Landmark Bancorp Inc: Form 10-Q for the period ended Sep 30, 2023

Overview. Landmark Bancorp, Inc. is a financial holding company incorporated under the laws of the State of Delaware and is engaged in the banking business through its wholly owned subsidiary, Landmark National Bank, and in the insurance business through its wholly owned subsidiary, Landmark Risk Management, Inc. References to the “Company,” “we,” “us,” and “our” refer collectively to Landmark Bancorp, Inc., Landmark National Bank and Landmark Risk Management, Inc. The Company is listed on the Nasdaq Global Market under the symbol “LARK.” The Bank is dedicated to providing quality financial and banking services to its local communities. Our strategy includes continuing a tradition of holding and acquiring quality assets while growing our commercial, commercial real estate and agriculture loan portfolios. We are committed to developing relationships with our borrowers and providing a total banking service.

The Bank is principally engaged in the business of attracting deposits from the general public and using such deposits, together with borrowings and other funds, to originate one-to-four family residential real estate, construction and land, commercial real estate, commercial, agriculture, municipal and consumer loans. Although not our primary business function, we invest in certain investment and mortgage-related securities using deposits and other borrowings as funding sources.

Landmark Risk Management, Inc., which was formed and began operations in 2017, is a Nevada-based captive insurance company which provides property and casualty insurance coverage to the Company and the Bank for which insurance may not be currently available or economically feasible in the current insurance marketplace. Landmark Risk Management, Inc. is subject to the regulations of the State of Nevada and undergoes periodic examinations by the Nevada Division of Insurance. On April 10, 2023, the IRS issued IR-2023-74 proposing regulations that classify 831(b) captives with less than a 65% claims loss ratio as a “listed transaction”. We are currently reviewing the proposed regulations and consulting with tax advisors to understand the impact on Landmark Risk Management if the final regulations are substantially similar to the proposed regulations. The ultimate impact of the proposal and the impact on the Company is uncertain.

Our results of operations depend generally on net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. Net interest income is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. In addition, we are subject to interest rate risk to the degree that our interest-earning assets mature or reprice at different times, or at different speeds, than our interest-bearing liabilities. Our results of operations are also affected by non-interest income, such as service charges, loan fees, gains from the sale of newly originated loans, gains or losses on investments and certain other non-interest related items. Our principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy costs, professional fees, data processing expenses and provision for credit losses.

We are significantly impacted by prevailing economic conditions, including federal monetary and fiscal policies, and federal regulations of financial institutions. Deposit balances are influenced by numerous factors such as competing investments, the level of income and the personal rate of savings within our market areas. Factors influencing lending activities include the demand for housing and the interest rate pricing competition from other lending institutions.

Currently, our business consists of ownership of the Bank, with its main office in Manhattan, Kansas and thirty additional branch offices in central, eastern, southeast and southwest Kansas, and our ownership of Landmark Risk Management, Inc. On October 1, 2022, the Company completed its acquisition of Freedom Bancshares, Inc., the holding company of Freedom Bank. Freedom Bank was founded in 2006 and operates out of a single location in Overland Park, Kansas.

In October 2023, we declared our 89th consecutive quarterly dividend, and we currently have no plans to change our dividend strategy given our current capital and liquidity position. However, while we have achieved a strong capital base and expect to continue operating profitably, our future dividend practice is dependent upon the performance of the economy and the Company’s overall performance. In addition, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022, we will not be permitted to make capital distributions (including for dividends and repurchases of stock) or pay discretionary bonuses to executive officers without restriction if we do not maintain 2.5% in Common Equity Tier 1 Capital attributable to a capital conservation buffer, a standard we exceeded at September 30, 2023.

Critical Accounting Policies. Critical accounting policies are those which are both most important to the portrayal of our financial condition and results of operations and require our management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies relate to the allowance for credit losses and the accounting for business combinations, each of which involve significant judgment by our management. On January 1, 2023, we adopted CECL which changed our allowance for credit losses from an incurred loss methodology to an expected loss methodology. The CECL model is subject to changes in our economic forecast, which can impact the calculation of our allowance for credit losses substantially. The impact of the adoption and more information on our allowance for credit losses is included in Notes 2 and 4 of the consolidated financial statements. Our most significant critical accounting estimates relate to the allowance for credit losses on loans, which involve significant judgment by our management. The analysis is updated on a quarterly basis based on historical loss information adjusted for current conditions and reasonable and supportable forecasts. Additionally, the Company considers asset quality trends, composition and trends in the loan portfolio, underlying collateral values, industry trends and other pertinent factors, including regulatory recommendations, which impacts the estimate of future credit losses. Other than CECL, there have been no material changes to the critical accounting policies included under Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the Securities and Exchange Commission on March 30, 2023.

Summary of Results. During the third quarter of 2023, we recorded net earnings of $2.9 million, which was an increase of $378,000, or 15.1%, from the $2.5 million of net earnings in the third quarter of 2022. During the first nine months of 2023, we recorded net earnings of $9.6 million, which was an increase of $931,000, or 10.7%, from the $8.7 million of net earnings in the first nine months of 2022. The increase in net earnings during 2023 was primarily related to an increase in interest income due to an increase in average interest earning assets and higher yields on those assets. The increase in assets was due to our acquisition of Freedom Bank and organic growth. Higher interest rates and average balances of interest bearing liabilities also increased our interest expense. The acquisition of Freedom Bank also contributed to an increase in non-interest expense in 2023.

The following table summarizes earnings and key performance measures for the periods presented:

(Dollars in thousands, except per share amounts)

(1) Per share values for the periods ended September 30, 2022 have been adjusted to give effect to the 5% dividend paid during December 2022.

(2) Ratios have been annualized and are not necessarily indicative of the results for the entire year.

(3) Net interest margin is presented on a fully tax equivalent basis, using a 21% federal tax rate.

Interest Income. Interest income of $16.8 million for the quarter ended September 30, 2023 increased $6.2 million, or 58.6%, as compared to the same period of 2022. Interest income on loans increased $5.5 million, or 68.6%, to $13.5 million for the quarter ended September 30, 2023, compared to the same period of 2022 due to higher yields and average balances. Our yields increased from 4.63% in the third quarter of 2022 to 5.93% in the third quarter of 2023. The increase in interest income on loans was also driven by an increase in average loan balances which increased from $687.7 million in the third quarter of 2022 to $906.3 million in the third quarter of 2023. Interest income on investment securities increased $698,000, or 27.7%, to $3.2 million for the third quarter of 2023, as compared to $2.5 million in the same period of 2022. The increase in interest income on investment securities was primarily the result of increased yields on investment securities, which increased from 2.18% in the third quarter of 2022 to 2.77% in the third quarter of 2023. Offsetting the higher investment securities income was a decrease in the average balances of investment securities which decreased from $494.3 million in the third quarter of 2022 to $486.7 million in the third quarter of 2023.

Interest income of $47.2 million for the nine months ended September 30, 2023 increased $18.2 million, or 62.8%, as compared to the same period of 2022. Interest income on loans increased $15.2 million, or 67.8%, to $37.5 million for the nine months ended September 30, 2023, compared to the same period of 2022 due to an increase in our average loan balances, which increased from $659.1 million during the first nine months of 2022 to $877.0 million during the first nine months of 2023. Also contributing to higher interest income was higher yields on loans, which increased from 4.54% in the nine months ended September 30, 2022 to 5.72% during the nine months ended September 30, 2023. Interest income on investment securities increased $3.1 million, or 48.5%, to $9.5 million for the first nine months of 2023, as compared to $6.4 million in the same period of 2022. The increase in interest income on investment securities was primarily the result of increased yields, which increased from 2.00% in the first nine months of 2022 to 2.72% in the first nine months of 2023. Also contributing to the higher yields on investment securities were higher average balances on investment securities, which increased from $464.7 million in the first nine months of 2022 compared to $493.9 million in the first nine months of 2023.

Interest Expense. Interest expense during the quarter ended September 30, 2023 increased $5.0 million, to $6.2 million, as compared to the same period of 2022. Interest expense on interest-bearing deposits increased $3.6 million, to $4.4 million for the quarter ended September 30, 2023 as compared to the same period of 2022. Our total cost of interest-bearing deposits increased from 0.39% in the third quarter of 2022 to 1.93% in the third quarter of 2023 as a result of higher rates and increased competition for deposits. Also contributing to higher interest expense was an increase in average interest-bearing deposit balances, which increased from $782.5 million in the third quarter of 2022 to $902.7 million in the third quarter of 2023. For the third quarter of 2023, interest expense on borrowings increased $1.4 million, to $1.8 million as compared to the same period of 2022 due to an increase in our average borrowings which increased from $44.9 million in the third quarter of 2022 to $126.5 million in the same period of 2023. Also contributing to the increase in interest expense on borrowings were higher rates, which increased from 2.18% in the third quarter of 2022 to 5.60% in the same period of 2023.

Interest expense during the nine months ended September 30, 2023 increased $12.8 million, to $14.8 million, as compared to the same period of 2022. Interest expense on interest-bearing deposits increased $9.1 million, to $10.4 million for the nine months ended September 30, 2023 as compared to the same period of 2022. The increase in interest expense on interest-bearing deposits was the result of higher rates as our cost of interest-bearing deposits increased from 0.22% in the first nine months of 2022 to 1.57% in the first nine months of 2023. The increase in interest expense on deposits was due to an increase in average interest-bearing deposit balances, which increased from $788.7 million in the first nine months of 2022 to $886.2 million in the same period of 2023. For the first nine months of 2023, interest expense on borrowings increased $3.8 million, to $4.4 million as compared to the same period of 2022, due primarily to an increase in our average outstanding borrowings which increased from $34.1 million in the first nine months of 2022 to $112.3 million in the first nine months of 2023. Also contributing to the higher interest expense on borrowings were higher average rates on our borrowings, which increased to 5.26% for the first nine months of 2023 compared to 1.60% for the same period of 2022.

Net Interest Income. Net interest income increased $1.2 million, or 12.4%, to $10.6 million for the third quarter of 2023 compared to the same period of 2022. The increase in net interest income was primarily a result of an increase in interest income on loans and investments, partially offset by higher interest expense. The accretion of purchase accounting adjustments increased net interest income by $282,000 in the third quarter of 2023 compared to an increase of $13,000 in the third quarter of 2022 and was primarily related to fair value adjustments on loans acquired in the Freedom Bank transaction. Compared to the same period last year, the increase in interest rates raised the yields on our interest-earning assets and the cost of our interest-bearing liabilities. Net interest margin, on a tax-equivalent basis, decreased from 3.21% in the third quarter of 2022 to 3.06% in the same period of 2023. Continued increases in interest rates may not result in a higher net interest margin as a result of increased competition for loans and deposits. Additionally, the deposit balance increases we have seen over the past few years may reverse resulting in the need for higher cost funding.

Net interest income increased $5.4 million, or 20.0%, to $32.4 million for the first nine months of 2023 compared to the same period of 2022. The increase in net interest income was primarily a result of an increase in interest income on loans and investments, partially offset by higher interest expense. The accretion of purchase accounting adjustments increased net interest income by $750,000 in the first nine months of 2023 compared to an increase of $22,000 in the first nine months of 2022 and was primarily related to fair value adjustments on loans acquired in the Freedom Bank transaction. Compared to the same period last year, the increase in interest rates raised the yields on our interest-earning assets and the cost of our interest-bearing liabilities. Net interest margin, on a tax-equivalent basis, increased from 3.08% in the first nine months of 2022 to 3.19% in the same period of 2023.

Average Assets/Liabilities. The following table reflects the tax-equivalent yields earned on average interest-earning assets and costs of average interest-bearing liabilities for the periods indicated (derived by dividing income or expense by the monthly average balance of assets or liabilities, respectively) as well as “net interest margin” (which reflects the effect of the net earnings balance) for the periods shown:

(Dollars in thousands)

(1) Income on tax exempt securities is presented on a fully tax-equivalent basis, using a 21% federal tax rate.

(2) Includes loans classified as non-accrual. Income on tax-exempt loans is presented on a fully tax-equivalent basis, using a 21% federal tax rate.

(3) Interest rate spread represents the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.

(4) Net interest margin represents annualized, tax-equivalent net interest income divided by average interest-earning assets.

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(Dollars in thousands)

(1) Income on tax exempt securities is presented on a fully tax-equivalent basis, using a 21% federal tax rate.

(2) Includes loans classified as non-accrual. Income on tax-exempt loans is presented on a fully tax-equivalent basis, using a 21% federal tax rate.

(3) Interest rate spread represents the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.

(4) Net interest margin represents annualized, tax-equivalent net interest income divided by average interest-earning assets.

35

Rate/Volume Table. The following table describes the extent to which changes in tax-equivalent interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities affected the Company’s interest income and expense for the periods indicated. The table distinguishes between (i) changes attributable to rate (changes in rate multiplied by prior volume), (ii) changes attributable to volume (changes in volume multiplied by prior rate), and (iii) net change (the sum of (i) and (ii)). The net changes attributable to the combined effect of volume and rate that cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

(Dollars in thousands)

(Dollars in thousands)

Provision for Credit Losses. On January 1, 2023, the Company adopted CECL and has established an allowance for credit losses (“ACL”) based on this framework. The ACL is based on the historical loss rates and the weighted average remaining maturity for financial assets measured at amortized costs including loans, investment securities and unfunded loan commitments. The historical loss rates are adjusted to reflect reasonable and supportable forecasts to estimate expected credit losses over the life of the financial asset. Upon adoption, the ACL on loans increased by $1.5 million and the ACL on held-to-maturity investment securities of $72,000 was recorded.

During the third quarter of 2023, we recorded no provision for credit losses as compared to a $500,000 provision for credit losses recorded in the same period of 2022. We recorded net loan recoveries of $521,000 during the third quarter of 2023 compared to net loan recoveries of $43,000 during the third quarter of 2022.

During the first nine months of 2023, we recorded a $299,000 provision for credit losses compared to no provision for credit losses in the first nine months of 2022. The $299,000 provision for credit losses during the first nine months of 2023 consisted of a $250,000 provision to the allowance for credit losses on loans, $30,000 to unfunded loan commitments and $19,000 to the allowance for credit losses on held-to-maturity investment securities. We recorded net loan recoveries of $406,000 during the nine months ended September 30, 2023 compared to net loan recoveries of $83,000 during the nine months ended September 30, 2022.

For further discussion of the allowance for credit losses, refer to the “Asset Quality and Distribution” section below.

Non-interest Income. Total non-interest income was $3.7 million in the third quarter of 2023, an increase of $123,000, or 3.5%, from the same period in 2022. The increase in non-interest income during the third quarter of 2023 compared to the same period last year was primarily due to recording a $353,000 loss on the sale of lower yielding investment securities in the third quarter of 2022 as well as an increase of $107,000 in fees and service charges primarily due to higher fees related to deposit accounts. Other non-interest income also increased by $180,000 which was primarily due to an increase in lease income associated with part of a branch facility that was vacant in the prior year. Partially offsetting this increase was a decrease of $558,000 in gains on sales of one-to-four family residential real estate loans as higher interest rates and low housing inventories reduced originations of these loans, which are typically sold in the secondary market. However, higher mortgage rates did result in increased originations of adjustable-rate loans this quarter which are maintained in our one-to-four family residential loan portfolio.

Total non-interest income was $11.0 million in the first nine months of 2023, a increase of $88,000, or 0.8%, from the first nine months of 2022, primarily as a result of recording of a $353,000 loss on the sale of lower yielding investment securities in the third quarter of 2022 as well as an increase of $378,000 in fees and services charges due primarily to higher overdraft charges and servicing fees. Offsetting the increase in non-interest income was a decrease of $1.0 million in gains on sales of loans. Our gains on sales of loans decreased as our originations of secondary market one-to-four family residential real estate loans slowed due to the increase in mortgage interest rates and decreased inventory in the housing market in our market areas.

Non-interest Expense. Non-interest expense totaled $10.7 million for the third quarter of 2023, an increase of $1.3 million, or 13.4%, over the same quarter of 2022. The increase in non-interest expense in the third quarter of 2023 compared to the same period last year was mainly due to higher compensation and benefits, occupancy and equipment, data processing and other non-interest expense due to the acquisition of Freedom Bank. Also contributing to the increases were higher amortization costs associated with the purchase accounting entries related to the acquisition. Offsetting the increase was a decrease in acquisition costs from the third quarter of 2022 associated with the acquisition of Freedom Bank.

Non-interest expense totaled $31.4 million for the first nine months of 2023, an increase of $4.1 million or 15.0%, from $27.3 million for the first nine months of 2022. The increase in non-interest expense in the nine months of 2023 compared to the same period last year was mainly due to higher compensation and benefits, occupancy and equipment, data processing, and other non-interest expense due to the acquisition of Freedom Bank. Partially offsetting the increases in non-interest expense were acquisition costs of $355,000 during the first nine months of 2022 related to the acquisition of Freedom Bank.

Income Tax Expense. During the third quarter of 2023, we recorded income tax expense of $671,000, compared to $522,000 during the same period of 2022. Our effective tax rate increased from 17.3% in the third quarter of 2022 to 18.9% in the third quarter of 2023. The increase in the effective tax rate was primarily related to losses of our captive insurance subsidiary which are not deductible for income taxes.

We recorded income tax expense of $2.1 million for the first nine months of 2023 compared to $1.9 million in the same period of 2022. Our effective tax rate was 18.0% in the first nine months of 2022 compared to 17.7% in the first nine months of 2023.

Financial Condition. Economic conditions in the United States slowed during the first nine months of 2023 as elevated inflation levels and higher interest rates impacted the economy. The increase in interest rates has impacted financial institutions resulting in higher costs of funding and lower fair values for investment securities. Three large regional banks have been closed by the Federal Deposit Insurance Corporation (FDIC) mainly due to liquidity concerns, resulting from interest rate risk issues and large concentrations of uninsured corporate deposits. The liquidity issues faced by these banks related to their operations and business strategies and the Company does not have these same concerns. We maintain strong capital and liquidity, and a stable, conservative deposit portfolio with a majority of our deposits being retail-based and FDIC insured. We spend significant time each month monitoring our interest rate and concentration risks through our asset/liability management and lending strategies that involve a relationship-based banking model offering stability and consistency. The State of Kansas and the geographic markets in which the Company operates were also impacted by these economic headwinds. Supply chain constraints, labor shortages and geopolitical events have contributed to the rising inflation levels which are impacting all areas of the economy both nationally and locally. The Company’s allowance for credit losses included estimates of the economic impact of these conditions and other qualitative factors on our loan portfolio. However, our loan portfolio is diversified across various types of loans and collateral throughout the markets in which we operate. Aside from a few problem loans that management is working to resolve, our asset quality has remained strong over the past few years. While further increases in problem assets may arise, management believes its efforts to run a high quality financial institution with a sound asset base will continue to create a strong foundation for continued growth and profitability in the future.

Asset Quality and Distribution. Our primary investing activities are the origination of one-to-four family residential real estate, construction and land, commercial real estate, commercial, agriculture, municipal and consumer loans and the purchase of investment securities. Total assets increased $54.7 million, or 3.5%, from December 31, 2022 to $1.6 billion at September 30, 2023.

The allowance for credit losses is established through a provision for credit losses based on our economic projections. At September 30, 2023, our allowance for credit losses on loans totaled $11.0 million, or 1.17% of gross loans outstanding, compared to $8.8 million, or 1.03% of gross loans outstanding, at December 31, 2022. The increase in our allowance for credit losses on loans as a percentage of gross loans outstanding was primarily due to the adoption of CECL on January 1, 2023.

As of September 30, 2023 and December 31, 2022, approximately $9.9 million and $13.0 million, respectively, of loans were considered classified and assigned a risk rating of special mention, substandard or doubtful. These ratings indicate that these loans were identified as potential problem loans having more than normal risk and raised doubts as to the ability of the borrowers to comply with present loan repayment terms. Even though borrowers were experiencing moderate cash flow problems as well as some deterioration in collateral value, management believed the ACL was sufficient to cover expected losses related to such loans at September 30, 2023 and December 31, 2022, respectively.

Loans past due 30-89 days and still accruing interest totaled $6.2 million, or 0.66% of gross loans, at September 30, 2023, compared to $738,000, or 0.09% of gross loans, at December 31, 2022. The increase in delinquent loans was primarily due to two relationships which have returned to performing status subsequent to September 30, 2023. At September 30, 2023, $4.4 million in loans were on non-accrual status, or 0.47% of gross loans, compared to $3.3 million, or 0.39% of gross loans, at December 31, 2022. Non-accrual loans consist of loans 90 or more days past due and certain impaired loans. The increase in non-accrual loans during the third quarter of 2023 was principally associated with one commercial lending relationship which was classified as non-accrual as of September 30, 2023. There were no loans 90 days delinquent and accruing interest at September 30, 2023 or December 31, 2022.

As part of our credit risk management, we continue to manage the loan portfolio to identify problem loans and have placed additional emphasis on commercial real estate and construction and land relationships. We are working to resolve the remaining problem credits or move the non-performing credits out of the loan portfolio. At September 30, 2023 and December 31, 2022, we had $934,000 of real estate owned. As of September 30, 2023, real estate owned primarily consisted of commercial buildings, undeveloped land and residential real estate properties. The Company is currently marketing all of the remaining properties in real estate owned.

Liability Distribution. Our primary ongoing sources of funds are deposits, FHLB borrowings, proceeds from principal and interest payments on loans and investment securities and proceeds from the sale of mortgage loans and investment securities. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates and economic conditions. We experienced an increase of $7.4 million, or 0.6% in total deposits during the first nine months of 2023, to $1.3 billion at September 30, 2023. The increase in deposits was primarily due to an increase in our brokered deposit balances, which increased from $10.3 million at December 31, 2022 to $72.4 million at September 30, 2023.

Non-interest-bearing deposits at September 30, 2023, were $395.0 million, or 30.20% of deposits, compared to $410.1 million, or 31.5% of deposits, at December 31, 2022. Money market and checking deposit accounts were 44.8% of our deposit portfolio and totaled $586.7 million at September 30, 2023, compared to $626.7 million, or 48.2% of deposits, at December 31, 2022. Savings accounts decreased to $157.1 million, or 12.0% of deposits, at September 30, 2023, from $170.6 million, or 13.1% of deposits, at December 31, 2022. Certificates of deposit totaled $169.2 million, or 12.9% of deposits, at September 30, 2023, compared to $93.3 million, or 7.2% of deposits, at December 31, 2022. The increase in certificates of deposit was primarily related to higher public fund balances, customers seeking higher interest rates and brokered certificates of deposits, which increased from $1.0 million at December 31, 2022 to $32.2 million at September 30, 2023.

Total deposits include estimated uninsured deposits of $202.8 million and $192.9 million as of September 30, 2023 and December 31, 2022, respectively. This represents approximately 15.5% of our total deposits at September 30, 2023 and compares favorably with other similar community banking organizations. Over 95.3% of the Company’s total deposits were considered core deposits at September 30, 2023. These deposit balances are from retail, commercial and public fund customers located in the markets where the Company has bank branch locations.

Certificates of deposit at September 30, 2023, scheduled to mature in one year or less totaled $104.8 million. Historically, maturing deposits have generally remained with the Bank, and we believe that a significant portion of the deposits maturing in one year or less will remain with us upon maturity in some type of deposit account.

Total borrowings increased $48.6 million to $116.8 million at September 30, 2023, from $68.3 million at December 31, 2022. The increase in total borrowings was due to an increase in FHLB borrowings. The increase in FHLB borrowings was to fund loan growth and to offset the decline in non-brokered deposits.

Cash Flows. During the nine months ended September 30, 2023, our cash and cash equivalents decreased by $665,000. Our operating activities provided net cash of $11.4 million during the first nine months of 2023 primarily as a result of net earnings. Our investing activities used net cash of $63.4 million during the first nine months of 2023, primarily due to loan growth. Financing activities provided net cash of $52.7 million during the first nine months of 2023, primarily as a result of an increase in FHLB borrowings.

Liquidity. Our most liquid assets are cash and cash equivalents and investment securities available-for-sale. The levels of these assets are dependent on the operating, financing, lending and investing activities during any given year. These liquid assets totaled $486.6 million at September 30, 2023 and $521.5 million at December 31, 2022. During periods in which we are not able to originate a sufficient amount of loans and/or periods of high principal prepayments, we generally increase our liquid assets by investing in short-term, high-grade investments or holding higher balances of cash and cash equivalents.

Liquidity management is both a daily and long-term function of our strategy. Excess funds are generally invested in short-term investments. Excess funds are typically generated as a result of increased deposit balances, while uses of excess funds are generally deposit withdrawals and loan advances. In the event we require funds beyond our ability to generate them internally, additional funds are generally available through the use of FHLB advances, a line of credit with the FHLB, other borrowings or through pledging or sales of investment securities. While the sale of available-for-sale investment securities would result in losses due to the current interest environment, pledging these securities as collateral would not result in a loss. At September 30, 2023, we had $74.6 million borrowed on our line of credit with the FHLB. At September 30, 2023, we had collateral pledged to the FHLB that would allow us to borrow $204.1 million, subject to FHLB credit requirements and policies. At September 30, 2023, we had no borrowings through the Federal Reserve discount window, while our borrowing capacity with the Federal Reserve was $57.2 million. We also have various other federal funds agreements, both secured and unsecured, with correspondent banks totaling approximately $30.0 million in available credit under which we had no outstanding borrowings at September 30, 2023. At September 30, 2023, we had subordinated debentures totaling $21.7 million and $12.6 million of repurchase agreements. At September 30, 2023, the Company had no borrowings against a $5.0 million line of credit from an unrelated financial institution maturing on November 1, 2024, with an interest rate that adjusts daily based on the prime rate less 0.50%. This line of credit has covenants specific to capital and other financial ratios, which the Company was in compliance with at September 30, 2023. The Company also borrowed $8.0 million from the same unrelated financial institution at a fixed rate of 6.15%. This borrowing matures on September 1, 2027 and requires quarterly principal and interest payments. The original $10.0 million of borrowings was used to fund part of the acquisition of Freedom Bancshares, Inc.

Off Balance Sheet Arrangements. As a provider of financial services, we routinely issue financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by us generally to guarantee the payment or performance obligation of a customer to a third party. While these standby letters of credit represent a potential outlay by us, a significant amount of the commitments may expire without being drawn upon. We have recourse against the customer for any amount the customer is required to pay to a third party under a standby letter of credit. The letters of credit are subject to the same credit policies, underwriting standards and approval process as loans made by us. Most of the standby letters of credit are secured, and in the event of nonperformance by the customers, we have the right to the underlying collateral, which could include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities. The contract amount of these standby letters of credit, which represents the maximum potential future payments guaranteed by us, was $2.4 million at September 30, 2023.

At September 30, 2023, we had outstanding loan commitments, excluding standby letters of credit, of $199.8 million. We anticipate that sufficient funds will be available to meet current loan commitments. These commitments consist of unfunded lines of credit and commitments to finance real estate loans.

Capital. Current regulatory capital regulations require financial institutions (including banks and bank holding companies) to meet certain regulatory capital requirements. The Company and the Bank are subject to the Basel III Rules that implemented the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Basel III Rules are applicable to all U.S. banks that are subject to minimum capital requirements, as well as to bank and savings and loan holding companies other than “small bank holding companies” (generally, non-public bank holding companies with consolidated assets of less than $3.0 billion).

The Basel III Rules require a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, a Tier 1 capital to risk-weighted assets minimum ratio of 6.0%, a Total Capital to risk-weighted assets minimum ratio of 8.0%, and a Tier 1 leverage minimum ratio of 4.0%. A capital conservation buffer, equal to 2.5% common equity Tier 1 capital, is also established above the regulatory minimum capital requirements (other than the Tier 1 leverage ratio). As of September 30, 2023 and December 31, 2022, the Bank met the requirements to be “well capitalized,” which is the highest rating available under the regulatory capital regulations framework for prompt corrective action. Management believed that as of September 30, 2023, the Company and the Bank met all capital adequacy requirements to which we are subject.

Dividends. During the quarter ended September 30, 2023, we paid a quarterly cash dividend of $0.21 per share to our stockholders.

The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations. In addition, under the Basel III Rules, financial institutions have to maintain 2.5% in common equity Tier 1 capital attributable to the capital conservation buffer in order to pay dividends and make other capital distributions. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of September 30, 2023. The National Bank Act imposes limitations on the amount of dividends that a national bank may pay without prior regulatory approval. Generally, the amount is limited to the bank’s current year’s net earnings plus the adjusted retained earnings for the three preceding years. As of September 30, 2023, approximately $12.0 million was available to be paid as dividends to the Company by the Bank without prior regulatory approval.

Additionally, our ability to pay dividends is limited by the subordinated debentures that are held by three business trusts that we control. Interest payments on the debentures must be paid before we pay dividends on our capital stock, including our common stock. We have the right to defer interest payments on the debentures for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we may pay dividends on our capital stock.

Our assets and liabilities are principally financial in nature, and the resulting net interest income thereon is subject to changes in market interest rates and the mix of various assets and liabilities. Interest rates in the financial markets affect our decisions relating to pricing our assets and liabilities, which impact net interest income, a significant cash flow source for us. As a result, a substantial portion of our risk management activities relates to managing interest rate risk.

Our Asset/Liability Management Committee monitors the interest rate sensitivity of our balance sheet using earnings simulation models. We have set policy limits of interest rate risk to be assumed in the normal course of business and monitor such limits through our simulation process.

We have been successful in meeting the interest rate sensitivity objectives set forth in our policy. Simulation models are prepared to determine the impact on net interest income for the coming twelve months, including one using interest rates as of the forecast date, and forecasting volumes for the twelve-month projection. This position is then subjected to a shift in interest rates of 100, 200 and 300 basis points with an impact to our net interest income on a one-year horizon as follows:

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Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

Forward-Looking Statements

This document (including information incorporated by reference) contains, and future oral and written statements by us and our management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to our financial condition, results of operations, plans, objectives, future performance and business. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of our management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and we undertake no obligation to update any statement in light of new information or future events.

Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on operations and future prospects of us and our subsidiaries include, but are not limited to, the following:

• The effects of changes in interest rates (including the effects of changes in the rate of prepayments of our assets) and the policies of the Federal Reserve (including and the recent and potential additional rate increases by the Federal Reserve) including on our net interest income and the value of our security portfolio.
• The strength of the United States economy in general and the strength of the local economies in which we conduct our operations, including the effects of inflationary pressures and supply chain constraints on such economies, which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of our assets.
• The economic impact of past and any future terrorist attacks, acts of war, including the current Israeli-Palestinian conflict and the conflict in Ukraine, or threats thereof, and the response of the United States to any such threats and attacks.
• The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, consumer protection, insurance, tax, trade and monetary and financial matters, including any changes in response to the recent failures of other banks.
• Our ability to compete with other financial institutions due to increases in competitive pressures in the financial services sector, including from non-bank competitors such as credit unions and “fintech” companies.
• Our inability to obtain new customers and to retain existing customers.
• The timely development and acceptance of products and services.
• Technological changes implemented by us and by other parties, including third-party vendors, which may be more difficult to implement or more expensive than anticipated or which may have unforeseen consequences to us and our customers.
• Our ability to develop and maintain secure and reliable electronic systems.
• The effectiveness of our risk management framework.
• The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents and our ability to identify and address such incidents.
• Interruptions involving our information technology and telecommunications systems or third-party servicers.
• The effects of severe weather, natural disasters, widespread disease or pandemics (including the COVID-19 pandemic), and other external events.
• Our ability to retain key executives and employees and the difficulty that we may experience in replacing key executives and employees in an effective manner.
• Consumer spending and saving habits which may change in a manner that affects our business adversely.
• Our ability to successfully integrate acquired businesses and future growth.
• The costs, effects and outcomes of existing or future litigation.
• Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the FASB, such as the implementation of CECL.
• Our ability to effectively manage our credit risk.
• Our ability to forecast probable credit losses and maintain an adequate allowance for credit losses.
• Fluctuations in the value of securities held in our securities portfolio.
• Concentrations within our loan portfolio, large loans to certain borrowers, and large deposits from certain clients.
• The concentration of large deposits from certain clients who have balances above current FDIC insurance limits and may withdraw deposits to diversify their exposure.
• The level of non-performing assets on our balance sheets.
• Our ability to raise additional capital if needed.
• The effects of declines in real estate markets.
• The effects of fraudulent activity on the part of our employees, customers, vendors, or counterparties.

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These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning us and our business, including other factors that could materially affect our financial results, is included in our filings with the Securities and Exchange Commission, including the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2022 filed on March 30, 2023.

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2023. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2023 to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2023 that materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

There have been no material changes in the risk factors set forth under Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.