in the business of lending, including risks associated with the duration over which loans may be repaid, risks resulting from changes in economic conditions, risks inherent in dealing with individual borrowers, and risks resulting from changes in the value of loan collateral. We attempt to mitigate this risk by a thorough review of the creditworthiness of loan customers. Nevertheless, there is risk that our credit evaluations will prove to be inaccurate due to changed circumstances or otherwise.
Our allowance for credit losses may prove to be insufficient to absorb the expected losses in our loan portfolio. Lending money is a substantial part of our business. However, every loan we make carries a risk of nonpayment. This risk is affected by, among other things: the cash flow of the borrower and/or the project being financed; in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral; the credit history of a particular borrower; changes in economic and industry conditions; and the duration of the loan. The preparation of consolidated financial statements in conformity with GAAP requires management to make significant estimates that affect the financial statements. One of our most critical estimates is the level of the allowance for credit losses. In addition, bank regulatory agencies periodically review the allowance for credit losses and may require an increase in the provision for possible credit losses or the recognition of further loan charge-offs, based on judgments different than those of management. Any increases in the allowance for credit losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Company’s financial condition and results of operations.
Our financial instruments expose us to certain market and credit risks and may increase the volatility of earnings and AOCI. We hold certain financial instruments measured at fair value. For those financial instruments measured at fair value, we are required to recognize the changes in the fair value of such instruments in earnings or accumulated other comprehensive income (“AOCI”) each quarter. Therefore, any increases or decreases in the fair value of these financial instruments have a corresponding impact on reported earnings or AOCI. Fair value can be affected by a variety of factors, many of which are beyond our control, including our credit position, interest rate volatility, capital markets volatility, and other economic factors. Accordingly, we are subject to mark-to-market risk, and the application of fair value accounting may cause our earnings and AOCI to be more volatile than would be suggested by our underlying performance.
Material breaches in security of bank systems may have a significant effect on the Company’s business. Financial institutions are under continuous threat of loss due to cyber-attacks, especially as we continue to expand customer capabilities to utilize internet and other remote channels to transact business. A material breach of our systems may result from actions by our employees, vendors, third-party administrators, or unknown third parties or through cyber-attacks and can occur whether the applications are in our or third party data centers or cloud-based software services.
The most significant cyber–attack risks that we face are e-fraud, denial of service, and loss of sensitive customer data. Loss from e-fraud occurs when cybercriminals breach and extract funds directly from customers or our accounts. Loss can occur as a result of negative customer experience in the event of a successful denial of service attack that disrupts availability of our on-line banking services. The breach of sensitive customer data, such as account numbers and social security numbers, could present significant operational, reputational, legal and regulatory costs to us. We collect, process and store sensitive consumer data by utilizing computer systems and telecommunications networks operated by both banks and third-party service providers. We have security, backup and recovery systems in place, as well as a business continuity plan to ensure systems will not be inoperable. We also have security to prevent unauthorized access to the system. In addition, we require third-party service providers to maintain similar controls. However, we cannot be certain that these measures will be successful. A security breach in the system and loss of confidential information could result in losing customers’ confidence and thus the loss of their business as well as additional significant costs for credit monitoring activities.
We face indirect technology, cybersecurity, and operational risks relating to the customers, and other third parties with whom we do business or upon whom we rely to facilitate or enable our business activities, including, for example, financial counterparties, regulators, and providers of critical infrastructure such as internet access and electrical power. As a result of increasing consolidation, interdependence, and complexity of financial entities and technology systems, a technology failure, cyber-attack, or other information or security breach that significantly degrades, deletes, or compromises the systems or data of one or more financial entities could have a material impact on counterparties or other market participants, including us. This consolidation, interconnectivity, and complexity increases the risk of operational failure. Any third-party technology failure, cyber-attack, or other information or security breach, termination, or constraint could, among other things, adversely affect our ability to effect transactions, service our customers, manage our exposure to risk, or expand our business.
The Company may be exposed not only to a systems failure or cyber-attack that may be experienced by a vendor or market infrastructure with which the Company is directly connected, but also to a systems breakdown or cyber-attack involving another party to which such a vendor or infrastructure is connected. The Company increasingly faces the risk of operational failure or cyber-attacks with respect to the systems of those parties. Security breaches affecting the Company’s customers, employees, agents, or suppliers, or systems breakdowns or failures, security breaches or human error or misconduct affecting other external parties, may require the Company to take steps to protect the integrity of its own operational systems or to safeguard confidential information, including restricting the access of customers to their accounts. These actions can increase the Company’s operational costs and potentially diminish customer satisfaction and confidence in the Company.
Furthermore, the widespread and expanding interconnectivity among financial institutions, clearing banks, payment processors, financial technology companies, securities exchanges, clearing houses and other financial market infrastructures increases the risk that the disruption of an operational system involving one institution or entity, including due to a cyber-attack, may cause industry-wide operational disruptions that could materially affect the Company’s ability to conduct business. In addition, the risks associated with the disruption of an operational system of a third party could be exacerbated to the extent that the services provided by that system are used by a significant number or proportion of market participants.
The ineffectiveness, failure or other disruption of operational systems upon which the Company depends, including due to a systems malfunction, cyber incident or other systems failure, could result in unfavorable ripple effects in the financial markets and for the Company and its customers.
The cyber-attack could have adverse impacts on our business. As previously disclosed, we sustained a cyber-attack in April 2023 that resulted in a temporary disruption to the computer systems of The Middlefield Banking Company. A cybersecurity firm investigated the nature and scope of the incident, evaluated our systems, and confirmed that nonpublic information relating to current and former employees, customers and others was obtained from our systems. While the information varies by individual, some of the types of information that may have been obtained include name, Social Security number, driver’s license information, date of birth, financial account information, medical information, passport number, payment card information, and username and password. We are presently defending a class action lawsuit related to the misappropriated data. Whether or not such data was misused, the perception that the nonpublic information could be used in a harmful manner or that not enough was done to protect the information from cyber-attacks could cause harm to our reputation and result in the loss of business from current or future customers, which could have an adverse effect on our business, results of operations, and financial condition. While the incident is not expected to have a material impact on the Company’s business, the cyber-attack the Bank experienced in April 2023 increases the risk associated with any future cybersecurity incidents, particularly the risk of damage to the Company’s reputation.
We have implemented enhanced security measures to safeguard our systems and data, and we intend to continue implementing additional measures in the future. However, our measures may not be sufficient to maintain the confidentiality, security, or availability of the data we collect, store, and use to operate our business. Security measures implemented by our service providers or their service providers also may not be sufficient. Efforts to hack or circumvent security measures, efforts to gain unauthorized access to, exploit or disrupt the operation or integrity of our data or systems, failures of systems or software to operate as designed or intended, viruses, “ransomware” or other malware, “supply chain” attacks, “phishing” or other types of business communications compromises, operator error, or inadvertent releases of data may in the future impact our information systems and records or those of our service providers. Security measures, no matter how well designed or implemented, may only mitigate and not fully eliminate risks, and security events, when detected by security tools or third parties, may not always be immediately understood or acted upon. Any additional significant theft of, unauthorized access to, compromise or loss of, loss of access to, or fraudulent use of our systems or data could result in legal, regulatory and other consequences, including remedial and other expenses, fines, or litigation. These risks could have a material adverse effect on our business, results of operations, or financial condition as well as harm to our reputation.
The Company remains subject to risks and uncertainties due to the incident, including litigation, changes in customer behavior, and additional regulatory scrutiny. Although we maintain cybersecurity insurance coverage insuring against costs resulting from cyber-attacks (including the April 2023 attack), potential disputes with insurers about the availability of insurance coverage could occur. Further, should we experience future cyber incidents, or should industry trends drive rate increases resulting from growth in volume and significance of cyber incidents broadly, we may incur higher costs for cybersecurity insurance coverage. The risks relating to future breaches in our, or our vendors', data security infrastructure, including in connection with cyber incidents, could have a material adverse effect on our business, results of operations or financial condition or may result in operational impairments and financial losses, as well as significant harm to our reputation.
A material disruption in the operation of our business functions, facilities, and systems or third party service providers’ facilities and systems could have a significant negative impact on our operations. Our necessary dependence upon automated systems to record and process transaction volumes poses the risk that technical system flaws or employee errors, tampering or manipulation of those systems will result in losses and may be difficult to detect. We may also be subject to disruptions of the operating systems arising from events that are beyond our control (for example, computer viruses, cyber-attacks, or electrical or telecommunications outages). We are further exposed to the risk that third party service providers may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud, operational errors, or external events). A disruption in our operations occurred in April 2023 as a result of a cyber-attack. Please refer to the immediately preceding risk factor for information on this incident. These disruptions may interfere with our ability to service our customers and could result in a financial loss or liability as well as negatively impact our reputation.
The increasing complexity of the Company’s operations presents varied risks that could affect its earnings and financial condition. The Company processes a large volume of transactions on a daily basis and is exposed to numerous types of risks related to internal processes, people and systems. These risks include, but are not limited to, the risk of fraud by persons inside or outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, breaches of data security and our internal control system and compliance with a complex array of consumer and safety and soundness regulations. We could also experience additional loss as a result of potential legal actions that could arise as a result of operational deficiencies or as a result of noncompliance with applicable laws and regulations.
The Company has established and maintains a system of internal controls that provides management with information on a timely basis and allows for the monitoring of compliance with operational standards. These systems have been designed to manage operational risks at an appropriate, cost-effective level. Procedures exist that are designed to ensure that policies relating to conduct, ethics, and business practices are followed. Losses from operational risks may still occur, however, including losses from the effects of operational errors.
A lack of liquidity could impair our ability to fund operations and adversely impact our business, financial condition and results of operations. Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, sales of our investment securities, sales of loans or other sources could have a substantial negative effect on our liquidity and our ability to continue our growth strategy.
Our most important source of funds is deposits. As of December 31, 2023, approximately $690.9 million, or 48.4%, of our total deposits were negotiable order of withdrawal, or NOW, savings, and money market accounts. Historically our savings, money market deposit and NOW accounts have been stable sources of funds. However, these deposits are subject to potentially dramatic fluctuations in availability or price due to certain factors that may be outside of our control, such as a loss of confidence by customers in us or the banking sector generally, customer perceptions of our financial health and general reputation, increasing competitive pressures from other financial services firms for consumer or corporate customer deposits, changes in interest rates, and returns on other investment classes, any of which could result in significant outflows of deposits within short periods of time or significant changes in pricing necessary to maintain current customer deposits or attract additional deposits, increasing our funding costs and reducing our net interest income and net income.
Additional liquidity is provided by our ability to borrow from the FHLB of Cincinnati, and the Federal Reserve Bank of Cleveland. We also may borrow funds from third-party lenders, such as other financial institutions. Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry. Our access to funding sources could also be affected by one or more adverse regulatory actions against us.
We rely extensively on models in managing many aspects of our business, and these models may be inaccurate or misinterpreted. We rely extensively on models in managing many aspects of our business, including liquidity and capital planning, credit and other risk management, pricing, and reserving. The models may prove in practice to be less predictive than we expect. The errors or inaccuracies in our models may be material, and could lead us to make wrong or sub-optimal decisions in managing our business, and this could have a material adverse effect on our business, financial condition, or results of operations.
We are dependent on our management team and key employees, and if we are not able to attract and retain them, our business operations could be materially adversely affected. Our success depends, in large part, on our management team and key employees. During 2023, we experienced a transition in the chief financial officer position. We have a new chief executive officer since January 1, 2024. Our management team has significant industry experience. Our future success also depends on our continuing ability to attract, develop, motivate and retain key employees. Qualified individuals are in high demand, and we may incur significant costs to attract and retain them. Because the market for qualified individuals is highly competitive, we may not be able to attract and retain qualified officers or candidates. The loss of any of our management team or our key employees could materially adversely affect our ability to execute our business strategy, and we may not be able to find adequate replacements on a timely basis, or at all. We cannot ensure that we will be able to retain the services of any members of our management team or other key employees. Failure to attract and retain a qualified management team and qualified key employees could have a material adverse effect on our business, financial condition and results of operations. The Company has non-competition agreements with senior officers and key personnel.
Our operations could be interrupted if our third-party service providers experience difficulty, terminate their services, or fail to comply with banking regulations. We depend to a significant extent on a number of relationships with third-party service providers. Specifically, we receive core systems processing, essential web hosting and other internet systems, deposit processing and other processing services from third-party service providers. If these third-party service providers experience difficulties or terminate their services and we are unable to transition to other service providers in an orderly manner, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition, and results of operations could be adversely affected, perhaps materially. Even if we are able to replace them, it may be at a higher cost to us, which could adversely affect our business, financial condition, and results of operations.
We have a continuing need for technological change, and we may not have the resources to effectively implement new technology or we may experience operational challenges when implementing new technology. The financial services industry 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 enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our market area. We may experience operational challenges as we implement these new technology enhancements, or seek to implement them across all of our offices and business units, which could result in us not fully realizing the anticipated benefits from such new technology or require us to incur significant costs to remedy any such challenges in a timely manner.
We may need to raise additional capital in the future, and such capital may not be available when needed or at all. We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, particularly if our asset quality or earnings were to deteriorate significantly. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial condition. Economic conditions and the loss of confidence in financial institutions may increase our cost of funding and limit access to certain customary sources of capital, including inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve.
We cannot give assurance that such capital will be available on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of counterparties participating in the capital markets, or a downgrade of the Company’s debt ratings, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. Moreover, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our business, financial condition, and results of operations.
The value of our goodwill and core deposit intangible assets may decline in the future. As of December 31, 2023, we had $43.0 million of goodwill and core deposit intangible assets. A significant decline in our expected future cash flows, a significant adverse change in the business climate, slower growth rates, or a significant and sustained decline in the price of the Company’s common stock may necessitate taking charges in the future related to the impairment of our goodwill and core deposit intangible assets. If we were to conclude that a future write-down of goodwill and core deposit intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our business, financial condition, and results of operations.
Risks Relating to Economic and Market Conditions
Our business may be adversely affected by conditions in the financial markets and economic conditions generally. As economic conditions relating to the COVID-19 pandemic have improved, the Federal Reserve has shifted its focus to limiting inflationary and other potentially adverse effects of the extensive pandemic-related government stimulus, which signals the potential for a continued period of economic uncertainty even though the pandemic has subsided. In addition, there are continuing concerns related to, among other things, the level of U.S. government debt and fiscal actions that may be taken to address that debt, a potential resurgence of economic and political tensions with China and the Russian invasion of Ukraine, all of which may have a destabilizing effect on financial markets and economic activity. Economic pressure on consumers and overall economic uncertainty may result in changes in consumer and business spending, borrowing and savings habits. These economic conditions or other negative developments in the domestic or international credit markets or economies may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability.
As the result of the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:
● | declines in demand for loans and other banking services and products, as well as a decline in the credit quality of our loan portfolio; |
● |
decreases in office occupancy following the COVID-19 pandemic could negatively impact the future cash flows and market values of the affected properties that leads to an increased provision for credit losses and adversely affect our operating results and financial condition; |
● | collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase; |
● | the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; |
● |
a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of our quarterly cash dividend; |
● |
cyber security risks are increased as the result of an increase in the number of employees working remotely; and |
● |
Federal Deposit Insurance Corporation premiums may increase if the agency experiences additional resolution costs for bank failures. |
Any one or a combination of the factors identified above could negatively impact our business, financial condition and results of operations and prospects.
The Company operates in a highly competitive industry and market area. The Company faces significant competition both in making loans and in attracting deposits. Competition is based on interest rates and other credit and service charges, the quality of services rendered, the convenience of banking facilities, the range and type of products offered and, in the case of loans to larger commercial borrowers, lending limits, among other factors. Competition for loans comes principally from commercial banks, savings banks, savings and loan associations, credit unions, mortgage banking companies, insurance companies, and other financial service companies. The Company’s most direct competition for deposits has historically come from commercial banks, savings banks, and savings and loan associations. Technology has also lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. The wide acceptance of Internet-based commerce has resulted in a number of alternative payment processing systems and lending platforms in which banks play only minor roles. Customers can now maintain funds in prepaid debit cards or digital currencies, and pay bills and transfer funds directly without the direct assistance of banks. Our profitability depends upon our continued ability to successfully compete in our market areas. Larger competitors may be able to achieve economies of scale and, as a result, offer a broader range of products and services. The Company’s ability to compete successfully depends on a number of factors, including, among other things:
● |
the ability to develop, maintain, and build long-term customer relationships based on top quality service, high ethical standards, and safe, sound assets; |
● |
the ability to expand the Company’s market position; |
● |
the scope, relevance, and pricing of products and services offered to meet customer needs and demands; |
● |
the rate at which the Company introduces new products and services relative to its competitors; |
● |
customer satisfaction with the Company’s level of service; and |
● |
industry and general economic trends |
Failure to perform in any of these areas could significantly weaken the Company’s competitive position, which could adversely affect growth and profitability.
Changing interest rates have a direct and immediate impact on financial institutions. The interest rate risk that exists for most or all financial institutions arises out of interest rates that increase more than anticipated or that increase more quickly than expected. If interest rates change more abruptly than we have simulated or if the increase is greater than we have simulated, this could have an adverse effect on our net interest income and equity value. The risk of nonpayment of loans — or credit risk — is not the only lending risk. Lenders are subject also to interest rate risk. Fluctuating rates of interest prevailing in the market affect a bank’s net interest income, which is the difference between interest earned from loans and investments, on one hand, and interest paid on deposits and borrowings, on the other. Changes in the general level of interest rates can affect our net interest income by affecting the difference between the weighted-average yield earned on our interest-earning assets and the weighted-average rate paid on our interest-bearing liabilities, or interest rate spread, and the average life of our interest-earning assets and interest-bearing liabilities. Changes in interest rates also can affect (i) our ability to originate loans, (ii) the value of our interest-earning assets, and our ability to realize gains from the sale of such assets, (iii) our ability to obtain and retain deposits in competition with other available investment alternatives, and (iv) the ability of our borrowers to repay adjustable or variable rate loans. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions, and other factors beyond our control. Although the Company believes that the estimated maturities of our interest-earning assets currently are well balanced in relation to the estimated maturities of our interest-bearing liabilities (which involves various estimates as to how changes in the general level of interest rates will impact these assets and liabilities), there can be no assurance that our profitability would not be adversely affected during any period of changes in interest rates.
A prolonged economic downturn in our market area would adversely affect our loan portfolio and our growth prospects. Our lending market area is concentrated in northeastern, central, and western Ohio, particularly Ashtabula, Cuyahoga, Delaware, Franklin, Geauga, Hardin, Logan, Madison, Portage, Summit, Trumbull, and Union Counties. A significant percentage of our loan portfolio is secured by real estate collateral, primarily residential mortgage loans. Commercial and industrial loans to small and medium-sized businesses also represent a significant percentage of our loan portfolio. The asset quality of our loan portfolio is largely dependent upon the area’s economy and real estate markets. A prolonged economic downturn would likely lead to deterioration of the credit quality of our loan portfolio and reduce our level of customer deposits, which in turn would hurt our business. Borrowers may be less likely to repay their loans as scheduled or at all. Moreover, the value of real estate or other collateral that may secure our loans could be adversely affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies and geographic locations. A prolonged economic downturn could, therefore, result in losses that could materially and adversely affect our business.
Inflation could negatively impact our business and profitability. Volatility and uncertainty related to inflation and the effects of inflation, which may lead to increased costs for businesses and consumers and potentially contribute to poor business and economic conditions generally, may also enhance or contribute to some of the risks discussed herein. For example, higher inflation, or volatility and uncertainty related to inflation, could reduce demand for the Company’s products, adversely affect the creditworthiness of the Company’s borrowers or result in lower values for the Company’s investment securities and other interest-earning assets. Although inflation in 2023 was reduced compared to 2022, inflationary pressures remain elevated. Future inflation metrics are uncertain for 2024 and onward.
Risks Associated with the Company’s Common Stock
The Company may issue additional shares of its common stock in the future, which could dilute a shareholder's ownership of common stock. The Company's articles of incorporation authorize its Board of Directors, without shareholder approval, to, among other things, issue additional shares of common stock. The issuance of any additional shares of common stock could be dilutive to a shareholder's ownership of Company common stock. To the extent that the Company issues options or warrants to purchase common stock in the future and the options or warrants are exercised, the Company's shareholders may experience further dilution. Holders of shares of Company common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares and, therefore, shareholders may not be permitted to invest in future issuances of Company common stock.
If an entity holds as little as a 5% interest in our outstanding securities, that entity could, under certain circumstances, be subject to regulation as a "bank holding company." Any entity, including a "group" composed of natural persons, owning or controlling with the power to vote 25% or more of our outstanding securities, or 5% or more if the holder otherwise exercises a "controlling influence" over us, may be subject to regulation as a "bank holding company" in accordance with the Bank Holding Company Act of 1956. In addition, any bank holding company or foreign bank with a U.S. presence may be required to obtain the approval of the Federal Reserve Board under the Bank Holding Company Act to acquire or retain 5% or more of our outstanding securities. Becoming a bank holding company imposes statutory and regulatory restrictions and obligations, such as providing managerial and financial strength for its bank subsidiaries. Regulation as a bank holding company could require the holder to divest all or a portion of the holder's investment in our securities or those nonbanking investments that may be deemed impermissible or incompatible with bank holding company status, such as a material investment in a company unrelated to banking.
Anti-takeover provisions could delay or prevent an acquisition or change in control by a third party. Provisions of the Ohio General Corporation Law, our Amended and Restated Articles of Incorporation, and our Code of Regulations, including a staggered board and supermajority voting requirements, could make it more difficult for a third party to acquire control of us or could have the effect of discouraging a third party from attempting to acquire control of us.
Risks Related to the Legal and Regulatory Environment
The banking industry is heavily regulated; the compliance burden to the industry is considerable; the principal beneficiary of federal and state regulation is the public at large and depositors, not stockholders. The Company and its subsidiaries are and will remain subject to extensive state and federal government supervision and regulation. Supervision and regulation affect many aspects of the banking business, including permissible activities, lending, investments, payment of dividends, the geographic locations in which our services can be offered, and numerous other matters. State and federal supervision and regulation are intended principally to protect depositors, the public, and the deposit insurance fund administered by the FDIC. Protection of stockholders is not a goal of banking regulation.
The burdens of federal and state banking regulation place banks in general at a competitive disadvantage compared to less regulated competitors. Applicable statutes, regulations, agency and court interpretations, and agency enforcement policies have undergone significant changes, and could change significantly again. Compliance with regulations can be difficult and costly, and changes to regulations often impose additional compliance costs. Federal and state banking agencies also require banks and bank holding companies to maintain adequate capital. Failure to maintain adequate capital or to comply with applicable laws, regulations, and supervisory agreements could subject a bank or bank holding company to federal or state enforcement actions, including termination of deposit insurance, imposition of fines and civil penalties, and, in the most severe cases, appointment of a conservator or receiver for a depositary institution. Changes in applicable laws and regulatory policies could adversely affect the banking industry generally or the Company in particular. The Company gives you no assurance that we will be able to adapt successfully to industry changes caused by governmental actions.
Recent negative developments affecting the banking industry, and resulting media coverage, have eroded customer confidence in the banking system. The closures of Silicon Valley Bank and Signature Bank in March 2023 and First Republic Bank in May 2023, and concerns about similar future events, have generated significant market volatility among publicly traded bank holding companies. These market developments have negatively impacted customer confidence in the safety and soundness of banks. While the Department of the Treasury, the Federal Reserve, and the FDIC took action to ensure that depositors of these failed banks had access to their deposits, including uninsured deposit accounts, there is no guarantee that bank runs similar to the ones that occurred in 2023 will not occur in the future and, if they were to occur, they may have a material and adverse impact on customer and investor confidence in banks negatively impacting the Company’s liquidity, capital, results of operations and stock price.
Regulatory examination scrutiny or new regulatory requirements arising from the recent events in the banking industry could increase the Company’s expenses and affect the Company’s operations. The Company anticipates increased regulatory scrutiny – in the course of routine examinations and otherwise designed to address the recent negative developments in the banking industry, all of which may increase the Company’s costs of doing business and reduce its profitability. Among other things, there may be an increased focus by both regulators and investors on the on-balance sheet liquidity of and funding sources for financial institutions, the composition of their deposits and the level of uninsured deposits, the amount of accumulated other comprehensive loss, capital levels, and interest rate risk management.
Environmental liability associated with commercial lending could have a material adverse effect on our business, financial condition or results of operations. A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. In addition, we own and operate certain properties that may be subject to similar environmental liability risks.
Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures requiring the performance of an environmental site assessment before initiating any foreclosure action on real property, these assessments may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our business, financial condition, or results of operations.
The Current Expected Credit Loss accounting standard could add volatility to our allowance for credit losses and may have a material adverse effect on our financial condition and results of operations. Effective January 1, 2023, we adopted the Financial Accounting Standard Board (the ”FASB”) Account Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 325); Measurement of Credit Losses on Financial Instruments, commonly referred to as “CECL”. CECL changed the allowance for credit losses methodology from an incurred loss impairment methodology to an expected loss methodology, which is more dependent on future economic forecasts, assumptions and models than previous accounting standards and could result in increases in, and add volatility to, our allowance for credit losses and future provisions for credit losses. These forecasts, assumptions and models are inherently uncertain and are based upon management’s reasonable judgment in light of information currently available.
Regulatory requirements affecting our loans secured by commercial real estate could limit our ability to leverage our capital and adversely affect our growth and profitability. Rising commercial real estate lending concentrations may expose institutions like the Bank to unanticipated earnings and capital volatility in the event of adverse changes in the commercial real estate market. In addition, institutions that are exposed to significant commercial real estate concentration risk may be subject to increased regulatory scrutiny. The federal banking agencies have issued guidance for institutions that are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions that have (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution’s total risk-based capital; or (ii) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the outstanding balance of the institution's commercial real estate loan portfolio has increased 50% or more during the prior 36 months are encouraged to identify and monitor credit concentrations and enhance risk management systems. At December 31, 2023, non-owner occupied commercial real estate loans (including construction, land, and land development loans) represent 294.5% of total risk-based capital. Construction, land, and land development loans represent 63.4% of total risk-based capital as of December 31, 2023. Management has extensive experience in commercial real estate lending. Management has implemented and continues to maintain heightened risk management procedures and strong underwriting criteria with respect to its commercial real estate portfolio. Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes to cash flows, interest rate increases, and declines in net operating income. Nevertheless, we may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company has an extensive capital planning policy, which includes pro forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well-capitalized ratios.
We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations. The Bank Secrecy Act of 1970, the Uniting and Strengthening America by Providing Appropriate Tools to Intercept and Obstruct Terrorism Act of 2001, or the USA Patriot Act or Patriot Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and to file reports such as suspicious activity reports and currency transaction reports. We are required to comply with these and other anti-money laundering requirements. Our federal and state banking regulators, the Financial Crimes Enforcement Network, or FinCEN, and other government agencies are authorized to impose significant civil money penalties for violations of anti-money laundering requirements. We are also subject to increased scrutiny of compliance with the regulations issued and enforced by the Office of Foreign Assets Control, or OFAC. If our program is deemed deficient, we could be subject to liability, including fines, civil money penalties and other regulatory actions, which may include restrictions on our business operations and our ability to pay dividends, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have significant reputational consequences for us. Any of these circumstances could have a material adverse effect on our business, financial condition or results of operations.
Government regulation could restrict our ability to pay cash dividends. Dividends from the Bank are the only significant source of cash for the Company. Statutory and regulatory limits could prevent the Bank from paying dividends or transferring funds to the Company. The Company cannot assure you that subsidiary Bank profitability will continue to allow dividends to the Company, and the Company therefore cannot assure you that the Company will be able to continue paying regular, quarterly cash dividends.
General Risk Factors
Climate change, natural disasters, acts of war or terrorism, the impact of pandemics or epidemics, 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.
Aggressive actions by hostile governments or groups, including armed conflict or intensified cyber-attacks, could expand in unpredictable ways by drawing in other countries or escalating into full-scale war with potentially catastrophic consequences, particularly if one or more of the combatants possess nuclear weapons. Depending on the scope of the conflict, the hostilities could result in:
● |
worldwide economic disruption |
|
● |
heightened volatility in financial markets |
|
● |
severe declines in asset values, accompanied by widespread selloffs of investments |
|
● |
diminished consumer, business and investor confidence |
|
● |
events arising from local or larger-scale civil or political unrest, any outbreak or escalation of hostilities, or terrorist acts. |
The Company could also experience more numerous and aggressive cyber-attacks launched by or under the sponsorship of one or more of the adversaries in such a conflict.
Litigation could adversely affect our results of operations, profitability and cash flows. From time to time, we have been and may be involved in various legal proceedings and claims arising in our ordinary course of business. Other than a lawsuit filed on January 8, 2024 relating to the disclosure of customers’ personally identifiable information as a result of the April 2023 cyber-attack, we are not a party to any material legal proceeding. Litigation may result in a diversion of management’s attention and resources, significant costs, including monetary damages and legal fees, and injunctive relief, and may contribute to current and future stock price volatility. No assurance can be made that future litigation will not result in material financial exposure or reputational harm, which could have a material adverse effect upon our results of operations, profitability or cash flows.
Item 1B — Unresolved Staff Comments
Not applicable.
Risk Management and Strategy
We have developed a comprehensive Information Security Program (“ISP”) that was designed as the guiding policy to establish standards designed to protect the confidentiality of nonpublic, sensitive personal and business information, protect against potential threats to the security or integrity of such information, and protect against unauthorized access to or use of such information. The ISP applies to all Company employees, contractors, consultants, and third-party vendors as well as all technology owned and operated by the Bank. The scope of the ISP covers customer data as well as the Company’s strategic and proprietary information. The Board of Directors approves the ISP annually. Additionally, the Information Technology Steering Committee (“ITSC”) must approve significant modifications to the ISP prior to review and approval by the Board of Directors. The Chief Information Officer (“CIO”) is responsible for the implementation and maintenance of the ISP.
Key elements of our ISP include:
● |
Identification of sources and types of technology threats |
● |
Tools and processes to manage technology security, such as change control approval, employing a Unified Threat Management System, and usage of anti-virus and anti-spam hardware |
● |
Ongoing security assessments conducted by third-party vendors, such as vulnerability assessments and penetration testing, and mitigation of any findings |
● |
Continuous firewall monitoring provided by a third-party vendor |
● |
Information security training for employees provided by a third-party vendor |
● |
Annual security audits of third-party vendors |
Our Information Security Governance Plan (“InfoSec”) is a component of the ISP and provides for strategic oversight of critical aspects of the Bank’s information security. The objective of InfoSec is to provide a framework for decision-making and accountability for information security issues to ensure that the ISP is actively monitored and information security permeates through all areas and initiatives across the organization.
Security assessments are an ongoing activity within the Bank, and the Security Assessment Policy identifies security assessment requirements and those individuals accountable for ensuring the assessments comply with the requirements. All assessment activities must be approved by the Chief Risk Officer. The coverage of assessments includes, but is not limited to, physical security assessment, information technology general controls audit, vulnerability assessment, penetration testing, and social engineering testing. Results are shared with the ITSC, executive management and the Board of Directors.
There is an established Incident Response Program (“IRP”) that provides a framework for us to respond quickly, decisively, and appropriately to limit the impact of an adverse event, such as a cybersecurity incident, on customers and information resources. Procedures have been developed that outline the necessary steps should an incident occur, such as incident identification, classification, and escalation. We use a Cybersecurity Assessment Tool to assess our cybersecurity preparedness on a periodic basis. A Cybersecurity Incident Response Team, which is part of our general Incident Response Team, will take the appropriate actions as outlined in the IRP in the event a cybersecurity situation occurs.
We do not believe that risks from cybersecurity threats, including the previously disclosed cyber-attack that occurred in April 2023, have materially impacted or are reasonably likely to materially impact our overall business strategy, results of operations, or financial condition. We maintain cybersecurity insurance to cover the costs resulting from cyber-attacks; however, the policy may not cover all losses from cybersecurity incidents. Refer to the discussion on the April 2023 incident in Note 23 of our financial statements and the discussion of cybersecurity risk in Part I, Item 1A, “Risk Factors”.
Governance
Board of Directors
The Board of Directors, in coordination with the Audit Committee, oversees the Company’s management of cybersecurity risk. The Board receives monthly reports from the CIO, focusing on cybersecurity and information technology updates. The reports include key insights regarding our security risk score, areas of focus, and metrics from our third-party provider regarding security investigations and incidents as well as the results of training and phishing simulations. The Audit Committee receives periodic updates on information security risk and maturity of our ISP. The Audit Committee also receives reports with the results of security assessments conducted by third-parties.
Management
Under the leadership of the CIO, the Information Technology Steering Committee (“ITSC”) serves to improve the effectiveness of information technology at the Bank and ensure alignment with the Bank’s strategic business plan and statement of risk appetite. Composition of the ITSC will consist of senior management from the business areas. Meetings occur at least bi-annually. The ITSC is tasked with reviewing the Bank’s technology, information security, business continuity, digital initiatives, vendor management, and data management strategic direction and providing feedback to management.
The Information Security Governance Council (“ISGC”) acts on the behalf of and to assist the Board of Directors and executive management in fulfilling its oversight responsibilities regarding the Bank’s information security programs and risks. The ISGC is comprised of members from Risk, Information Technology, and other strategic areas within the Bank, including the CIO, and meets at least quarterly. The responsibilities of the ISGC include providing strategic oversight and implementation guidance for the ISP, aligning cybersecurity and business objectives, monitoring and reporting on cybersecurity and information security incidents, and promoting a strong culture around information security.
As stated above, the CIO is a member of the ISGC, chairs the ISTC, and reports to the Chief Strategy and Innovation Officer. The CIO has over 40 years of business experience in information technology and cybersecurity. We outsource the position of Chief Information Security Officer “(CISO”) to a third-party vendor that specializes in partnering with organizations to enhance cybersecurity management.
The Bank’s principal executive offices are located at 15985 East High Street, Middlefield, Ohio 44062.
As of the date of this Annual Report on Form 10-K, MBC has 21 banking centers, 1 loan production office, and one administrative office as listed below:
● |
branch offices in Middlefield (two offices), Chardon, and Newbury in Geauga County; |
● |
an administrative office in Middlefield in Geauga County; |
● |
branch offices in Garrettsville and Mantua in Portage County; |
● |
a branch office in Orwell in Ashtabula County; |
● |
a branch office in Cortland in Trumbull County; |
● |
branch offices in Dublin and Westerville in Franklin County; |
● |
a loan production office in Mentor in Lake County; |
● |
branch offices in Sunbury and Powell in Delaware County; |
● |
branch offices in Beachwood and Solon in Cuyahoga County; |
● |
a branch office in Twinsburg in Summit County; |
● |
a branch office in Plain City in Madison County; |
● |
branch offices in Ada and Kenton in Hardin County; |
● |
branch offices in Bellefontaine (two offices) in Logan County; |
● |
a branch office in Marysville in Union County. |
On December 31, 2023, the net book value of the Bank’s investment in premises and equipment totaled $21.3 million.
See the information in Note 23, which we incorporate here by reference.
From time to time, the Company and the subsidiary bank are involved in various other legal proceedings that are incidental to its business. In the opinion of management, no other current legal proceedings are material to the Company's financial condition or the subsidiary bank, either individually or in the aggregate.
Item 4 — Mine Safety Disclosures
Not applicable.
Part II
Item 5 — Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Details of repurchases of Company common stock during the fourth quarter of 2023 are included in the following table:
2023 period |
||||||||||||||||
In thousands, except per share data |
Total shares purchased |
Average price paid per share |
Total shares purchased as part of a publicly announced program (a) |
Maximum number of shares that may yet be purchased under the program |
||||||||||||
October 1-31 |
- | $ | - | - | 293,910 | |||||||||||
November 1-30 |
- | - | - | 293,910 | ||||||||||||
December 1-31 |
- | - | - | 293,910 | ||||||||||||
Total |
- | $ | - |
Our common stock is traded on the NASDAQ Capital Market under the symbol “MBCN.” At the close of business on December 31, 2023, there were approximately 1,173 shareholders of record. Our cash dividend payout policy is reviewed regularly by management and the Board of Directors. Our Board of Directors has consistently declared cash dividends on our common stock. Any dividends declared and paid in the future would depend upon several factors, including capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. No assurance can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in future periods. Our future payment of dividends may depend, in part, upon receipts of dividends from the Bank, which are restricted by banking regulations.
Information relating to the market for Middlefield’s common equity and related shareholder matters appears under “Return on Equity and Assets” and “Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters” in the Company’s 2023 Annual Report to Shareholders and is incorporated herein by reference.
Not applicable.
Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations
The above-captioned information appears under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2023 Annual Report to Shareholders and is incorporated herein by reference.
Item 7A — Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 8 — Financial Statements and Supplementary Data
The Consolidated Financial Statements of the Company and its subsidiaries, together with the report thereon by S.R. Snodgrass, P.C. (PCAOB: 000
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of Middlefield Banc Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Middlefield Banc Corp. and subsidiaries (the “Company”) as of December 31, 2023 and 2022; the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for the years then ended; and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with auditing standards generally accepted in the United States of America, the Company’s internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 28, 2024, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. .
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company changed its method of accounting for credit losses effective January 1, 2023, due to the adoption of Accounting Standards Codification (ASC) Topic 326, Financial Instruments – Credit Losses.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent, with respect to the Company, in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Basis of Opinion (Continued)
We conducted our audits in accordance with the standards of the PCAOB and in accordance with the auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Allowance for Credit Losses on Loans (ACL)
Description of the Matter
The Company’s loan portfolio totaled $1.5 billion as of December 31, 2023, and the associated allowance for credit losses on loans was $21.7 million. As discussed in Notes 1 and 6 to the consolidated financial statements, the allowance for credit losses (ACL) related to loans is a contra-asset valuation account, calculated in accordance with ASC 326, that is deducted from the amortized cost basis of loans to present the net amount expected to be collected. The amount of the ACL represents management’s best estimate of current expected credit losses on these financial instruments considering all relevant available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instruments.
The Company’s methodology for estimating the allowance for credit losses on loans includes quantitative and qualitative components of the calculation. For pooled loans, the Company utilizes a discounted cash flow (“DCF”) methodology to estimate credit losses over the expected life of loan. The DCF methodology combines probability of default, the loss given default, and prepayment speed assumptions to estimate a reserve for each loan. The quantitative loss rates are adjusted by current and forecasted macroeconomic assumptions and return to the mean after the forecasted periods. The sum of all the loan level reserves are aggregated for each portfolio segment and a loss factor is derived. These quantitative loss factors are also supplemented by certain qualitative risk factors reflecting management’s view of how losses may vary from those represented by quantitative loss rates. Qualitative loss factors are applied to each portfolio segment with the amounts determined by correlation of credit stress to the maximum loss factor. Changes in these assumptions could have a material effect on the Company’s financial results.
We identified auditing ACL on pooled loans as a critical audit matter because the methodology to determine the estimate of credit losses significantly changed upon adoption of ASC 326, including the application of new accounting policies, the use of subjective judgments for both the quantitative and qualitative calculations and overall changes made to the loss estimation models. Performing audit procedures to evaluate the implementation and subsequent application of ASC 326 for loans involved a high degree of auditor judgment and required significant effort.
Allowance for Credit Losses on Loans (ACL) (Continued)
How We Addressed the Matter in Our Audit
The primary procedures we performed related to this critical audit matter (CAM) included:
● Testing the design, implementation, and operating effectiveness of internal controls over the adoption and calculation of the allowance for credit losses, including the qualitative factor adjustments.
● Evaluated the reasonableness of selected loss drivers utilized and loss driver forecasts for loan pools
● Testing the completeness and accuracy of the significant data points that management uses in their evaluation of the qualitative adjustments.
● Testing the anchoring calculation that management completes to properly align the magnitude of the adjustments with the Company’s historical loss data.
● Evaluating the directional consistency and reasonableness of management’s conclusions regarding basis points applied (whether positive or negative) based on the trends identified in the underlying data.
● Testing the mathematical accuracy of the application of the qualitative adjustments to the loan segments within the ACL calculation.
Measurement Period Adjustment – Loan Valuation
Description of the Matter
During 2022, the Company completed the acquisition of Liberty Bancshares, Inc, as disclosed in Note 21 to the consolidated financial statements. The transaction was accounted for by applying the acquisition method. Subsequent to December 31, 2022, the Company utilized the measurement period to post an adjustment of $4.6 million to goodwill for updated information regarding the fair value of loans acquired.
Auditing the Company’s accounting for the acquisition of Liberty Bancshares, Inc. was complex due to the significant estimation required by management to determine the fair value of the loans acquired of $307 million. The Company determined the fair value of the acquired loans by estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. The significant estimation was primarily due to the judgment involved in determining the discount rate used to discount the expected cash flows for acquired loans to establish the acquisition-date fair value of the loans.
How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over the Company’s accounting for the measurement period adjustment. Our tests included testing controls over the completeness and accuracy of the data and the estimation process supporting the fair value of loans acquired. We also tested management’s discount rate used in the valuation model.
To test the estimated fair value of the loans acquired, we performed audit procedures that included, among others, evaluating the Company’s valuation methodology, evaluating the discount rate used by the Company’s valuation specialist, and evaluating the completeness and accuracy of the underlying data.
We have served as the Company’s auditor since 1986.
/s/
March 28, 2024
MIDDLEFIELD BANC CORP.
CONSOLIDATED BALANCE SHEET
(Dollar amounts in thousands)
December 31, | December 31, | |||||||
2023 | 2022 | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | $ | ||||||
Federal funds sold | ||||||||
Cash and cash equivalents | ||||||||
Investment securities available for sale, at fair value | ||||||||
Other investments | ||||||||
Loans: | ||||||||
Commercial real estate: | ||||||||
Owner occupied | ||||||||
Non-owner occupied | ||||||||
Multifamily | ||||||||
Residential real estate | ||||||||
Commercial and industrial | ||||||||
Home equity lines of credit | ||||||||
Construction and other | ||||||||
Consumer installment | ||||||||
Total loans | ||||||||
Less: allowance for credit losses | ||||||||
Net loans | ||||||||
Premises and equipment, net | ||||||||
Goodwill | ||||||||
Core deposit intangibles | ||||||||
Bank-owned life insurance | ||||||||
Other real estate owned | ||||||||
Accrued interest receivable and other assets | ||||||||
TOTAL ASSETS | $ | $ | ||||||
LIABILITIES | ||||||||
Deposits: | ||||||||
Noninterest-bearing demand | $ | $ | ||||||
Interest-bearing demand | ||||||||
Money market | ||||||||
Savings | ||||||||
Time | ||||||||
Total deposits | ||||||||
Federal Home Loan Bank advances | ||||||||
Other borrowings | ||||||||
Accrued interest payable and other liabilities | ||||||||
TOTAL LIABILITIES | ||||||||
STOCKHOLDERS' EQUITY | ||||||||
Common stock, par value; shares authorized, and shares issued; and shares outstanding | ||||||||
Retained earnings | ||||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ||||
Treasury stock, at cost; and shares | ( | ) | ( | ) | ||||
TOTAL STOCKHOLDERS' EQUITY | ||||||||
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | $ |
See accompanying notes to the consolidated financial statements.
MIDDLEFIELD BANC CORP.
CONSOLIDATED INCOME STATEMENT
(Dollar amounts in thousands, except per share data)
Year Ended |
||||||||
December 31, |
||||||||
2023 |
2022 |
|||||||
INTEREST AND DIVIDEND INCOME |
||||||||
Interest and fees on loans |
$ | $ | ||||||
Interest-earning deposits in other institutions |
||||||||
Federal funds sold |
||||||||
Investment securities: |
||||||||
Taxable interest |
||||||||
Tax-exempt interest |
||||||||
Dividends on stock |
||||||||
Total interest and dividend income |
||||||||
INTEREST EXPENSE |
||||||||
Deposits |
||||||||
Short-term borrowings |
||||||||
Other borrowings |
||||||||
Total interest expense |
||||||||
NET INTEREST INCOME |
||||||||
Provision for credit losses |
||||||||
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES |
||||||||
NONINTEREST INCOME |
||||||||
Service charges on deposit accounts |
||||||||
Loss on equity securities |
( |
) | ( |
) | ||||
Loss on other real estate owned |
( |
) | ||||||
Earnings on bank-owned life insurance |
||||||||
Gain on sale of loans |
||||||||
Revenue from investment services |
||||||||
Gross rental income |
||||||||
Other income |
||||||||
Total noninterest income |
||||||||
NONINTEREST EXPENSE |
||||||||
Salaries and employee benefits |
||||||||
Occupancy expense |
||||||||
Equipment expense |
||||||||
Data processing and information technology costs |
||||||||
Ohio state franchise tax |
||||||||
Federal deposit insurance expense |
||||||||
Professional fees |
||||||||
Other real estate owned writedowns |
||||||||
Advertising expense |
||||||||
Software amortization expense |
||||||||
Core deposit intangible amortization |
||||||||
Gross other real estate owned expenses |
||||||||
Merger-related costs |
||||||||
Other expense |
||||||||
Total noninterest expense |
||||||||
Income before income taxes |
||||||||
Income taxes |
||||||||
NET INCOME |
$ | $ | ||||||
EARNINGS PER SHARE |
||||||||
Basic |
$ | $ | ||||||
Diluted |
$ | $ |
See accompanying notes to the consolidated financial statements.
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(Dollar amounts in thousands)
Year Ended | ||||||||
December 31, | ||||||||
2023 | 2022 | |||||||
Net income | $ | $ | ||||||
Other comprehensive income (loss): | ||||||||
Unrealized holding gain (loss) on securities available for sale | ( | ) | ||||||
Tax effect | ( | ) | ||||||
Total other comprehensive income (loss): | ( | ) | ||||||
Comprehensive income (loss): | $ | $ | ( | ) |
See accompanying notes to the consolidated financial statements.
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollar amounts in thousands)
Accumulated | ||||||||||||||||||||||||
Other | Total | |||||||||||||||||||||||
Common Stock | Retained | Comprehensive | Treasury | Stockholders' | ||||||||||||||||||||
Shares | Amount | Earnings | (Loss) Income | Stock | Equity | |||||||||||||||||||
Balance, December 31, 2021 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
Net income | ||||||||||||||||||||||||
Other comprehensive loss | ( | ) | ( | ) | ||||||||||||||||||||
Common stock issued in business combination |