10-K 1 f10k2020_sbfinancialgroup.htm ANNUAL REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

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

 

For the fiscal year ended December 31, 2020

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ___________ to ____________

 

Commission File Number 001-36785

 

SB FINANCIAL GROUP, INC.

(Exact name of Registrant as specified in its charter)

 

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

 

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

 

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

 

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

 

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

 

Not Applicable

 

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

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. Non-Accelerated Filer ☒ Smaller Reporting 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. Yes ☒ No ☐

 

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

 

The aggregate market value of the common shares of the registrant held by non-affiliates computed by reference to the price at which the common shares were last sold as of the last business day of the registrant’s most recently completed second fiscal quarter was $127.5 million.

 

The number of common shares of the registrant outstanding at February 26, 2021 was 7,389,626.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Shareholders to be held on April 26, 2021 are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 

 

 

SB FINANCIAL GROUP, INC.

 

2020 ANNUAL REPORT ON FORM 10-K

 

TABLE OF CONTENTS

 

PART I    
     
Item 1. Business 1
Item 1A. Risk Factors 17
Item 1B. Unresolved Staff Comments 31
Item 2. Properties 31
Item 3. Legal Proceedings 33
Item 4. Mine Safety Disclosures 33
Supplemental Item: Information about our Executive Officers 33
     
PART II    
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 34
Item 6. Selected Financial Data 35
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 36
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 45
Item 8. Financial Statements and Supplementary Data 47
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 48
Item 9A. Controls and Procedures 48
Item 9B. Other Information 48
     
PART III    
     
Item 10. Directors, Executive Officers and Corporate Governance 49
Item 11. Executive Compensation 50
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 50
Item 13. Certain Relationships and Related Transactions, and Director Independence 50
Item 14. Principal Accountant Fees and Services 50
     
PART IV    
     
Item 15. Exhibits and Financial Statement Schedules 51
Item 16. Form 10-K Summary 51
     
Signatures and Certifications 56

 

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PART I

 

Item 1. Business.

 

Certain statements contained in this Annual Report on Form 10-K which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. See “Cautionary Statement Regarding Forward-Looking Information” under Item 1A. Risk Factors on page 17 of this Annual Report on Form 10-K.

 

General

 

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

 

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

 

State Bank and Trust Company

 

The State Bank and Trust Company (“State Bank”) is an Ohio state-chartered bank and wholly owned subsidiary of the Company. State Bank offers a full range of commercial banking services, including checking accounts, savings accounts, money market accounts and time certificates of deposit; automatic teller machines; commercial, consumer, agricultural and residential mortgage loans; personal and corporate trust services; commercial leasing; bank credit card services; safe deposit box rentals; internet banking; private client group services; and other personalized banking services. The trust and financial services division of State Bank offers various trust and financial services, including asset management services for individuals and corporate employee benefit plans, as well as brokerage services through Cetera Investment Services, an unaffiliated company. State Bank presently operates 21 banking centers, located within the Ohio counties of Allen, Defiance, Franklin, Fulton, Hancock, Lucas, Paulding, Wood and Williams, and one banking center located in Allen County, Indiana. State Bank also presently operates five loan production offices, located in Franklin, Lucas and Seneca Counties, Ohio, Hamilton County, Indiana and Monroe County, Michigan. At December 31, 2020, State Bank had 238 full-time equivalent employees.

 

SBFG Title, LLC

 

SBFG Title, LLC dba Peak Title Agency (“SBFG Title”) was formed as an Ohio limited liability company in March 2019 and purchased all of the assets and real estate of an Ohio-based title agency effective March 15, 2019. At December 31, 2020, SBFG Title, LLC had six full-time equivalent employees.

 

RFCBC

 

RFCBC, Inc. (“RFCBC”) is an Ohio corporation and wholly owned subsidiary of the Company that was incorporated in August 2004. RFCBC operates as a loan subsidiary in servicing and working out problem loans and is presently inactive. At December 31, 2020, RFCBC had no employees.

 

Rurbanc Data Services

 

Rurbanc Data Services, Inc. dba RDSI Banking Systems (“RDSI”) was formed in 1964 and became an Ohio corporation in June 1976. In September 2006, RDSI acquired Diverse Computer Marketers, Inc. (“DCM”), which was merged into RDSI effective December 31, 2007. Effective January 1, 2018, the Company completed the sale of the customer contracts and certain other assets of RDSI’s remaining check and statement processing business operated through the DCM division. As a result of the sale, RDSI is presently inactive and had no material operations or employees at December 31, 2020.

 

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Rurban Mortgage Company

 

Rurban Mortgage Company (“RMC”) is an Ohio corporation and wholly owned subsidiary of State Bank. RMC is a mortgage company and is presently inactive. At December 31, 2020, RMC had no employees.

 

SBT Insurance

 

SBT Insurance, LLC (“SBI”) is an Ohio corporation and wholly owned subsidiary of State Bank. SBI is an insurance company that engages in the sale of insurance products to retail and commercial customers of State Bank. At December 31, 2020, SBI had no employees.

 

SB Captive

 

SB Captive, Inc. (“SB Captive”) is a Nevada corporation and wholly owned subsidiary of SB Financial Group, Inc. SB Captive is a self-insurance company that provides coverage to State Bank and SB Financial Group. The purpose of the Captive is to mitigate insurance risk by participating in a pool with other banks. At December 31, 2020, SB Captive, Inc. had no employees.

 

Rurban Statutory Trust II

 

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

 

Competition

 

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

 

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

 

Supervision and Regulation

 

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

 

Regulation of Bank Holding Companies and Their Subsidiaries in General

 

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

 

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

 

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

 

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

 

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

 

The Federal Home Loan Bank (“FHLB”) provide credit to their members in the form of advances. As a member of the FHLB of Cincinnati, State Bank must maintain certain minimum investments in the capital stock of the FHLB of Cincinnati. State Bank was in compliance with these requirements at December 31, 2020.

 

Economic Growth, Regulatory Relief and Consumer Protection Act

 

On May 25, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Regulatory Relief Act”) was enacted, which repealed or modified certain provisions of the Dodd-Frank Act and eased restrictions on all but the largest banks (those with consolidated assets in excess of $250 billion). Bank holding companies with consolidated assets of less than $100 billion, including the Company, are no longer subject to enhanced prudential standards. The Regulatory Relief Act also relieves bank holding companies and banks with consolidated assets of less than $100 billion, including the Company, from certain record-keeping, reporting and disclosure requirements. Certain other regulatory requirements applied only to banks with consolidated assets in excess of $50 billion and so did not apply to the Company even before the enactment of the Regulatory Relief Act.

 

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Restrictions on Dividends

 

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

 

The ability of the Company to obtain funds for the payment of dividends and for other cash requirements is largely dependent on the amount of dividends that may be declared by State Bank and the Company’s other subsidiaries. State Bank may not pay dividends to the Company if, after paying such dividends, it would fail to meet the required minimum levels under the risk-based capital guidelines and the minimum leverage ratio requirements. In addition, State Bank must obtain the approval of the FRB and the Ohio Division of Financial Institutions (“ODFI”) if a dividend in any year would cause the total dividends for that year to exceed the sum of the current year’s net profits and the retained net profits for the preceding two years, less required transfers to surplus. At December 31, 2020, State Bank had $26.9 million of excess earnings over the preceding three years.

 

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

 

Affiliate Transactions

 

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

 

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

 

Federally insured banks are subject, with certain exceptions, to certain additional restrictions (including collateralization) on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, such banks are prohibited from engaging in certain tying arrangements in connection with any extension of credit or the providing of any property or service.

 

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The Coronavirus Aid, Relief, and Economic Security Act of 2020

 

In response to the novel COVID-19 pandemic (“COVID-19”), the Coronavirus Aid, Relief, and Economic Security Act of 2020, as amended (the “CARES Act”), was signed into law on March 27, 2020, to provide national emergency economic relief measures. Many of the CARES Act’s programs are dependent upon the direct involvement of U.S. financial institutions, such as the Company and State Bank, and have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of Treasury, the FRB and other federal banking agencies, including those with direct supervisory jurisdiction over the Company and State Bank. Furthermore, as COVID-19 evolves, federal regulatory authorities continue to issue additional guidance with respect to the implementation, lifecycle, and eligibility requirements for the various CARES Act programs as well as industry-specific recovery procedures for COVID-19. In addition, it is possible that Congress will enact supplementary COVID-19 response legislation, including amendments to the CARES Act or new bills comparable in scope to the CARES Act. For example, on December 27, 2020, the Consolidated Appropriations Act, 2021 (the “CAA”) was signed into law, which, among other things, allowed certain banks to temporarily postpone implementation of the current expected credit loss model (accounting standard), which is described below. The Company is continuing to assess the impact of the CARES Act and other statues, regulations and supervisory guidance related to COVID-19.

 

The CARES Act amended the loan program of the Small Business Administration (the “SBA”), in which State Bank participates, to create a guaranteed, unsecured loan program, the Paycheck Protection Program (the “PPP”), to fund operational costs of eligible businesses, organizations and self-employed persons during COVID-19. In June 2020, the Paycheck Protection Program Flexibility Act was enacted, which, among other things, gave borrowers additional time and flexibility to use PPP loan proceeds.

 

Shortly thereafter, and due to the evolving impact of COVID-19, additional legislation was enacted authorizing the SBA to resume accepting PPP applications on July 6, 2020, and extending the PPP application deadline to August 8, 2020. As a participating lender in the PPP, State Bank continues to monitor legislative, regulatory, and supervisory developments related thereto. On September 29, 2020, the federal bank regulatory agencies issued a final rule that neutralizes the regulatory capital and liquidity coverage ratio effects of participating in certain COVID-19 liquidity facilities due to the fact there is no credit or market risk in association with exposures pledged to such facilities. As a result, the final rule supports the flow of credit to households and businesses affected by COVID-19.

 

The CARES Act encouraged the FRB, in coordination with the Secretary of the Treasury, to establish or implement various programs to help mitigate the adverse effects of COVID-19 on midsize businesses, nonprofits, and municipalities. In April 2020, the Federal Reserve established the Main Street Lending Program (“MSLP”) to implement certain of these recommendations. The MSLP supported lending to small and medium-sized businesses that were in sound financial condition before the onset of COVID-19. On November 19, 2020, Treasury Secretary Steven Mnuchin indicated that he would not reauthorize extending the MSLP past December 31, 2020. However, the FRB extended the program to January 8, 2021, in order to process loans that were submitted on or before December 14, 2020. The program ended on January 8, 2021.

 

Regulatory Capital

 

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

 

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

 

Common equity for the common equity tier 1 capital ratio generally includes common stock (plus related surplus), retained earnings, accumulated other comprehensive income (unless an institution elects to exclude such income from regulatory capital), and limited amounts of minority interests in the form of common stock, subject to applicable regulatory adjustments and deductions.

 

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

 

Tier 2 capital, which can be included in the total capital ratio, generally consists of other preferred stock and subordinated debt meeting certain conditions plus limited amounts of the allowance for loan and lease losses, subject to specified eligibility criteria, less applicable deductions.

 

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

 

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

 

The Basel III Capital Rules also place restrictions on the payment of capital distributions, including dividends, and certain discretionary bonus payments to executive officers if the banking organization does not hold a capital conservation buffer of greater than 2.5 percent composed of common equity tier 1 capital above its minimum risk-based capital requirements, or if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5 percent at the beginning of the quarter.

 

In September 2019, the FRB, along with other federal bank regulatory agencies, issued a final rule, effective January 1, 2020, that gave community banks, including the Company, the option to calculate a simple leverage ratio to measure capital adequacy if the community banks met certain requirements. Under the rule, a community bank was eligible to elect the Community Bank Leverage Ratio (“CBLR”) framework if it had less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a leverage ratio greater than 9.0%. Under the rule, a community bank is eligible to elect the Community Bank Leverage Ratio (“CBLR”) framework if it had less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a leverage ratio greater than 9.0%. Qualifying institutions that elected to use the CBLR framework (each, a CBLR Bank”) and that maintain a leverage ratio of greater than 9.0% will be considered to have satisfied the risk-based and leverage capital requirements in the regulatory agencies’ generally applicable capital rules and to have met the well-capitalized ratio requirements. No CBLR Bank was required to calculate or report risk-based capital, and each CBLR Bank could opt out of the framework at any time, without restriction, by reverting to the generally applicable risk-based capital rule. Pursuant to the CARES Act, on August 26, 2020, the federal banking agencies adopted a final rule that temporarily lowered the CBLR threshold and provides a gradual transition back to the prior level. Specifically, the CBLR threshold was reduced to 8.0% for the remainder of 2020, increased to 8.5% for 2021, and will return to 9.0% beginning January 1, 2022. This final rule became effective on October 1, 2020. The Company does not intend to elect utilization of the CBLR in assessing capital adequacy and intends to continue to follow existing capital rules.

 

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

 

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At December 31, 2020, State Bank was in compliance with all of the regulatory capital requirements to which it was subject. For State Bank’s capital ratios, see Note 17 to the Consolidated Financial Statements under Item of 8 of this report (the “Consolidated Financial Statements”).

 

The FRB has adopted regulations governing prompt corrective action to resolve the problems of capital deficient and otherwise troubled state-chartered member banks. At each successively lower defined capital category, a bank is subject to more restrictive and numerous mandatory or discretionary regulatory actions or limits, and the FRB has less flexibility in determining how to resolve the problems of the institution. In addition, the FRB generally can downgrade a bank’s capital category, notwithstanding its capital level, if, after notice and opportunity for hearings, the bank is deemed to be engaged in an unsafe or unsound practice, because it has not corrected deficiencies that resulted in it receiving a less than satisfactory examination rating on matters other than capital or it is deemed to be in an unsafe or unsound condition. State Bank’s capital at December 31, 2020, met the standards for the highest capital category, a “well-capitalized” bank.

 

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

 

Federal Deposit Insurance Corporation

 

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

 

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

 

The FDIC assesses a quarterly deposit insurance premium on each insured institution based on risk characteristics of the institution and may also impose special assessments in emergency situations, which fund the DIF. Pursuant to the Dodd-Frank Act, the FDIC has established 2 percent as the Designated Reserve Ratio (“DRR”), which is the amount in the DIF as a percentage of all DIF insured deposits. In March 2016, the FDIC adopted final rules designed to meet the statutory minimum DRR of 1.35 percent by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act requires the FDIC to offset the effect on insured institutions with assets of less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. Although the FDIC’s rules reduced assessment rates on all banks, they imposed a surcharge on banks with assets of $10 billion or more to be paid until the DRR reached 1.35%.The DRR met the statutory minimum of 1.35% on September 30, 2018. As a result, the previous surcharge imposed on banks with assets of $10 billion or more was lifted. In addition, preliminary assessment credits have been determined by the FDIC for banks with assets of less than $10 billion, which had previously contributed to the increase of the DRR to 1.35%. On June 30, 2019, the DRR reached 1.40%, and the FDIC applied credits for banks with assets of less than $10 billion (“small bank credits”) beginning September 30, 2019. The FDIC will continue to apply small bank credits so long as the DRR is at least 1.35%. State Bank utilized its $0.2 million assessment credit during the [third and fourth quarters of 2019]. The FDIC rules further changed the method of determining risk-based assessment rates for established banks with less than $10 billion in assets to better ensure that banks taking on greater risks pay more for deposit insurance than banks that take on less risk.

 

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

 

Community Reinvestment Act

 

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

 

SEC and NASDAQ Regulation

 

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

 

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

 

USA Patriot Act

 

The Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) gives the United States government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Title III of the Patriot Act encourages information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions. Among other requirements, Title III and related regulations require regulated financial institutions to establish a program specifying procedures for obtaining identifying information from customers seeking to open new accounts and establish enhanced due diligence policies, procedures and controls designed to detect and report suspicious activity. State Bank has established policies and procedures that State Bank believes comply with the requirements of the Patriot Act.

 

8

 

 

Office of Foreign Assets Control Regulation

 

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

 

Executive and Incentive Compensation

 

The Dodd-Frank Act requires that the federal banking agencies, including the FRB and the FDIC, issue a rule related to incentive-based compensation. No final rule implementing this provision of the Dodd-Frank Act has, as of the date of the filing of this Annual Report on Form 10-K, been adopted, but a proposed rule was published in 2016 that expanded upon a prior proposed rule published in 2011. The proposed rule is intended to: (i) prohibit incentive-based payment arrangements that the banking agencies determine could encourage certain financial institutions to take inappropriate risks by providing excessive compensation or that could lead to material financial loss; (ii) require the board of directors of those financial institutions to take certain oversight actions related to incentive-based compensation; and (iii) require those financial institutions to disclose information concerning incentive-based compensation arrangements to the appropriate federal regulator. Although a final rule has not been issued, the Company has undertaken efforts to ensure that the Company’s incentive compensation plans do not encourage inappropriate risks, consistent with the principles identified above.Public company compensation committee members must meet heightened independence requirements and consider the independence of compensation consultants, legal counsel and other advisors to the compensation committee. A compensation committee must have the authority to hire advisors and to have the public company fund reasonable compensation of such advisors.

 

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

 

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

 

Consumer Protection Laws and Regulations

 

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

 

The Equal Credit Opportunity Act (prohibiting discrimination in any credit transaction on the basis of any of various criteria);
The Truth in Lending Act (requiring that credit terms are disclosed in a manner that permits a consumer to understand and compare credit terms more readily and knowledgeably);

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

 

9

 

 

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

 

Cybersecurity

 

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

 

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

 

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

 

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

 

Effect of Environmental Regulation

 

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

 

Human Capital Resources

 

At December 31, 2020, we employed 244 full time equivalent employees. Approximately 69% of our team are female with an average tenure for our entire team of 8.80 years. The success of our business is highly dependent on our team members, who provide value to our customers and communities through their dedication to our Value Proposition – “Your lifetime provider of convenient and innovative financial services, delivered by a passionate and caring staff”. We seek to hire a well-qualified team who are a good fit for our organization, and our selection and promotion processes are without bias and include the active recruitment of minorities and women.

 

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

 

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

 

   2020   2019   2018 
  Average       Average   Average       Average   Average       Average 
($ in thousands)  Balance   Interest   Rate   Balance   Interest   Rate   Balance   Interest   Rate 
Assets                                             
Taxable securities/cash  $185,480   $2,328    1.26%  $95,216   $3,226    3.39%  $85,238   $2,618    3.07%
Non-taxable securities   6,625    333    5.03%   10,108    345    3.41%   11,379    439    3.86%
Loans, net1   880,338    39,974    4.54%   809,651    40,829    5.04%   749,055    36,422    4.86%
Total earning assets   1,072,443    42,635    3.98%   914,975    44,400    4.85%   845,672    39,479    4.67%
Cash and due from banks   14,553              47,135              38,990           
Allowance for loan losses   (10,165)             (8,370)             (8,361)          
Premises and equipment   23,776              23,779              21,795           
Other assets   60,789              50,413              49,170           
Total assets  $1,161,396             $1,027,932             $947,266           
                                              
Liabilities                                             
Savings and interest-bearing demand deposits  $492,267   $3,152    0.64%  $427,858   $2,846    0.67%  $401,577   $1,754    0.44%
Time deposits   247,955    2,918    1.18%   262,040    5,814    2.22%   225,467    3,560    1.58%
Repurchase agreements & other   22,832    70    0.31%   15,288    82    0.54%   16,458    37    0.22%
Advances from FHLB   14,186    309    2.18%   16,066    402    2.50%   22,108    460    2.08%
Trust preferred securities   10,310    256    2.48%   10,310    430    4.17%   10,310    401    3.89%
Total interest-bearing liabilities   787,550    6,705    0.85%   731,562    9,574    1.31%   675,920    6,212    0.92%
                                              
Demand deposits   211,004              146,401              137,253           
Other liabilities   23,645              16,779              12,999           
Total liabilities   1,022,199              894,742              826,172           
Shareholders’ equity   139,197              133,190              121,094           
                                              
Total liabilities and shareholders’ equity  $1,161,396             $1,027,932             $947,266           
                                              
Net interest income (tax equivalent basis)       $35,930             $34,826             $33,267      
                                             
Net interest income as a percent of average interest-earning assets - GAAP measure             3.35%             3.81%             3.93%
                                             
Net interest income as a percent of average interest-earning assets - Non-GAAP measure2             3.36%             3.82%             3.95%

 

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

 

1Nonaccruing loans and loans held for sale are included in the average balances.
2Interest on tax exempt securities and loans is computed on a tax equivalent basis using a 21 percent statutory tax rate, and added to the net interest income. The tax equivalent adjustment was $0.15, $0.17 and $0.14 million in 2020, 2019 and 2018, respectively.

 

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

 

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

 

   Total         
   Variance   Variance Attributable To 
($ in thousands)  2020/2019   Volume   Rate 
Interest income               
Taxable securities  $(898)  $3,058   $(3,956)
Non-taxable securities1   (12)   (119)   107 
Loans, net of unearned income and deferred fees1   (855)   3,565    (4,420)
Total interest income   (1,765)   6,504    (8,269)
                
Interest expense               
Savings and interest-bearing demand deposits  $306   $428   $(122)
Time deposits   (2,896)   (313)   (2,583)
Repurchase agreements & other   (12)   40    (52)
Advances from FHLB   (93)   (48)   (45)
Trust preferred securities   (174)   -    (174)
Total interest expense   (2,869)   107    (2,976)
                
Net interest income  $1,104   $6,397   $(5,293)

 

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

 

II.INVESTMENT PORTFOLIO

 

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

 

($ in thousands)  2020   2019   2018 
U.S. Treasury and government agencies  $6,864   $12,202   $18,670 
Mortgage-backed securities   127,761    78,182    60,943 
State and political subdivisions   12,275    10,564    11,356 
Other corporate securities   2,506    -    - 
                
Totals  $149,406   $100,948   $90,969 

 

B.The maturity distribution and weighted-average interest rates of securities available-for-sale at December 31, 2020, are set forth in the table below. The weighted-average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount:

 

   Maturing 
($ in thousands)  Within
One Year
   After One
Year but
within
Five Years
   After Five
Years but
within
Ten Years
   After
Ten Years
   Total 
U.S. Treasury and government agencies  $2,558   $1,057   $3,249   $-   $6,864 
Mortgage-backed securities   32    2,966    12,377    112,386    127,761 
State and political subdivisions   1,072    2,703    2,658    5,842    12,275 
Other corporate securities   -    -    2,506    -    2,506 
                          
Total securities by maturity  $3,662   $6,726   $20,790   $118,228   $149,406 
                          
Weighted-average yield by maturity1   2.85%   2.99%   2.75%   1.59%   1.85%

 

1Yields are presented on a tax-equivalent basis.

 

C.Excluding those holdings of the investment portfolio in U.S. Treasury securities and other agencies of the U.S. Government, there were no other securities of any one issuer, which exceeded 10 percent of the shareholders’ equity of the Company at December 31, 2020.

 

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III.LOAN PORTFOLIO

 

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

 

($ in thousands)  2020   2019   2018   2017   2016 
Loans held for investment (HFI)                    
Commercial business and agricultural  $260,002   $202,041   $179,053   $153,501   $161,227 
Commercial real estate   370,820    366,782    340,791    332,154    284,084 
Residential real estate   182,165    193,159    187,104    150,854    142,452 
Consumer & other loans   61,157    62,808    64,336    59,619    56,335 
                          
Total loans   874,144    824,790    771,284    696,128    644,098 
                          
Unearned income   (1,421)   720    599    487    335 
Total loans, net of unearned income  $872,723   $825,510   $771,883   $696,615   $644,433 

 

Concentrations of Credit Risk: The Company makes commercial, real estate and installment loans to customers located mainly in the Tri-State region of Ohio, Indiana and Michigan. Commercial loans include loans collateralized by commercial real estate, business assets and, in the case of agricultural loans, crops and farm equipment and the loans are expected to be repaid from cash flow from operations of businesses. As of December 31, 2020, commercial business and agricultural loans made up approximately 29.6 percent of the loans held for investment (“HFI”) loan portfolio while commercial real estate loans accounted for approximately 42.5 percent of the HFI loan portfolio. Residential first mortgage loans made up approximately 20.9 percent of the HFI loan portfolio and are secured by first mortgages on residential real estate, while consumer loans to individuals made up approximately 7.0 percent of the HFI loan portfolio and are primarily secured by consumer assets.

 

B.Maturities and Sensitivities of Loans to Changes in Interest Rates: The following tables show the amounts of commercial, business and agricultural loans and commercial real estate loans outstanding as of December 31, 2020, which, based on remaining scheduled repayments of principal, are due in the periods indicated. Also, the amounts have been classified according to sensitivity to changes in interest rates for loans due after one year (variable-rate loans are those loans with floating or adjustable interest rates).

 

   Maturing 
  Commercial   Commercial     
($ in thousands)  Business & Ag.   Real Estate   Total 
Within one year  $50,709   $30,370   $81,079 
After one year but within five years   108,820    111,556    220,376 
After five years   100,473    228,894    329,367 
                
Totals  $260,002   $370,820   $630,822 

 

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   Interest Sensitivity 
($ in thousands)  Fixed   Variable     
   Rate   Rate   Total 
Commercial Business & Agricultural            
Within one year  $32,494   $18,215   $50,709 
Due after one year but within five years   75,580    33,240    108,820 
Due after five years   15,163    85,310    100,473 
                
Totals   123,237    136,765    260,002 
                
Commercial RE & Construction               
Within one year   8,723    21,647    30,370 
Due after one year but within five years   48,988    62,568    111,556 
Due after five years   59,040    169,854    228,894 
                
Totals   116,751    254,069    370,820 
                
Total               
Within one year   41,217    39,862    81,079 
Due after one year but within five years   124,568    95,808    220,376 
Due after five years   74,203    255,164    329,367 
                
Totals  $239,988   $390,834   $630,822 

 

C.Risk Elements:

 

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

 

($ in thousands)  2020   2019   2018   2017   2016 
Loans accounted for on a nonaccrual basis  $6,426   $5,500   $2,906   $2,704   $2,737 
Accruing troubled debt restructurings   810    874    928    1,129    1,590 
                          
Total nonperforming loans and TDRs  $7,236   $6,374   $3,834   $3,833   $4,327 

 

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

 

($ in thousands)  2020   2019 
         
Cash basis interest income recognized on impaired loans outstanding  $218   $340 
Interest income actually recorded on impaired loans and included in net income for the period   167    361 
Unrecorded interest income on nonaccrual loans   326    76 

 

2.As of December 31, 2020, in addition to the $7.2 million of nonperforming loans reported under Item III.C above (which amount includes all loans classified by management as doubtful or loss), there were approximately $12.0 million in other outstanding loans where known information about possible credit problems of the borrowers caused management to have concerns as to the ability of such borrowers to comply with the present loan repayment terms (loans classified as substandard by management) and which may result in disclosure of such loans pursuant to Item III.C.1. at some future date. In regard to loans classified as substandard, management believes that such potential problem loans have been adequately evaluated in the allowance for loan losses.

 

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3.Foreign Loans Outstanding

 

None

 

4.Loan Concentrations

 

At December 31, 2020, loans outstanding related to agricultural operations or collateralized by agricultural real estate and equipment aggregated approximately $55.2 million, or 6.3 percent of total HFI loans.

 

D.Other Interest Bearing Assets

 

There were no other interest bearing assets as of December 31, 2020, which would be required to be disclosed under Item III.C.1 or Item III.C.2. if such assets were loans.

 

Management believes the allowance for loan losses at December 31, 2020 was adequate to absorb any losses on nonperforming loans, as the allowance balance is maintained by management at a level considered adequate to cover losses that are probable based on past loss experience, general economic conditions, information about specific borrower situations, including their financial position and collateral values, and other factors and estimates which are subject to change over time.

 

IV.SUMMARY OF LOAN LOSS EXPERIENCE

 

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

 

($ in thousands)  2020   2019   2018   2017   2016 
Loans                    
Loans outstanding at end of period  $872,723   $825,510   $771,883   $696,615   $644,433 
                          
Average loans outstanding during period  $880,338   $809,651   $749,055   $660,675   $603,875 
                          
Allowance for loan losses                         
Balance at beginning of period  $8,755   $8,167   $7,930   $7,725   $6,990 
                          
Loans charged off:                         
Commercial business and agricultural   (582)   (143)   (227)   (50)   (135)
Commercial real estate   -    -    (42)   (26)   (241)
Residential real estate   (82)   (53)   (30)   (61)   (20)
Consumer & other loans   (79)   (63)   (108)   (94)   (105)
    (743)   (259)   (407)   (231)   (501)
Recoveries of loans previously charged off:                         
Commercial business and agricultural   16    9    1    10    420 
Commercial real estate   -    1    28    2    5 
Residential real estate   40    14    2    6    2 
Consumer & other loans   6    23    13    18    59 
    62    47    44    36    486 
Net loans charged off   (681)   (212)   (363)   (195)   (15)
Provision for loan losses   4,500    800    600    400    750 
Balance at end of period  $12,574   $8,755   $8,167   $7,930   $7,725 
                          
Ratio of net charge offs to average loans   0.08%   0.03%   0.05%   0.03%   0.00%

 

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

 

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

 

   Allowance
Amount
   Percentage of Loans In Each Category to Total Loans   Allowance
Amount
   Percentage of Loans In Each Category to Total Loans   Allowance
Amount
   Percentage of Loans In Each Category to Total Loans   Allowance
Amount
   Percentage of Loans In Each Category to Total Loans   Allowance
Amount
   Percentage of Loans In Each Category to Total Loans 
($ in thousands)  2020   2019   2018   2017   2016 
Commercial business and agricultural  $3,570    29.6%  $2,317    24.6%  $1,917    23.3%  $1,328    22.1%  $1,551    25.1%
Commercial real estate   5,451    42.5%   3,602    44.4%   2,923    44.2%   3,779    47.7%   3,321    44.1%
Residential real estate   2,534    20.9%   2,203    23.4%   2,567    24.2%   2,129    21.7%   1,963    22.1%
Consumer & other loans   1,019    7.0%   633    7.6%   760    8.3%   694    8.6%   890    8.7%
Totals  $12,574    100.0%  $8,755    100.0%  $8,167    100.0%  $7,930    100.0%  $7,725    100.0%

 

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

 

V.DEPOSITS

 

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

 

   2020   2019   2018 
   Average   Average   Average   Average   Average   Average 
($ in thousands)  Amount   Rate   Amount   Rate   Amount   Rate 
                         
Savings and interest bearing demand deposits  $492,267    0.64%  $427,858    0.67%  $401,577    0.44%
Time deposits   247,955    1.18%   262,040    2.22%   225,467    1.58%
Demand deposits (non interest bearing)   211,004    -    146,401    -    137,253    - 
Totals  $951,226        $836,299        $764,297      

 

Maturities of time certificates of deposit and other time deposits of $100,000 or more outstanding at December 31, 2020, are summarized as follows:

 

($ in thousands)  Amount 
Three months or less  $36,639 
Over three months through six months   28,948 
Over six months and through twelve months   37,780 
Over twelve months   36,407 
      
Total  $139,774 

 

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VI.RETURN ON EQUITY AND ASSETS

 

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

 

($ in thousands)  2020   2019   2018 
     
Average total assets  $1,161,396   $1,027,932   $947,266 
Average shareholders’ equity  $139,197   $133,190   $121,094 
Net income  $14,944   $11,973   $11,638 
Net income available to common shareholders  $14,944   $11,023   $10,663 
Cash dividends declared  $0.40   $0.36   $0.32 
Return on average total assets   1.29%   1.16%   1.23%
Return on average shareholders’ equity   10.74%   8.99%   9.61%
Dividend payout ratio1   20.54%   23.84%   19.60%
Average shareholders’ equity to average assets   11.99%   12.96%   12.78%

 

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

 

VII.SHORT-TERM BORROWINGS

 

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

 

($ in thousands)  2020   2019   2018 
             
Amount outstanding at end of year  $20,189   $12,945   $15,184 
Weighted-average interest rate at end of year   0.20%   0.51%   0.49%
Maximum amount outstanding at any month end  $25,600   $22,675   $18,312 
Average amount outstanding during the year  $21,794   $15,288   $16,458 
Weighted-average interest rate during the year   0.32%   0.54%   0.22%

 

Item 1A. Risk Factors.

 

Cautionary Statement Regarding Forward-Looking Information

 

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

 

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

 

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Forward-looking statements involve risks and uncertainties. Actual results may differ materially from those predicted by the forward-looking statements because of various factors and possible events, including those factors discussed in the Risk Factors below. There is also the risk that the Company’s management or Board of Directors incorrectly analyzes these risks and forces, or that the strategies the Company develops to address them are unsuccessful.

 

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

 

Economic, Market and Political Risks:

 

The economic impact of COVID-19 or any other pandemic could adversely affect our business, financial condition, liquidity, and results of operations.

 

In March 2020, the World Health Organization declared COVID-19 a pandemic and the President of the United States declared COVID-19 a national emergency. COVID-19 has caused significant economic dislocation in the United States as many state and local governments have ordered non-essential businesses to close and residents to shelter in place at home. This has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. Various state governments and federal agencies are requiring lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees). The federal bank regulatory agencies have encouraged financial institutions to prudently work with affected borrowers, and new legislation has provided relief from reporting loan classifications due to modifications related to COVID-19.

 

Given the ongoing and dynamic nature of COVID-19, it is difficult to predict the full impact of the outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when COVID-19 can be controlled and abated and when and how the economy may be reopened. As of December 31, 2020, we hold and service PPP loans. These PPP loans are subject to the provisions of the CARES Act and to complex and evolving rules and guidance issued by the SBA and other government agencies. We expect that the great majority of our PPP borrowers will seek full or partial forgiveness of their loan obligations. We have credit risk on the PPP loans if the SBA determines that there is a deficiency in the manner in which we originated, funded or serviced loans, including any issue with the eligibility of a borrower to receive a PPP loan. We could face additional risks in our administrative capabilities to service our PPP loans, and risk with respect to the determination of loan forgiveness. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which we originated, funded or serviced the PPP loan, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty or, if the SBA has already paid under the guaranty, seek recovery of any loss related to the deficiency.

 

The spread of COVID-19 has also caused us to modify our business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. Further, technology in employees’ homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to such employees to be more limited or less reliable. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk from phishing, malware, and other cybersecurity attacks, all of which could expose us to risks of data or financial loss and could seriously disrupt our operations and the operations of any impacted customers.

 

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COVID-19 or a new pandemic could subject us to any of the following risks, any of which could, individually or in the aggregate, have a material adverse effect on our business, financial condition, liquidity, and results of operations:

 

demand for our products and services may decline, making it difficult to grow assets and income;
if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;
collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
our allowance for loan losses may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
as the result of the decline in the Federal Reserve Board’s target federal funds rate, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;
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;
a prolonged weakness in economic conditions resulting in a reduction of future projected earnings could result in our recording a valuation allowance against our current outstanding deferred tax assets;
we rely on third party vendors for certain services and the unavailability of a critical service due to COVID-19 could have an adverse effect on us; and
continued adverse economic conditions could result in protracted volatility in the price of our Common Shares.

 

Moreover, our future success and profitability substantially depend on the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to COVID-19 or any similar pandemic could harm our ability to operate our business or execute our business strategy. We may not be successful in finding and integrating suitable successors in the event of key employee loss or unavailability.

 

Even after the COVID-19 pandemic subsides, the U.S. economy will likely require time to recover, the length of which is unknown and during which the United States may experience a recession. Our business could be materially and adversely affected by such recession.

 

To the extent the effects of COVID-19 adversely impact our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in this section.

 

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

 

Our success depends to a large extent upon local and national economic conditions, as well as governmental fiscal and monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, fiscal and monetary policy, tariffs, a U.S. withdrawal from or significant renegotiation of trade agreements, trade wars, the election of a new U.S. President and changes in the membership of Congress in 2020, and other factors beyond our control may adversely affect our deposit levels and composition, the quality of investment securities available for purchase, demand for loans, the ability of our borrowers to repay their loans, and the value of the collateral securing loans made by us. Recent political developments have resulted in substantial changes in economic and political conditions for the U.S. and the remainder of the world. Disruptions in U.S. and global financial markets, and changes in oil production in the Middle East also affect the economy and stock prices in the U.S., which can affect our earnings capital, as well as the ability of our customers to repay loans. The potential effects of the United Kingdom leaving the European Union (Brexit) on the United States are still unknown. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral and our ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings and cash flows. In addition, our lending and deposit gathering activities are concentrated primarily in Northwest Ohio. As a result, our success depends in large part on the general economic conditions of these areas, particularly given that a significant portion of our lending relates to real estate located in this region. Therefore, adverse changes in the economic conditions in these areas, including those resulting from COVID-19, could adversely impact our earnings and cash flows.

 

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

 

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

 

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

 

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

 

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

 

LIBOR is used extensively in the U.S. and globally as a benchmark for various commercial and financial contracts, including adjustable rate mortgages, corporate debt, interest rate swaps and other derivatives. LIBOR is set based on interest rate information reported by certain banks, which may stop reporting such information after 2021. In November 2020, the Federal Reserve Board issued a statement supporting the release of a proposal and supervisory statements designed to provide a clear end date for U.S. Dollar LIBOR (“USD LIBOR”), and the federal banking agencies issued a release encouraging banks to stop entering into USD LIBOR contracts by the end of 2021, noting that most legacy contracts will mature prior to the date LIBOR ceases to be issued. It is uncertain at this time the extent to which those entering into financial contracts will transition to any other particular benchmark. Other benchmarks may perform differently than LIBOR or other alternative benchmarks or may have other consequences that cannot currently be anticipated. It is also uncertain what will happen with instruments that rely on LIBOR for future interest rate adjustments and which remain outstanding if LIBOR ceases to exist.

 

The Company’s primary exposure to LIBOR relates to its promissory notes with borrowers, swap contracts with clients, offsetting swap contracts with third parties related to the swap contracts with clients, and the Company’s LIBOR-based borrowings (if any). The Company’s contracts generally include a LIBOR term (for example, one month, three month, or one year) plus an incremental margin rate. The Company is working through this transition via a multi-disciplinary project team. We do not believe the change to a benchmark like SOFR will have a material impact on our financial condition, results of operations or cash flows.

 

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Risks Related to Our Business Operations:

 

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

 

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

 

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

 

On June 16, 2016, the FASB issued Accounting Standard Update (“ASU”) 2016-13 “Financial Instruments - Credit Losses”, which replaces the incurred loss model with an expected loss model, and is referred to as the current expected credit loss (“CECL”) model. Under the incurred loss model, loans are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. The new accounting guidance is effective for annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2019. However, the FASB has deferred the effective date for this ASU for smaller reporting companies, such as the Company, to annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2022. Under the CECL model, financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will bring with it significantly greater data requirements and changes to methodologies to accurately account for expected losses under the new parameters. If the methodologies and assumptions that we use in the CECL model are proven to be incorrect or inadequate, the allowance for credit losses may not be sufficient, resulting in the need for additional allowance for credit losses to be established, which could have a material adverse impact on our financial condition and results of operations.

 

We may further experience increased delinquencies, credit losses, and corresponding charges to capital, which could require us to increase our provision for loan losses associated with impacts related to the coronavirus outbreak due to quarantines, market downturns, increased unemployment rates, changes in consumer behavior related to pandemic fears, and related emergency response legislation. We cannot predict the full impact of the coronavirus outbreak or any other future global pandemic on our business, but we may experience increased delinquencies and credit losses as a result of the outbreak. Further, if real estate markets or the economy in general deteriorate (due to the coronavirus outbreak or otherwise), State Bank may experience increased delinquencies and credit losses. The allowance for loan losses may not be sufficient to cover actual loan-related losses. Additionally, banking regulators may require State Bank to increase its allowance for loan losses in the future, which could have a negative effect on the Company’s financial condition and results of operations. Additions to the allowance for loan losses will result in a decrease in net earnings and capital and could hinder our ability to grow our assets.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Future acquisitions or other expansion may adversely impact our financial condition and results of operations.

 

In the future, we may acquire other financial institutions or branches or assets of other financial institutions. We may also open new branches, enter into new lines of business, or offer new products or services. Any such acquisition or expansion of our business will involve a number of expenses and risks, which may include some or all of the following:

 

the time and expense associated with identifying and evaluating potential acquisitions or expansions;

the potential inaccuracy of estimates and judgments used to evaluate credit, operations, management and market risk with respect to target institutions;

the time and costs of evaluating new markets, hiring local management and opening new offices, and the delay between commencing these activities and the generation of profits from the expansion;

any financing required in connection with an acquisition or expansion;

the diversion of management’s attention to the negotiation of a transaction and the integration of the operations and personnel of the combining businesses;

entry into unfamiliar markets and the introduction of new products and services into our existing business;

the possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations; and

the risk of loss of key employees and customers.

 

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We may incur substantial costs to expand, and we can give no assurance that such expansion will result in the levels of profits we expect. Neither can we assure that integration efforts for any future acquisitions will be successful. We may issue equity securities in connection with acquisitions, which could dilute the economic and voting interests of our existing shareholders.

 

Our information systems may experience an interruption or security breach.

 

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

 

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

 

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

 

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

 

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

 

In addition, there have been instances where financial institutions have been victims of fraudulent activity in which criminals pose as customers to initiate wire and automated clearinghouse transactions out of customer accounts. The massive breach of the systems of a credit bureau in 2019 presents additional threats as criminals now have more information than ever before about a larger portion of our country’s population, which could be used by criminals to pose as customers initiating transfers of money from customer accounts. Although we have policies and procedures in place to verify the authenticity of our customers, we cannot assure that such policies and procedures will prevent all fraudulent transfers.

 

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We have implemented security controls to prevent unauthorized access to our computer systems, and we require that our third-party service providers maintain similar controls. However, the Company’s management cannot be certain that these measures will be successful. A security breach of the computer systems and loss of confidential information, such as customer account numbers and related information, could result in a loss of customers’ confidence and, thus, loss of business. We could also lose revenue if competitors gain access to confidential information about our business operations and use it to compete with us. While we maintain specific “cyber” insurance coverage, which would apply in the event of various breach scenarios, the amount of coverage may not be adequate in any particular case. Furthermore, because cyber threat scenarios are inherently difficult to predict and can take many forms, some breaches may not be covered under our cyber insurance coverage.

 

Further, we may be affected by data breaches at retailers and other third parties who participate in data interchanges with us and our customers that involve the theft of customer credit and debit card data, which may include the theft of our debit card PIN numbers and commercial card information used to make purchases at such retailers and other third parties. Such data breaches could result in us incurring significant expenses to reissue debit cards and cover losses, which could result in a material adverse effect on our results of operations.

 

To date, we have not experienced any material losses relating to cyber-attacks or other information security breaches, but there can be no assurance that we will not suffer such attacks or attempted breaches, or incur resulting losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, and our plans to continue to implement internet and mobile banking capabilities to meet customer demand. As cyber and other data security threats continue to evolve, we may be required to expend significant additional resources to continue to modify and enhance its protective measures or to investigate and remediate any security vulnerabilities.

 

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

 

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

 

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

 

One or more of the third parties utilized by us may experience a cybersecurity event or operational disruption and, if any such event does occur, it may not be adequately addressed, either operationally or financially, by such third party. Further, the operations of our third-party vendors could fail or otherwise become delayed as a result of COVID-19. Certain of these third parties may have limited indemnification obligations to us in the event of a cybersecurity event or operational disruption, or may not have the financial capacity to satisfy their indemnification obligations.

 

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

 

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

 

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

 

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

 

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

 

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

 

Legislative, Legal and Regulatory Risks:

 

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

 

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

 

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

 

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

 

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

 

The financial services industry is extensively regulated. We are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors, borrowers, the Deposit Insurance Fund and the banking system as a whole, and not to benefit our shareholders. Regulations affecting banks and financial services businesses are undergoing continuous change, especially in light of COVID-19 and the stimulus programs issued in connection therewith, and management cannot predict the effect of these changes. While such changes are generally intended to lessen the regulatory burden on financial institutions, the impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact us or our ability to increase the value of our business. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of a financial institution, the classification of assets held by a financial institution, the adequacy of a financial institution’s allowance for loan losses and the ability to complete acquisitions. Additionally, actions by regulatory agencies against us could cause us to devote significant time and resources to defending our business and may lead to penalties that materially affect us and our shareholders. Even the reduction of regulatory restrictions could have an adverse effect on us and our shareholders if such lessening of restrictions increases competition within our industry or our market area.

 

In light of conditions in the global financial markets and the global economy that occurred in the last decade, regulators have increased their focus on the regulation of the financial services industry. In the last several years, Congress and the federal bank regulators have acted on an unprecedented scale in responding to the stresses experienced in the global financial markets. Some of the laws enacted by Congress and regulations promulgated by federal bank regulators subject us and other financial institutions to additional restrictions, oversight and costs that may have an adverse impact on our business and results of operations. In addition to laws, regulations and supervisory and enforcement actions directed at the operations of financial institutions, proposals to reform the housing finance market consider significant changes to Fannie Mae and Freddie Mac, which could negatively affect our sales of loans.

 

Changes in accounting standards could influence our results of operations.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

27

 

 

Risks Related to Our Capital and Common Shares:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

General Risk Factors:

 

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

 

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

 

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

 

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

 

Changes in tax laws could adversely affect our performance.

 

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

 

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

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make significant estimates that affect the financial statements. Two of our most critical estimates are the level of the allowance for loan losses and the accounting for goodwill and other intangibles. Because of the inherent nature of these estimates, we cannot provide complete assurance that we will not be required to adjust earnings for significant unexpected loan losses, nor that we will not recognize a material provision for impairment of our goodwill. For additional information regarding these critical estimates, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on page 36 of this Annual Report on Form 10-K.

 

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We are at risk of increased losses from fraud.

 

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

 

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

 

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

 

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

 

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

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2. Properties.

 

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

 

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

 

SB Financial Group, Inc. Property List as of December 31, 2020
 
($ in thousands)  Description/Address  Leased/
Owned
  Total
Deposits
12/31/20
 
           
Main Banking Center & Corporate Office       
401  Clinton Street, Defiance, OH  Owned  $266,066 
            
Banking Centers/Drive-Thru’s        
1419  West High Street, Bryan, OH  Owned   55,266 
510  Third Street, Defiance, OH (Drive-thru)  Owned    N/A  
1600  North Clinton Street, Defiance, OH  Leased   40,370 
312  Main Street, Delta, OH  Owned   22,147 
4080  West Dublin Granville Road, Dublin, OH  Owned   68,074 
201  East Lincoln Street, Findlay, OH  Owned   16,443 
408  South Main Street Suite A, Findlay, OH  Leased   - 
12832  Coldwater Road, Fort Wayne, IN  Owned   25,742 
1232  North Main Street, Bowling Green, OH  Owned   13,513 
235  Main Street, Luckey, OH  Owned   36,662 
133  East Morenci Street, Lyons, OH  Owned   23,099 
930  West Market Street, Lima, OH  Owned   65,239 
1201  East Main Street, Montpelier, OH  Owned   46,885 
218  North First Street, Oakwood, OH  Owned   25,021 
220  North Main Street, Paulding, OH  Owned   63,184 
610  East South Boundary Street, Perrysburg, OH  Owned   16,641 
119  South State Street, Pioneer, OH  Owned   36,343 
6401  Monroe Street, Sylvania, OH  Owned   80,093 
311  Main Street, Walbridge, OH  Owned   34,437 
101  North Michigan Street, Edon, OH  Owned   53,931 
1379  North Shoop Avenue, Wauseon, OH  Owned   59,854 
            
Loan Production Offices        
307  North Wayne Street, Angola, IN  Owned    N/A  
10100  Lantern Road, Suite 240, Fishers, IN  Leased    N/A  
94  Granville Street, Gahanna, OH  Owned    N/A  
8194  Secor Road, Lambertville, MI  Leased    N/A  
1900  Monroe Street, Suite 108, Toledo, OH  Leased    N/A  
            
Service Facilities (SBT/ SBFG Title)        
104  Depot Street, Archbold, OH  Leased    N/A  
105  East Holland Street, Archbold, OH  Leased    N/A  
1911  Baltimore Road, Defiance, OH  Leased    N/A  
9101  Antares Avenue, Columbus, OH  Owned   N/A 
            
Total deposits     $1,049,011 

 

SB Captive operates from office space located at 101 Convention Center Dr.,

Suite 850, Las Vegas, NV 89109.

 

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The Company’s subsidiaries have several noncancellable leases for business use that expire over the next five years. Aggregate rental expense for these leases was $0.18 million and $0.19 million for the years ended December 31, 2020 and 2019, respectively.

 

Future minimum lease payments under operating leases are:
   ($ in thousands) 
2021  $195 
2022   144 
2023   132 
2024   129 
2025   129 
Thereafter   883 
Total minimum lease payments  $1,611 

 

Item 3. Legal Proceedings.

 

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

 

Item 4. Mine Safety Disclosures.

 

Not Applicable

 

Supplemental Item: Information about our Executive Officers

 

The following table lists the names and ages of the executive officers of the Company as of February 26, 2021, the positions presently held by each executive officer, and the business experience of each executive officer during their employment at the Company. Unless otherwise indicated, each person has held his or her principal occupation(s) for more than five years.

 

Name   Age   Position(s) Held with the Company and
its Subsidiaries and Principal Occupation(s)
Mark A. Klein   66  

Chairman of the Company since April 2015; Director of the Company since February 2010; President and Chief Executive Officer of the Company since January 2010 and of State Bank since January 2006; Director of State Bank since 2006; President of RDSI since October 2011; Member of State Bank Trust Investment Review Committee since March 2007.

         
Anthony V. Cosentino   59   Executive Vice President and Chief Financial Officer of the Company and State Bank since March 2010; Chief Financial Officer of RDSI since October 2011; Member of State Bank Trust Investment Review Committee since June 2010.

 

Ernesto Gaytan   49   Executive Vice President and Chief Technology Innovation and Operations Officer of the Company since July 2018; Chief Technology Innovation Officer since November 2017.
         
Jonathan R. Gathman   47  

Executive Vice President and Senior Lending Officer of the Company since October 2005; Senior Vice President and Commercial Lending Manager from June 2005 through October 2005; Vice President and Commercial Lender from February 2003 through June 2005. Began working for State Bank in May 1996.

         
Keeta J. Diller   64  

Executive Vice President and Chief Risk Officer of the Company since July 2019; Senior Vice President and Chief Enterprise Risk Management Officer from August 2018 through July 2019; Senior Vice President and Audit Coordinator and Director of Operations from December 2011 through August 2018; Vice President and Internal Auditor from January 2010 through December 2011; Corporate Secretary for the Company since 1996; Began working for State Bank in February 1990 as the Accounting Supervisor.

 

33

 

 

PART II

 

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

 

Market Information

 

Our common shares are traded on the NASDAQ Capital Market under the symbol “SBFG”. There were 7,407,034 common shares outstanding as of December 31, 2020, which were held by approximately 1,236 record holders.

 

The Company paid quarterly dividends on its common shares in the aggregate amounts of $0.40 per share and $0.36 per share in 2020 and 2019, respectively. The Company presently anticipates continuing to pay quarterly dividends in the future at similar levels. However, there is no guarantee that dividends on our common shares will continue in the future.

 

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

 

 

   Period Ending 
Index  12/31/15   12/31/16   12/31/17   12/31/18   12/31/19   12/31/20 
SB Financial Group, Inc.   100.00    147.20    172.30    155.92    190.51    181.48 
NASDAQ Composite Index   100.00    108.87    141.13    137.12    187.44    271.64 
SNL U.S. Bank NASDAQ Index   100.00    138.65    145.97    123.04    154.47    132.56 

 

Source: S&P Global Market Intelligence

© 2021

 

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The table below reflects the common shares repurchased by the Company during the three months ended December 31, 2020. The Company has 253,360 shares remaining of the 500,000 approved under the existing share repurchase program which was authorized on July 21, 2020 and expires December 31, 2021.

 

   (a)   (b)   (c)   (d) 
Period  Total Number of Shares Purchased   Weighted Average Price Paid per Share   Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs   Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs 
10/01/20 - 10/31/20   44,641   $15.50    118,158    381,842 
11/01/20 - 11/30/20   62,349    18.20    180,507    319,493 
12/01/20 - 12/31/20   66,133    18.38    246,640    253,360 
Totals   173,123   $17.57    246,640    253,360 

 

Item 6. Selected Financial Data.

 

Financial Highlights

Year Ended December 31,

 

($ in thousands, except per share data)                
   2020   2019   2018   2017   2016 
Earnings                    
Interest income  $42,635   $44,400   $39,479   $32,480   $29,051 
Interest expense   6,705    9,574    6,212    4,094    3,198 
Net interest income   35,930    34,826    33,267    28,386    25,853 
Provision for loan losses   4,500    800    600    400    750 
Noninterest income   30,096    18,016    16,624    17,217    17,889 
Noninterest expense   43,087    37,410    34,847    31,578    30,091 
Provision for income taxes   3,495    2,659    2,806    2,560    4,117 
Net income   14,944    11,973    11,638    11,065    8,784 
Preferred stock dividends   -    950    975    975    975 
Net income available to common   14,944    11,023    10,663    10,090    7,809 
                          
Per Common Share Data                         
Basic earnings  $1.96   $1.71   $1.72   $2.10   $1.60 
Diluted earnings   1.96    1.51    1.51    1.74    1.38 
Cash dividends declared   0.40    0.36    0.32    0.28    0.24 
Total equity per share   19.39    17.53    16.36    15.03    13.75 
Total tangible equity per share   16.30    15.23    15.39    13.27    11.59 
                          
Average Balances                         
Average total assets  $1,161,396   $1,027,932   $947,266   $854,569   $789,045 
Average equity   139,197    133,190    121,094    89,538    84,540 
                          
Ratios                         
Return on average total assets   1.29%   1.16%   1.23%   1.29%   1.11%
Return on average equity   10.74    8.99    9.61    12.36    10.39 
Cash dividend payout ratio1   20.54    23.84    19.60    13.50    15.11 
Average equity to average assets   11.99    12.96    12.78    10.48    10.71 
                          
Period End Totals                         
Total assets  $1,257,839   $1,038,577   $986,828   $876,627   $816,005 
Total investments; fed funds sold   149,406    100,948    90,969    82,790    90,128 
Loans held for sale   7,234    7,258    4,445    3,940    4,434 
Total loans & leases   872,723    825,510    771,883    696,615    644,433 
Allowance for loan losses   12,574    8,755    8,167    7,930    7,725 
Total deposits   1,049,011    840,219    802,552    729,600    673,073 
Advances from FHLB   8,000    16,000    16,000    18,500    26,500 
Trust preferred securities   10,310    10,310    10,310    10,310    10,310 
Total equity   142,923    136,094    130,435    94,000    86,548 

 

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

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

 

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

 

The following discussion provides a review of the consolidated financial condition and results of operations of SB Financial and its subsidiaries (collectively, the “Company”). This discussion should be read in conjunction with the Company’s consolidated financial statements and related footnotes as of and for the years ended December 31, 2020 and 2019.

 

Strategic Discussion

 

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

 

Increase profitability through ongoing diversification of revenue streams: For the twelve months ended December 31, 2020, the Company generated $30.1 million in noninterest income, or 45.6 percent of total operating revenue from fee-based products. These revenue sources include fees generated from saleable residential mortgage loans, retail deposit products, wealth management services, saleable business-based loans (small business and farm service) and title agency revenue. For the twelve months ended December 31, 2019, the Company generated $18.0 million in revenue from fee-based products, or 34.1 percent of total operating revenue.

 

Strengthen our penetration in all markets served: Over our 118-year history of continuous operation in Northwest Ohio, we have established a significant presence in our traditional markets in Defiance, Fulton, Paulding and Williams counties in Ohio. In our newer markets of Bowling Green, Columbus, Findlay, Toledo (Ohio) and Ft. Wayne (Indiana), our current market penetration is minimal but we believe our potential for growth is significant. We have expanded and committed additional resources to our presence in the Findlay and Wauseon markets. We continue to seek to expand the presence and penetration in all of our markets.

 

Expand product utilization by new and existing customers: As of December 31, 2020, we served 32,519 households and provided 95,210 products and services (2.93 products & services per household) to these households. Our strategy is to continue to expand the scope of our relationship with each household via our dynamic “on-boarding” process. Proactively identifying client needs is a key ingredient of our value proposition. As of December 31, 2019, we served 30,377 households and provided 91,154 products and services (3.00 products & services per household) to these households.

 

Deliver gains in operational excellence: Our management team believes that becoming and remaining a high-performance financial services company will depend upon seamlessly and consistently delivering operational excellence, as demonstrated by the Company’s leadership in the origination and servicing of residential mortgage loans. As of December 31, 2020, the Company serviced 8,543 residential mortgage loans with a principal balance of $1.3 billion. As of December 31, 2019, the Company serviced 8,155 loans with a principal balance of $1.2 billion.

 

Sustain asset quality: As of December 31, 2020, the Company’s asset quality metrics remained strong. Specifically, total nonperforming assets were $7.3 million, or 0.58 percent of total assets. Total delinquent loans at December 31, 2020 were 0.75 percent of total loans. As of December 31, 2019, the Company had total nonperforming assets of $5.3 million, or 0.51 percent of total assets. Total delinquent loans at December 31, 2019 were 0.28 percent of total loans.

 

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Critical Accounting Policies

 

The accounting and reporting policies of the Company are in accordance with generally accepted accounting principles in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the Company’s Consolidated Financial Statements for the years ended December 31, 2020 and 2019. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The Company’s financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective or complex.

 

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

 

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

 

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

 

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

 

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

 

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

 

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Changes in Financial Condition

 

Total assets at December 31, 2020, were $1.26 billion, compared to $1.04 billion at December 31, 2019. Loans (excluding loans held for sale) were $872.7 million at December 31, 2020, compared to $825.5 million at December 31, 2019. Total deposits were $1.05 billion at December 31, 2020, compared to $840.2 million at December 31, 2019. Deposit and loan balances were elevated due to the PPP initiative and the acquisition of the Edon State Bank.

 

Total equity was $142.9 million at December 31, 2020, up 5.0 percent from $136.1 million at December 31, 2019. Net income less dividends increase retained earnings by $11.8 million for 2020.

 

($ in thousands)  Years Ended December 31, 
Total loans  2020   2019   % Change 
Commercial business & agriculture  $258,507   $202,761    27.5%
Commercial real estate   370,984    366,782    1.1%
Residential real estate   182,076    193,159    -5.7%
Consumer & other   61,156    62,808    -2.6%
Loans held for investment  $872,723   $825,510    5.7%
                
Loans held for sale  $7,234   $7,258    -0.3%

 

Total deposits  2020   2019   % Change 
Noninterest bearing demand  $251,649   $158,357    58.9%
Interest-bearing demand   176,785    131,084    34.9%
Savings & money market   391,028    293,025    33.4%
Time deposits   229,549    257,753    -10.9%
Total deposits  $1,049,011   $840,219    24.8%
                
Total shareholders’ equity  $142,923   $136,094    5.0%

 

Loans held for investment increased $47.2 million, or 5.7 percent, to $872.7 million at December 31, 2020. The largest component of this increase was in commercial business loans, which rose $55.7 million. The 2020 results were impacted by the Company’s participation in the PPP, which increased commercial balances by approximately $70.5 million. In addition, the Company acquired the Edon State Bank in June of 2020 that increased loan balances by $16.4 million.

 

Deposits increased $208.8 million, or 24.9 percent, to $1.05 billion at December 31, 2020. Deposit growth for the year included $139.0 million in demand deposits and $98.0 million in savings and money market deposits. The Company added approximately $51.0 million in deposit balances from the Edon State Bank acquisition in 2020.

 

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Stockholders’ equity at December 31, 2020, was $142.9 million or 11.4 percent of total assets compared to $136.1 million or 13.1 percent of total assets at December 31, 2019.

 

Asset Quality  Years Ended December 31, 
($ in thousands)  2020   2019   % Change 
Nonaccruing loans  $6,426   $5,500    16.8%
Accruing restructured loans (TDRs)   810    874    -7.3%
OREO & repossessed assets   23    305    -92.5%
Nonperforming assets   7,259    6,679    8.7%
Net charge offs   681    212    221.2%
Loan loss provision   4,500    800    462.5%
Allowance for loan losses   12,574    8,755    43.6%
                
Nonperforming assets/total assets   0.58%   0.64%   -9.3%
Net charge offs/average loans   0.08%   0.03%   166.7%
Allowance/loans   1.44%   1.06%   35.9%
Allowance/nonperforming loans   173.22%   137.35%   26.1%

 

Nonperforming assets consisting of loans, Other Real Estate Owned (“OREO”) and accruing TDRs totaled $7.3 million, or 0.58 percent of total assets at December 31, 2020, an increase of $0.6 million or 8.7 percent from 2019. Net charge offs were up during 2020, at $0.68 million, which was a $0.47 million increase compared to 2019. The Company’s loan loss allowance at December 31, 2020, now covers nonperforming loans at 174 percent, up from 137 percent at December 31, 2019.

 

As detailed in the risk factors, the CARES Act provided for significant consumer and small business relief due to the impact of the COVID-19 pandemic. The Company provided payment relief to a number of consumer and small business customers throughout 2020. As detailed in the table below, loans in forbearance/deferral status as of December 31, 2020 were $23.2 million. An additional $11.7 million of sold mortgage relationships were also in deferral at year-end.

 

Loans in Deferral Status              Linked Qtr. 
($ in thousands, except ratios)  Dec. 2020   Sep. 2020   Jun. 2020   Change 
Total Commercial  $23,175   $36,366   $142,682   $(13,191)
Total Consumer   -    28    350    (28)
Total Portfolio Mortgage   -    1,959    10,274    (1,959)
Total Balance Sheet Deferrals  $23,175   $38,353   $153,306   $(15,178)
% of Total loans   2.66%   4.33%   17.00%   -1.67%
                     
Total Sold Mortgage  $11,685   $42,317   $41,751   $(30,632)

 

Regulatory capital reporting is required for State Bank only, as the Company is now exempt from quarterly regulatory capital level measurement pursuant to the Small Bank Holding Company Policy Statement. As of December 31, 2020, State Bank met all regulatory capital levels required to be considered well-capitalized (See Note 17 to the Consolidated Financial Statements).

 

Earnings Summary – 2020 vs. 2019

 

Net income for 2020 was $14.9 million, or $1.96 per diluted share, compared with net income of $12.0 million and net income available to common of $11.0 million, or $1.51 per diluted share, for 2019. State Bank reported net income for 2020 of $16.0 million, which was up from the $12.5 million in net income in 2019. SBFG Title reported net income for 2020 of $0.6 million, which was up from the $0.3 million in 2019.

 

Positive results for 2020 included loan growth of $47.2 million, and deposit growth of $208.8 million. The mortgage banking business line continues to contribute significant revenues, with residential real estate loan production of $694.2 million for the year, resulting in $25.4 million of revenue from gains on sale. The level of mortgage origination was up from the $445.3 million in 2019. The Company’s loans serviced for others ended the year at $1.3 billion, up from $1.2 billion at December 31, 2019. The Company realized over $1.4 million in revenue from the PPP initiative.

 

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Operating revenue was up compared to the prior year by $13.2 million, or 25.0 percent, which was impacted by a $3.6 million temporary OMSR impairment. Our 2020 results include the full year impact from SBFG Title with net income of $0.6 million, and SB Captive, with net income of $0.9 million. Net interest margin on a fully tax equivalent basis (“FTE”) for 2020 was 3.36 percent, down 46 basis points from 2019.

 

Operating expense was up compared to the prior year by $5.7 million, or 15.2 percent, due to compensation and fringe benefit cost increases as a result of higher mortgage commission levels. Operating leverage (growth in revenue divided by growth in operating expense) for the year was a positive 1.6 times.

 

Net charge offs for 2020 of $0.68 million resulted in a loan loss provision of $4.5 million, compared to net charge offs of $0.21 million and a $0.8 million loan loss provision in 2019.

 

Results of Operations

 

   Years Ended December 31, 
($ in thousands, except per share data)  2020   2019   % Change 
Total assets  $1,257,839   $1,038,577    21.1%
Total investments   149,406    100,948    48.0%
Loans held for sale   7,234    7,258    -0.3%
Loans, net of unearned income   872,723    825,510    5.7%
Allowance for loan losses   12,574    8,755    43.6%
Total deposits   1,049,011    840,219    24.8%
                
Total operating revenue1  $66,026   $52,842    24.9%
Net interest income   35,930    34,826    3.2%
Loan loss provision   4,500    800    462.5%
Noninterest income   30,096    18,016    67.1%
Noninterest expense   43,087    37,410    15.2%
Net income   14,944    11,973    24.8%
Net income available to common shareholders   14,944    11,023    35.6%
Diluted earnings per share   1.96    1.51    29.8%

 

1Operating revenue equals net interest income plus noninterest income.

 

Net Interest Income  Years Ended December 31, 
($ in thousands)  2020   2019   % Change 
Total net interest income  $35,930   $34,826    3.2%

 

Net interest income was $35.9 million for 2020 compared to $34.8 million for 2019, an increase of $1.1 million or 3.2 percent. Average earning assets increased to $1.07 billion in 2020, compared to $915.0 million in 2019, an increase of $157.4 million or 17.2 percent due to higher loan volume. The consolidated 2020 full year net interest margin on an FTE basis decreased 46 basis points to 3.36 percent compared to 3.82 percent for the full year of 2019. PPP activity during 2020 increased margin revenue by $2.0 million for the full year of 2020. We will continue to realize fee income from the forgiveness of these Phase I PPP loans throughout 2021 and we are beginning Phase II of the program in early 2021.

 

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Provision for loan losses of $4.5 million was taken in 2020 compared to $0.8 million taken for 2019. For 2020, net charge offs totaled $0.68 million, or 0.08 percent of average loans. This charge off level was higher than 2019, in which net charge offs were $0.21 million or 0.03 percent of average loans.

 

Noninterest Income  Years Ended December 31, 
($ in thousands)  2020   2019   % Change 
Wealth management fees  $3,245   $3,093    4.9%
Customer service fees   2,807    2,761    1.7%
Gains on sale of residential loans & OMSR’s   25,350    8,413    201.3%
Mortgage loan servicing fees, net   (5,138)   (397)   1194.2%
Gain on sale of non-mortgage loans   453    1,255    -63.9%
Title Insurance income   1,913    1,120    70.8%
Net gain on sale of securities   -    206    N/M 
Gain (loss) on sale/disposal of assets   3    (5)   -160.0%
Other   1,463    1,570    -6.8%
Total noninterest income  $30,096   $18,016    67.1%

 

Total noninterest income was $30.1 million for 2020 compared to $18.0 million for 2019, representing an increase of $12.1 million, or 67.0 percent, year-over-year. This increase was driven by a 201.3 percent increase in gains on sale of residential real estate loans and the addition of our title agency. The Company sold $598.5 million of originated mortgages into the secondary market in 2020, which allowed our serviced loan portfolio to grow to $1.3 billion at December 31, 2020 from $1.2 billion at December 31, 2019. The higher servicing balance of the portfolio led to the 13.7 percent increase in mortgage loan servicing income. Sales of non-mortgage loans (small business and farm credits) decreased in 2020 as compared to 2019, as SBA activity was focused on the PPP initiative. The Company continued to expand its wealth management assets under care, which resulted in a 4.9 percent increase in wealth fee income.

 

Noninterest Expense  Years Ended December 31, 
($ in thousands)  2020   2019   % Change 
Salaries & employee benefits  $25,397   $22,064    15.1%
Net occupancy expense   2,891    2,603    11.1%
Equipment expense   3,186    2,828    12.7%
Data processing fees   3,055    1,973    54.8%
Professional fees   3,307    2,476    33.6%
Marketing expense   658    895    -26.5%
Telephone and communications   535    466    14.8%
Postage and delivery expense   415    340    22.1%
State, local and other taxes   1,146    1,092    4.9%
Employee expense   535    795    -32.7%
Other expense   1,962    1,878    4.5%
Total noninterest expense  $43,087   $37,410    15.2%

 

Total noninterest expense was $43.1 million for 2020 compared to $37.4 million for 2019, representing a $5.7 million, or 15.2 percent, increase year-over-year. Total full-time equivalent employees ended 2020 at 244, which was down 8 from year end 2019.

 

Salaries and benefits were driven by higher compensation costs in the mortgage division. Professional fees were higher due to higher spending on legal in connection with acquisition activities. The addition of our title agency added $0.5 million in operating expense for the year. Our acquisition of The Edon State Bank Company of Edon, Ohio in June 2020 added $1.2 million in merger related non-recurring expense and a minimal amount of ongoing operating expense. (See Notes 3 and 8 to the Consolidated Financial Statements for additional information)

 

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Earnings Summary – 2019 vs. 2018

 

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

 

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

 

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

 

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

 

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

 

Goodwill, Intangibles and Capital Purchases

 

The Company completed its most recent annual goodwill impairment test as of December 31, 2020. At December 31, 2020, the Company’s reporting unit was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment. The main changes to goodwill for the year included the purchase of the Edon State Bank. The Company’s goodwill is further reviewed in Note 8 to the Consolidated Financial Statements.

 

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

 

Liquidity

 

Liquidity relates primarily to the Company’s ability to fund loan demand, meet deposit customers’ withdrawal requirements and provide for operating expenses. Sources used to satisfy these needs consist of cash and due from banks, interest-bearing deposits in other financial institutions, securities available-for-sale, loans held for sale and borrowings from various sources. These assets, excluding the borrowings, are commonly referred to as liquid assets. Liquid assets were $303.2 million at December 31, 2020, compared to $135.3 million at December 31, 2019.

 

The Company’s commercial real estate, first mortgage residential, agricultural and multi-family mortgage portfolio of $608.4 million at December 31, 2020, can and is readily used to collateralize borrowings, which is an additional source of liquidity. Management believes the Company’s current liquidity level, without these borrowings, is sufficient to meet its current and anticipated liquidity needs. At December 31, 2020, all eligible commercial real estate, residential first, multi-family mortgage and agricultural loans were pledged under a Federal Home Loan Bank (“FHLB”) blanket lien.

 

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Significant additional off-balance-sheet liquidity is available in the form of FHLB advances, unused federal funds lines from correspondent banks and the national certificate of deposit market. Management expects the risk of changes in off-balance-sheet arrangements to be immaterial to earnings. Based on the current collateralization requirements of the FHLB, approximately $103.5 million of additional borrowing capacity existed at December 31, 2020.

 

At December 31, 2020 and 2019, the Company had $41.0 million in federal funds lines available. The Company also had $67.5 million in unpledged securities at December 31, 2020 available for additional borrowings.

 

The cash flow statements for the periods presented provide an indication of the Company’s sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. A discussion of the cash flow statements for 2020 and 2019 follows:

 

The Company experienced positive cash flows from operating activities in 2020 and 2019. Net cash from operating activities was $23.9 million and $18.8 million for the years ended December 31, 2020 and 2019, respectively. Significant operating items for 2020 included gain on sale of loans of $25.8 million and net income of $14.9 million. Cash provided by the sale of loans held for sale were $603.2 million. Cash used in the origination of loans held for sale were $582.5 million.

 

The Company experienced negative cash flows from investing activities in 2020 and 2019. Net cash used in investing activities was $57.2 million and $67.6 million for the years ended December 31, 2020 and 2019, respectively. The changes for 2020 include the purchase of available-for-sale securities of $129.8 million, and net increase in loans of $31.7 million. The changes for 2019 include the purchase of available-for-sale securities of $22.5 million and net increase in loans of $65.5 million. The Company had proceeds from repayments, maturities, sales and calls of securities of $84.0 million and $22.5 million in 2020 and 2019, respectively.

 

The Company experienced positive cash flows from financing activities in 2020 and 2019. Net cash from financing activities was $146.9 million and $27.5 million for the years ended December 31, 2020 and 2019, respectively. Positive cash flows of $157.7 million and $37.7 million is attributable to the change in deposits for 2020 and 2019, respectively.

 

The Company uses an Economic Value of Equity (“EVE”) analysis to measure risk in the balance sheet incorporating all cash flows over the estimated remaining life of all balance sheet positions. The EVE analysis calculates the net present value of the Company’s assets and liabilities in rate shock environments that range from -400 basis points to +400 basis points. The results of this analysis are reflected in the following table.

 

43

 

 

Economic Value of Equity

December 31, 2020

($ in thousands)

 

Change in rates  $ Amount   $ Change   % Change 
+400 basis points  $243,779   $61,586    33.80%
+300 basis points   231,590    49,398    27.11%
+200 basis points   217,936    35,743    19.62%
+100 basis points   202,260    20,067    11.01%
Base Case   182,193    -    - 
-100 basis points   154,509    (27,684)   -15.19%

 

Economic Value of Equity

December 31, 2019

($ in thousands)

 

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

 

Tabular Disclosure of Contractual Obligations

 

The following table details the Company’s contractual obligations as of December 31, 2020, which were comprised of long-term debt obligations, other debt obligations, operating lease obligations and other long-term liabilities. Long-term debt obligations are comprised of FHLB Advances of $8.0 million. Other debt obligations are comprised of Trust Preferred securities of $10.3 million and operating leases of $1.6 million. The other long-term liabilities include time deposits of $229.5 million.

 

   Payment due by period 
($ in thousands)      Less than   1 - 3   3 - 5   More than 
Contractual obligations  Total   1 year   years   years   5 years 
Long-term debt obligations  $8,000   $2,500   $5,500   $-   $- 
                          
Other debt obligations   10,310    -    -    -    10,310 
                          
Operating lease obligations   1,611    195    276    257    883 
                          
Other long-term liabilities Reflected on the registrant’s balance sheet under GAAP   229,549    156,761    65,917    6,689    182 
                          
Totals  $249,470   $159,456   $71,693   $6,946   $11,375 

 

44

 

 

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

 

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

 

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

 

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

 

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

 

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

 

There are several ways an institution can manage interest rate risk including: 1) matching repricing periods for new assets and liabilities, for example, by shortening or lengthening terms of new loans, investments, or liabilities; 2) selling existing assets or repaying certain liabilities; and 3) hedging existing assets, liabilities, or anticipated transactions. An institution might also invest in more complex financial instruments intended to hedge or otherwise change interest rate risk. Interest rate swaps, futures contracts, options on futures contracts, and other such derivative financial instruments can be used for this purpose. Because these instruments are sensitive to interest rate changes, they require management’s expertise to be effective. The Company has not purchased derivative financial instruments in the past, but during 2019 and 2018 the Company entered into interest rate swap agreements as an accommodation to certain loan customers (see Note 10 to the Consolidated Financial Statements). The Company may purchase such instruments in the future if market conditions are favorable.

 

The following table details quantitative disclosures of market risk and provides information about the Company’s financial instruments used for purposes other than trading that are sensitive to changes in interest rates as of December 31, 2020. The table does not present when these items may actually reprice. For loans receivable, securities, and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities as well as the historical impact of interest rate fluctuations on the prepayment of loans and mortgage backed securities. For core deposits (demand deposits, interest-bearing checking, savings, and money market deposits) that have no contractual maturity, the table presents principal cash flows and applicable related weighted-average interest rates based upon the Company’s historical experience, management’s judgment and statistical analysis, as applicable, concerning their most likely withdrawal behaviors. The current historical interest rates for core deposits have been assumed to apply for future periods in this table as the actual interest rates that will need to be paid to maintain these deposits are not currently known. Weighted-average variable rates are based upon contractual rates existing at the reporting date.

45

 

 

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

 

($ in thousands)  2021   2022   2023   2024   2025   Thereafter   Total 
Rate sensitive assets                            
Variable rate loans  $77,748   $27,786   $14,253   $11,861   $13,649   $74,207   $219,504 
Average interest rate   3.91%   3.61%   3.50%   3.12%   3.10%   2.71%   3.35%
Adjustable rate loans   29,892    27,155    25,048    24,771    23,568    220,525    350,959 
Average interest rate   4.41%   4.42%   4.27%   4.20%   4.17%   4.07%   4.15%
Fixed rate loans   49,655    76,172    32,715    16,641    15,855    111,222    302,260 
Average interest rate   3.51%   2.25%   4.57%   4.44%   4.13%   3.89%   3.53%
Total loans   157,295    131,113    72,016    53,273    53,072    405,954    872,723 
Average interest rate   3.88%   2.99%   4.25%   4.03%   3.88%   3.77%   3.73%
Fixed rate investment securities   32,367    13,758    8,658    8,318    6,540    83,065    152,706 
Average interest rate   1.17%   1.60%   1.81%   2.09%   2.07%   1.91%   1.73%
Variable rate investment securities   96    96    101    105    84    1,522    2,004 
Average interest rate   2.74%   2.75%   2.74%   2.73%   2.61%   3.34%   3.19%
Fed funds sold & other   -    -    -    -    -    -    - 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Total rate sensitive assets  $189,758   $144,967   $80,775   $61,696   $59,696   $490,541   $1,027,433 
Average interest rate   3.41%   2.85%   3.99%   3.77%   3.68%   3.45%   3.44%

 

Rate sensitive liabilities                                   
Demand - noninterest bearing  $35,520   $30,506   $26,201   $22,501   $19,327   $117,594   $251,649 
Demand - interest-bearing   21,032    18,529    16,326    14,383    12,673    93,842    176,785 
Average interest rate   0.04%   0.04%   0.04%   0.04%   0.04%   0.04%   0.04%
Money market accounts   27,097    23,702    20,731    18,131    15,859    110,644    216,164 
Average interest rate   0.29%   0.29%   0.29%   0.29%   0.29%   0.29%   0.29%
Savings   75,796    12,833    11,168    9,722    8,461    56,884    174,864 
Average interest rate   0.13%   0.13%   0.13%   0.13%   0.13%   0.13%   0.13%
Certificates of deposit   156,843    47,367    18,253    4,328    2,482    276    229,549 
Average interest rate   1.51%   1.57%   1.65%   1.09%   0.62%   0.99%   1.51%
Fixed rate FHLB advances   2,500    3,000    2,500    -    -    -    8,000 
Average interest rate   2.77%   2.88%   2.93%   0.00%   0.00%   0.00%   2.86%
Variable rate FHLB advances   -    -    -    -    -    -    - 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Fixed rate notes payable   -    -    -    -    -    -    - 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Variable rate notes payable   -    -    -    -    -    10,310    10,310 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   2.02%   2.02%
Fed funds purchased, repos & other   20,189    -    -    -    -    -    20,189 
Average interest rate   0.20%   0.00%   0.00%   0.00%   0.00%   0.00%   0.20%
Total rate sensitive liabilities  $338,977   $135,937   $95,179   $69,065   $58,802   $389,550   $1,087,510 
Average interest rate   0.78%   0.68%   0.48%   0.17%   0.13%   0.17%   0.45%

 

Comparison of 2020 to 2019

 

   First   Years         
($ in thousands)  Year   2 - 5   Thereafter   Total 
Total rate sensitive assets:                
December 31, 2020  $189,758   $347,134   $490,541   $1,027,433 
December 31, 2019   164,736    300,359    466,010    931,105 
Increase (decrease)  $25,022   $46,775   $24,531   $96,328 
                     
Total rate sensitive liabilities:                    
December 31, 2020  $338,977   $358,983   $389,550   $1,087,510 
December 31, 2019   286,957    310,950    281,567    879,474 
Increase (decrease)  $52,020   $48,033   $107,983   $208,036 

 

46

 

 

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

 

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

 

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

 

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

 

Item 8. Financial Statements and Supplementary Data.

 

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

 

47

 

 

SB Financial Group, Inc.

Consolidated Balance Sheets

at December 31,

 

($ in thousands)        
   2020   2019 
Assets        
Cash and due from banks  $140,690   $27,064 
Interest bearing time deposits   5,823    - 
Available-for-sale securities   149,406    100,948 
Loans held for sale   7,234    7,258 
Loans, net of unearned income   872,723    825,510 
Allowance for loan losses   (12,574)   (8,755)
Premises and equipment, net   23,557    23,385 
Federal Reserve and Federal Home Loan Bank Stock, at cost   5,303    4,648 
Foreclosed assets held for sale, net   23    305 
Interest receivable   3,799    3,106 
Goodwill   22,091    17,792 
Cash value of life insurance   17,530    17,221 
Mortgage servicing rights   7,759    11,017 
Other assets   14,475    9,078 
Total assets  $1,257,839   $1,038,577 
           
Liabilities and shareholders’ equity          
           
Liabilities          
Deposits          
Non interest bearing demand  $251,649   $158,357 
Interest bearing demand   176,785    131,084 
Savings   174,864    119,359 
Money market   216,164    173,666 
Time deposits   229,549    257,753 
Total deposits   1,049,011    840,219 
           
Repurchase agreements   20,189    12,945 
Federal Home Loan Bank advances   8,000    16,000 
Trust preferred securities   10,310    10,310 
Interest payable   616    1,191 
Other liabilities   26,790    21,818 
Total liabilities   1,114,916    902,483 
           
Commitments & Contingent Liabilities   -    - 
           
Shareholders’ Equity          
Preferred stock, no par value; authorized 200,000 shares; 2020 - 0 shares outstanding, 2019 - 0 shares outstanding   -    - 
Common stock, no par value; authorized 10,000,000 shares; 2020 - 8,180,712 shares issued, 2019 - 8,180,712 shares issued   54,463    54,463 
Additional paid-in capital   14,845    15,023 
Retained earnings   84,578    72,704 
Accumulated other comprehensive income   2,210    659 
Treasury stock, at cost; (2020 - 808,456 common shares, 2019 - 417,785 common shares)   (13,173)   (6,755)
Total shareholders’ equity   142,923    136,094 
Total liabilities and shareholders’ equity  $1,257,839   $1,038,577 

 

See Notes to Consolidated Financial Statements

 

F-1

 

 

SB Financial Group, Inc.

Consolidated Statements of Income

Years Ended December 31,

 

($ in thousands, except per share data)  2020   2019 
Interest Income        
Loans        
Taxable  $39,735   $40,529 
Tax exempt   239    300 
Securities          
Taxable   2,328    3,226 
Tax exempt   333    345 
Total interest income   42,635    44,400 
           
Interest Expense          
Deposits   6,070    8,660 
Repurchase agreements & other   70    82 
Federal Home Loan Bank advance expense   309    402 
Trust preferred securities expense   256    430 
Total interest expense   6,705    9,574 
           
Net Interest Income   35,930    34,826 
Provision for loan losses   4,500    800 
           
Net interest income after provision for loan losses   31,430    34,026 
           
Noninterest Income          
Wealth management fees   3,245    3,093 
Customer service fees   2,807    2,761 
Gain on sale of mortgage loans & OMSR   25,350    8,413 
Mortgage loan servicing fees, net   (5,138)   (397)
Gain on sale of non-mortgage loans   453    1,255 
Title insurance income   1,913    1,120 
Net gain on sale of securities   -    206 
Other income   1,466    1,565 
Total noninterest income   30,096    18,016 
           
Noninterest Expense          
Salaries and employee benefits   25,397    22,064 
Net occupancy expense   2,891    2,603 
Equipment expense   3,186    2,828 
Data processing fees   3,055    1,973 
Professional fees   3,307    2,476 
Marketing expense   658    895 
Telephone and communications   535    466 
Postage and delivery expense   415    340 
State, local and other taxes   1,146    1,092 
Employee expense   535    795 
Other expense   1,962    1,878 
Total noninterest expense   43,087    37,410 
           
Income before income tax   18,439    14,632 
Provision for income taxes   3,495    2,659 
Net Income  $14,944   $11,973 
           
Preferred share dividends   -    950 
Net income available to common shareholders  $14,944   $11,023 
Basic earnings per common share  $1.96   $1.71 
Diluted earnings per common share  $1.96   $1.51 

 

See Notes to Consolidated Financial Statements

 

F-2

 

 

SB Financial Group, Inc.

Consolidated Statements of Comprehensive Income

Years Ended December 31,

 

($ in thousands)  2020   2019 
         
Net income  $14,944   $11,973 
Other comprehensive income          
Available for sale investment securities:          
Gross unrealized holding gain arising in the period   1,963    1,327 
Related tax expense   (412)   (279)
Less: reclassification adjustment for gain realized in income   -    206 
Related tax expense   -    (43)
Net effect on other comprehensive income   1,551    1,211 
Total comprehensive income  $16,495   $13,184 

 

See Notes to Consolidated Financial Statements

 

F-3

 

 

SB Financial Group, Inc.

Consolidated Statements of Stockholders’ Equity

Years Ended December 31,

 

   Preferred   Common   Additional
Paid-in
   Retained   Accumulated
Other
Comprehensive
   Treasury     
($ in thousands, except per share data)  Stock   Stock   Capital   Earnings   Income (Loss)   Stock   Total 
January 1, 2020  $    -   $54,463   $15,023   $72,704   $659   $(6,755)  $136,094 
Net income                  14,944              14,944 
Other comprehensive income                       1,551         1,551 
Dividends on common, $0.40 per share                  (3,070)             (3,070)
Restricted stock vesting             (307)             307    - 
Stock options exercised             (253)             441    188 
Repurchased stock                            (7,166)   (7,166)
Stock based compensation expense             382                   382 
December 31, 2020  $-   $54,463   $14,845   $84,578   $2,210   $(13,173)  $142,923 

 

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

 

See Notes to Consolidated Financial Statements

 

F-4

 

 

SB Financial Group, Inc.

Consolidated Statements of Cash Flows

Years Ended December 31,

 

($ in thousands)    
   2020   2019 
Operating Activities        
Net Income  $14,944   $11,973 
Items not requiring (providing) cash          
Depreciation and amortization   1,937    1,879 
Provision for loan losses   4,500    800 
Expense of share-based compensation plan   382    417 
Amortization of premiums and discounts on securities   643    314 
Amortization of intangible assets   46    8 
Amortization of originated mortgage servicing rights   4,762    2,126 
Impairment of mortgage servicing rights   3,586    1,094 
Deferred income taxes   (2,444)   (279)
Proceeds from sale of loans held for sale   603,178    368,154 
Originations of loans held for sale   (582,538)   (364,472)
Gain from sale of loans   (25,803)   (9,668)
Loss (gain) on sales of assets   (2)   5 
Net gains on sales of securities   -    (206)
Changes in          
Interest receivable   (693)   (284)
Other assets   (5,209)   (3,680)
Interest payable & other liabilities   6,618    10,648 
Net cash provided by operating activities   23,907    18,829 
Investing Activities          
Purchases of available-for-sale securities   (129,796)   (38,455)
Proceeds from maturities of interest bearing time deposits   5,719    - 
Proceeds from maturities of available-for-sale securities   84,021    22,527 
Proceeds from sales of available-for-sale securities   -    7,375 
Proceeds from sales of portfolio loans   -    11,265 
Net change in loans   (31,706)   (65,504)
Purchase of premises, equipment   (1,980)   (2,043)
Proceeds from sales of premises, equipment   301    24 
Purchase of bank owned life insurance   -    (50)
Purchase of Federal Reserve and Federal Home Loan Bank Stock   (538)   (525)
Proceeds from sale of foreclosed assets   500    372 
Acquisition, net of cash acquired   16,263    (2,600)
Net cash used in investing activities   (57,216)   (67,614)
Financing Activities          
Net increase in demand deposits, money market, interest checking & savings accounts   195,501    21,376 
Net increase (decrease) in time deposits   (37,762)   16,291 
Net increase (decrease) in securities sold under agreements to repurchase   7,244    (2,239)
Repayment of Federal Home Loan Bank advances   (8,000)   - 
Net proceeds from share-based compensation plans   188    251 
Stock repurchase plan   (7,166)   (5,050)
Issuance of common shares   -    139 
Conversion of preferred stock   -    (1)
Dividends on common shares   (3,070)   (2,331)
Dividends on preferred shares   -    (950)
Net cash provided by financing activities   146,935    27,486 
Increase (decrease) in cash and cash equivalents   113,626    (21,299)
Cash and cash equivalents, beginning of year   27,064    48,363 
Cash and cash equivalents, end of year  $140,690   $27,064 
Supplemental cash flow information          
Interest paid  $7,280   $9,292 
Income taxes paid  $5,180   $3,084 
Fair value of assets acquired - premises and equipment (Peak Title)  $-   $1,161 
Supplemental non-cash disclosure          
Initial recognition of right-of-use lease assets  $248   $293 
Transfer of loans to loans held for sale  $-   $11,114 
Transfer of loans to foreclosed assets  $207   $551 
In conjunction with the Edon acquisition, liabilities assumed were:          
Fair value of assets acquired  $66,769   $- 
Cash paid in acquisition   (15,493)   - 
Liabilities assumed  $51,276   $- 

 

See Notes to Consolidated Financial Statements

F-5

 

 

SB Financial Group, Inc.

Notes to Consolidated Financial Statements

Years Ended December 31, 2020 and 2019

 

Note 1: Organization and Summary of Significant Accounting Policies

 

Organization and Nature of Operations

 

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

 

Principles of Consolidation

 

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

 

Use of Estimates

 

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

 

Cash Equivalents

 

The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2020 and 2019, cash equivalents consisted primarily of interest-bearing and noninterest bearing demand deposit balances held by correspondent banks.

 

At December 31, 2020, the Company’s correspondent cash accounts exceeded federally insured limits by $10.6 million. Additionally, the Company had approximately $115.9 million of cash held by the FRB and the FHLB, which is not federally insured.

 

Securities

 

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

 

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

 

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

 

F-6

 

 

Mortgage Loans Held for Sale

 

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

 

Loans

 

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

 

Allowance for Loan Losses

 

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

 

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

 

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

 

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

 

F-7

 

 

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

 

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

 

Premises and Equipment

 

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

 

Long-lived Asset Impairment

 

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

 

Federal Reserve Bank and Federal Home Loan Bank Stock

 

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

 

Foreclosed Assets Held for Sale

 

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

 

Goodwill

 

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

 

Core Deposits and Other Intangibles

 

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

 

Derivatives

 

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

 

F-8

 

 

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

 

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

 

Mortgage Servicing Rights

 

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

 

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

 

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

 

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

 

Share-Based Employee Compensation Plan

 

At December 31, 2020 and 2019, the Company had a share-based employee compensation plan (see Note 19 to the Consolidated Financial Statements).

 

Transfers of Financial Assets

 

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

 

F-9

 

 

Income Taxes

 

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

 

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

 

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

 

The Company files consolidated income tax returns with its subsidiaries. With a few exceptions, the Company is no longer subject to U.S. Federal, State and Local examinations by tax authorities for the years before 2017. As of December 31, 2020, the Company had no uncertain income tax positions.

 

Treasury Shares

 

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

 

Earnings Per Share

 

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

 

Comprehensive Income

 

Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes. Other comprehensive income includes unrealized appreciation (depreciation) on available-for-sale securities. AOCI consists solely of the cumulative unrealized gains and losses on available-for-sale securities net of income tax.

 

F-10

 

 

Revenue Recognition

 

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

 

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

 

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

 

New and applicable accounting pronouncements:

 

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

 

This ASU simplifies the test for goodwill impairment. Specifically, these amendments eliminate Step 2 from the goodwill impairment test, and also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The Company has adopted this ASU, and management did not believe the changes will have a material effect on the Company’s accounting and disclosures.

 

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

 

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

 

Accounting standards not yet adopted:

 

ASU No. 2020-04: Reference Rate Reform – Facilitation of the Effects of Reference Rate Reform on Financial Reporting (Topic 848)

 

This guidance provides temporary options to ease the potential burden in accounting for reference rate reform. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective as of March 12, 2020 through December 31, 2022. The Company anticipates being fully prepared to implement a replacement for the reference rate and has determined that any change will not have a material impact to the consolidated financial statements.

 

F-11

 

 

ASU No. 2020-01: Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323 and Topic 815

 

This guidance was issued in January 2020 to clarify that a company should consider observable transactions that require a company to either apply or discontinue the equity method of accounting under Topic 323, Investments-Equity Method and Joint Ventures, for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify that when determining the accounting for certain forward contracts and purchased options a company should not consider, whether upon settlement or exercise, if the underlying securities would be accounted for under the equity method or fair value option. The guidance is effective beginning after December 15, 2020. The Company is currently assessing the impact on its accounting and disclosures.

 

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

 

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

 

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

 

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

 

On November 15, 2019, the FASB delayed the effective date for certain small public companies and other private companies. As the Company is currently a smaller reporting company, the amendment will delay the effective date of ASU No. 2016-13 to the fiscal year beginning January 1, 2023.

 

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

 

Reclassifications:

 

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

 

F-12

 

 

Note 2: Earnings Per Share

 

Earnings per common share (“EPS”) is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the applicable period, excluding participating securities. Participating securities include non-vested restricted stock awards. Non-vested restricted stock awards are considered participating securities to the extent the holders of these securities receive non-forfeitable dividends at the same rate as holders of common shares. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share plus the convertible impact of preferred shares and the dilutive effect of stock compensation using the treasury stock method. EPS for the years ended December 31, 2020 and 2019 is computed as follows:

 

   Twelve Months Ended Dec. 31, 
($ and outstanding shares in thousands - except per share data)  2020   2019 
Distributed earnings allocated to common shares  $3,070   $2,331 
Undistributed (in excess of) earnings allocated to common shares   11,858    8,675 
Net earnings allocated to common shares   14,928    11,006 
Net earnings allocated to participating securities   16    17 
Dividends on convertible preferred shares   -    950 
Net Income allocated to common shares and participating securities  $14,944   $11,973 
           
Weighted average shares outstanding for basic earnings per share   7,613    6,456 
Dilutive effect of stock compensation   22    46 
Dilutive effect of convertible shares   -    1,433 
Weighted average shares outstanding for diluted earnings per share   7,635    7,935 
           
Basic earnings per common share  $1.96   $1.71 
           
Diluted earnings per common share  $1.96   $1.51 

 

There were no anti-dilutive shares in 2020 or 2019.

 

Note 3: Business Combination

 

Effective June 5, 2020, the Company acquired Edon Bancorp and its subsidiary, The Edon State Bank Company of Edon, Ohio. Edon Bancorp was headquartered in Edon, Ohio and had one retail banking office. The Edon State Bank was merged with and into State Bank, with State Bank surviving. Under the terms of the merger agreement, shareholders of Edon received fixed consideration of $103.50 in cash for each share of Edon common stock for total consideration of $15.5 million. The Company accounted for the transaction under the acquisition method of accounting, which means that the acquired assets and liabilities were recorded at fair value at the date of acquisition.

 

In accordance with ASC 805, the Company expensed approximately $1.2 million of direct acquisition costs during the twelve months ended December 31, 2020. The $1.2 million in merger expense was split between data processing and professional fees expense. As a result of the acquisition, the Company recorded $4.3 million of goodwill and $0.7 million of intangible assets in the second quarter of 2020. The Company was able to increase both its deposit and loan base and acquire new households in a new market. It is expected that this transaction will result in business synergies and economies of scale. The acquisition was consistent with the Company’s strategy to expand its presence in Northwest Ohio and to increase profitability by introducing existing products and services to the acquired customer base. The intangible assets are related to core deposits, which are being amortized over 10 years on a straight-line basis. For tax purposes, goodwill is non-deductible but will be evaluated annually for impairment.

 

F-13

 

 

The following table summarizes the fair value of the total consideration transferred as part of the acquisition as well as the fair value of identifiable assets and liabilities assumed as of the effective date of the transaction based on assumptions that are subject to change as management continues to evaluate relevant information as it becomes available. If, prior to the end of the one-year measurement period for finalizing the purchase price allocation, relevant information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be recorded in the reporting period in which the adjustment amounts are determined. Potential adjustments, if any, will be related to assets that may have changes to valuation amounts that were not readily determinable at the acquisition date.

 

The contractual principal of loans at the acquisition date was $16.8 million and the estimate of the contractual cash flows not expected to be collected is $0.4 million.

 

($ in thousands)  June 5,
2020
 
Fair value of assets acquired    
     
Cash and cash equivalents  $31,756 
Interest bearing time deposits   11,542 
Investment securities   1,362 
Federal Home Loan Bank stock   117 
Loans held for investment   16,395 
Premises and equipment   446 
Goodwill   4,299 
Core deposit intangible   660 
Other assets   192 
Total assets acquired  $66,769 
      
Fair value of liabilities assumed     
      
Deposits  $51,053 
Other liabilities   223 
Total liabilities assumed   51,276 
Total purchase price (cash)  $15,493 

 

F-14

 

 

Pro Forma Financial Information

 

The results of operations of Edon Bancorp have been included in the Company’s consolidated financial statements since the acquisition date of June 5, 2020. The following schedule includes the pro forma results for the three and twelve months ended December 31, 2020 and 2019, as if the Edon acquisition had occurred as of the beginning of the reporting periods presented. The acquisition’s impact was immaterial to the Company’s operating performance for the twelve months ended December 31, 2020.

 

   Twelve Months Ended
December 31
 
Summary of Operations ($ in thousands)  2020   2019 
         
Net interest income  $36,429   $36,307 
Provision for loan losses   4,500    806 
Net interest income after provision  $31,929   $35,501 
           
Non interest income   30,140    18,132 
Non interest expense   44,158    38,484 
Income before income taxes  $17,911   $15,149 
Income tax expense*   3,384    2,768 
Net income  $14,527   $12,381 
Preferred share dividends   -    487 
           
Net income to common shareholders  $14,527   $11,894 
Basic earnings per share  $1.90   $1.84 
Diluted earnngs per share  $1.90   $1.56 

 

*Income tax expense for Edon calculated using a 21% statuatory rate

 

Certain nonrecurring costs were included in the pro-forma, specifically $0.7 million was incurred by Edon prior to the acquisition in the 2020 fiscal year and the Company incurred $1.2 million in nonrecurring costs for the acquisition in the 2020 fiscal year. The Company and Edon incurred no acquisition related costs for the 2019 fiscal year.

 

Note 4: Available-for-Sale Securities

 

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

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized     
($ in thousands)  Cost   Gains   Losses   Fair Value 
December 31, 2020:                
U.S. Treasury and Government agencies  $6,541   $323   $-   $6,864 
Mortgage-backed securities   125,973    1,845    (57)   127,761 
State and political subdivisions   11,595    680    -    12,275 
Other corporate securities   2,500    6    -    2,506 
                     
Totals  $146,609   $2,854   $(57)  $149,406 

 

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

 

F-15

 

 

The amortized cost and fair value of securities available-for-sale at December 31, 2020, by contractual maturity, are shown below. Expected maturities differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   Amortized   Fair 
($ in thousands)  Cost   Value 
Within one year  $3,560   $3,630 
Due after one year through five years   3,681    3,760 
Due after five years through ten years   8,011    8,413 
Due after ten years   5,384    5,842 
    20,636    21,645 
Mortgage-backed securities   125,973    127,761 
           
Totals  $146,609   $149,406 

 

The fair value of securities pledged as collateral, to secure public deposits and for other purposes, was $53.7 million at December 31, 2020, and $34.8 million at December 31, 2019. Securities delivered for repurchase agreements (not included above) were $28.2 million at December 31, 2020 and $19.5 million at December 31, 2019.

 

There were no realized gains or losses on available-for-sale securities in 2020. Gross gains of $0.2 million was a reclassification from accumulated other comprehensive income and is included in the net gain on sales of securities for 2019. The related tax expense for net security gains for 2019 was $0.04 million and was a reclassification from accumulated other comprehensive income and is included in the income tax expense line in the income statement.

 

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2020 and 2019, was $27.3 million and $38.8 million, respectively, which was approximately 18 percent and 38 percent, respectively, of the Company’s available-for-sale investment portfolio.

 

Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary.

 

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

 

F-16

 

 

The following tables present securities with unrealized losses at December 31, 2020 and 2019:

 

   Less than 12 Months   12 Months or Longer   Total 
($ in thousands)
December 31, 2020
  Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
 
                         
U.S. Treasury and Government agencies  $-   $     -   $-   $    -   $-   $      - 
Mortgage-backed securities   26,582    (54)   717    (3)   27,299    (57)
State and political subdivisions   -    -    -    -    -    - 
Other corporate securities   -    -    -    -    -    - 
                               
Totals  $26,582   $(54)  $717   $(3)  $27,299   $(57)

 

   Less than 12 Months   12 Months or Longer   Total 
December 31, 2019  Fair Value   Unrealized Losses   Fair Value   Unrealized Losses   Fair Value   Unrealized Losses 
                         
U.S. Treasury and Government agencies  $872   $(1)  $2,598   $(1)  $3,470   $(2)
Mortgage-backed securities   30,692    (157)   4,264    (45)   34,956    (202)
State and political subdivisions   339    (1)   -    -    339    (1)
                               
Totals  $31,903   $(159)  $6,862   $(46)  $38,765   $(205)

 

The unrealized loss on the securities portfolio decreased by $0.15 million as of December 31, 2020, from the prior year. Management reviews these securities on a quarterly basis and has determined that no impairment exists. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation. When the Company does not intend to sell a debt security, and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income.

 

Note 5: Loans and Allowance for Loan Losses

 

The following tables present the categories of loans at December 31, 2020 and 2019:

 

   Total Loans   Nonaccrual Loans 
($ in thousands)  December 2020   December 2019   December 2020   December 2019 
Commercial & industrial  $204,767   $151,047   $902   $1,772 
Commercial real estate - owner occupied   113,169    98,488    1,450    1,362 
Commercial real estate - nonowner occupied   257,651    268,294    962    464 
Agricultural   55,235    50,994    -    - 
Residential real estate   182,165    193,159    2,704    1,635 
Home equity line of credit (HELOC)   46,310    48,070    390    249 
Consumer   14,847    14,738    18    18 
Total loans  $874,144   $824,790   $6,426   $5,500 
                     
Net deferred costs (fees)  $(1,421)  $720           
                     
Total loans, net deferred costs (fees)  $872,723   $825,510           
                     
Allowance for loan losses  $(12,574)  $(8,755)          

 

F-17

 

 

The Company makes commercial, agri-business, consumer and residential loans to customers throughout its defined market area. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

Forward sale commitments are commitments to sell groups of residential mortgage loans that the Company originates or purchases as part of its mortgage banking activities. The Company commits to sell the loans at specified prices in a future period, typically within forty-five days. These commitments are acquired to reduce market risk on mortgage loans in the process of origination and mortgage loans held-for-sales since the Company is exposed to interest rate risk during the period between issuing a loan commitment and the sales of the loan into the secondary market.

 

Listed below is a summary of loan commitments, unused lines of credit and standby letters of credit as of December 31, 2020 and 2019.

 

($ in thousands)  2020   2019 
Loan commitments and unused lines of credit  $215,616   $187,855 
Standby letters of credit   3,161    2,657 
Totals  $218,777   $190,512 

 

There are various contingent liabilities that are not reflected in the consolidated financial statements, including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on the Company’s consolidated financial condition or results of operations.

 

The risk characteristics of each loan portfolio segment are as follows:

 

Commercial & Industrial and Agricultural

 

Commercial & industrial and agricultural loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may include a personal guarantee. Short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

F-18

 

 

Commercial Real Estate (Owner and Nonowner Occupied)

 

Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The characteristics of properties securing the Company’s commercial real estate portfolio are diverse, but with geographic location almost entirely in the Company’s market area. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In general, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate versus non-owner-occupied loans.

 

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

Residential Real Estate, Home Equity Line of Credit (“HELOC”) and Consumer

 

Residential and consumer loans consist of two segments – residential mortgage loans and personal loans. Residential mortgage loans are secured by 1-4 family residences and are generally owner-occupied, and the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. HELOCs are typically secured by a subordinate interest in 1-4 family residences, and consumer personal loans are secured by consumer personal assets, such as automobiles or recreational vehicles. Some consumer personal loans are unsecured, such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that these loans are of smaller individual amounts and spread over a large number of borrowers.

 

F-19

 

 

The following tables present the balance of the allowance for loan and lease losses (“ALLL”) and the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2020 and 2019:

 

($ in thousands)                        
For the Twelve Months Ended December 31, 2020  Commercial
& industrial
   Commercial
real estate
   Agricultural   Residential
real estate
   Consumer   Total 
                         
Beginning balance  $1,883   $3,602   $434   $2,203   $633   $8,755 
Charge offs   (582)   -    -    (82)   (79)   (743)
Recoveries   16    -    -    40    6    62 
Provision   1,757    1,849    62    373    459    4,500 
Ending balance  $3,074   $5,451   $496   $2,534   $1,019   $12,574 

 

December 31, 2020  Commercial
& industrial
   Commercial
real estate
   Agricultural   Residential
real estate
   Consumer   Total 
Allowance:                        
Ending balance:                        
individually evaluated for impairment  $-   $174   $-   $160   $3   $337 
Ending balance:                              
collectively evaluated for impairment  $3,074   $5,277   $496   $2,374   $1,016   $12,237 
                               
Totals  $3,074   $5,451   $496   $2,534   $1,019   $12,574 
                               
Loans:                              
Ending balance:                              
individually evaluated for impairment  $849   $2,202   $-   $2,746   $162   $5,959 
Ending balance:                              
collectively evaluated for impairment  $203,918   $368,618   $55,235   $179,419   $60,995   $868,185 
                               
Totals  $204,767   $370,820   $55,235   $182,165   $61,157   $874,144 

 

($ in thousands)
For the Twelve Months Ended December 31, 2019
  Commercial
& industrial
   Commercial
real estate
   Agricultural   Residential
real estate
   Consumer   Total 
                         
Beginning balance  $1,435   $2,923   $482   $2,567   $760   $8,167 
Charge offs   (143)   -    -    (53)   (63)   (259)
Recoveries   9    1    -    14    23    47 
Provision (credit)   582    678    (48)   (325)   (87)   800 
Ending balance  $1,883   $3,602   $434   $2,203   $633