EDGAR 10-K Filing

Company CIK: 1358356
Filing Year: 2022
Filename: 1358356_10-K_2022_0001437749-22-004465.json

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ITEM 1. BUSINESS
Item 1. Business
Organized in 1988, Limestone Bancorp, Inc. (the Company) is a bank holding company headquartered in Louisville, Kentucky. The Company’s common stock is traded on Nasdaq’s Capital Market under the symbol LMST. The Company operates Limestone Bank, Inc. (the Bank), the thirteenth largest bank domiciled in the Commonwealth of Kentucky based on total assets. The Bank operates banking offices in 14 counties in Kentucky. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Bullitt and Henry. The Bank serves south central, southern, and western Kentucky from banking centers in Barren, Butler, Daviess, Edmonson, Green, Hardin, Hart, Ohio, and Warren counties. The Bank also has banking centers in Lexington, Kentucky, the second largest city in the state, and Frankfort, Kentucky, the state capital. The Bank is a traditional community bank with a wide range of personal and business banking products and services. As of December 31, 2021, the Company had total assets of $1.42 billion, total loans of $1.0 billion, total deposits of $1.21 billion and stockholders’ equity of $131.0 million.
Website Access to Reports
The Company files reports with the SEC including the Annual Report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K, and proxy statements, as well as any amendments to those reports. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are also accessible at no cost on the Company’s web site at http://www.limestonebank.com after they are electronically filed with the SEC. The information contained on our website is not included, a part of, or incorporated by reference into this Annual Report on Form 10-K.
Markets
The Bank operates in markets that include the four largest cities in Kentucky - Louisville, Lexington, Bowling Green and Owensboro - and in other communities along the I-65, Western Kentucky Parkway, and Natcher Parkway corridors.
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Louisville/Jefferson, Bullitt and Henry Counties: The Company’s headquarters are in Louisville, the largest city in Kentucky. The Bank also has banking offices in Bullitt County, south of Louisville, and Henry County, east of Louisville. The Company’s banking offices in these counties also serve the contiguous counties of Spencer, Shelby and Oldham to the east and northeast of Louisville. The area’s major employers are diversified across many industries and include the Worldport air hub for United Parcel Service (“UPS”), two Ford assembly plants, Humana, Norton Healthcare, the University of Louisville, Brown-Forman, Churchill Downs, YUM! Brands, and Texas Roadhouse.
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Lexington/Fayette County: Lexington, located in Fayette County, is the second largest city in Kentucky. Lexington is the financial, educational, retail, healthcare and cultural hub for Central and Eastern Kentucky. It is known worldwide for its horse farms and Keeneland Race Track, and proudly boasts of itself as “The Horse Capital of the World”. It is also the home of the University of Kentucky and Transylvania University. The area’s major employers include Toyota, Xerox, Lexmark, and Valvoline.
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Frankfort/Franklin County: Frankfort, located along Interstate 64 in Franklin County, is the capital of the Commonwealth of Kentucky and the seat of Franklin County. Frankfort is home to Kentucky’s General Assembly or Legislature which consists of the Kentucky Senate and the Kentucky House of Representatives. Frankfort is also the home of the Kentucky State University and major employers including Montaplast of North America, Inc., Buffalo Trace Distillery, Topy Corporation, Beam, Inc., and Nashville Wire Products.
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Southern Kentucky: This market includes Bowling Green, the third largest city in Kentucky, located about 120 miles south of Louisville and 60 miles north of Nashville, Tennessee. Bowling Green, located in Warren County, is the home of Western Kentucky University and is the economic hub of the area. This market also includes communities in the contiguous Barren County, including the city of Glasgow. Major employers in Barren and Warren Counties include General Motor’s Corvette plant, automotive supply chain manufacturers, and R.R. Donnelley’s regional printing facility.
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Owensboro/Daviess County: Owensboro, located on the banks of the Ohio River, is Kentucky’s fourth largest city. The city is called a festival city, with over 20 annual community celebrations that attract visitors from around the world, including its world famous Bar-B-Q Festival which attracts over 80,000 visitors. It is an industrial, medical, retail and cultural hub for Western Kentucky. The area employers include Owensboro Medical System, US Bank Home Mortgage, Titan Contracting, Specialty Food Group, and Toyotetsu.
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South Central Kentucky: South of the Louisville metropolitan area, the Bank has banking offices in Butler, Edmonson, Green, Hardin, Hart, and Ohio Counties. This region includes stable community markets comprised primarily of agricultural and service-based businesses. Each of the Company’s banking offices in these markets has a stable customer and core deposit base.
Products and Services
The Bank meets its customers’ banking needs with a broad range of financial products and services. Its lending services include real estate, commercial, mortgage, agriculture and equine, and consumer loans to those in its communities and to small to medium-sized businesses, the owners and employees of those businesses, as well as other executives and professionals. Lending operations are complemented with an array of retail and commercial deposit products. In addition, the Bank offers customers drive-through banking facilities, curbside banking services, automatic teller machines, night depository, personalized checks, credit cards, debit cards, internet banking, mobile banking, curbside banking, treasury management services, remote deposit services, electronic funds transfers through ACH services, domestic and foreign wire transfers, cash management and vault services, and loan and deposit sweep accounts.
Human Capital Resources
At December 31, 2021, the Company had 227 full-time equivalent employees and a total of 233 employees (“team members”). The Bank’s team members are instrumental in building, maintaining, and servicing the customer relationships that make the community banking model a success. The Bank strives to attract and retain a well-qualified, enthusiastic workforce by offering competitive compensation packages, comprehensive benefits, training, and opportunities for professional development and advancement. Team members are held accountable to the Bank’s core values, which are:
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Commitment to honesty and integrity;
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Commitment to have a positive and constructive attitude;
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Commitment to be a team player;
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Commitment to conduct oneself in a professional manner; and
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Commitment to celebrate successes.
The Company’s team members are not subject to a collective bargaining agreement, and management considers the Company’s relationship with its team members to be good. The Bank is consistently recognized as one of the “Best Places to Work in Kentucky.”
Acquisitions
The Bank maintains an acquisition strategy to selectively grow its franchise as a complement to its organic growth strategies. Management regularly explores opportunities to acquire banks, branches, or financial institutions in existing, adjacent, and complementary markets that align with the Bank’s business model and strategic plan.
Competition
The banking business is highly competitive, and the Bank experiences competition from a number of other financial institutions and non-bank financial competitors, many of whom may not be subject to the same extensive regulatory regime as the Bank. Competition is based upon relationships, the quality and scope of services levels, interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the convenience of banking facilities, the availability of technology channels, and, in the case of loans to commercial borrowers, relative lending limits. The Bank competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, farm credit organizations, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national, and international financial institutions that operate offices within the Company’s market area and beyond.
Supervision and Regulation
Bank and Holding Company Laws, Rules and Regulations. The Company and the Bank are subject to an extensive system of the laws, rules, and regulations that are intended primarily for the protection of customers, the Deposit Insurance Fund (DIF), and the banking system in general and not for the protection of shareholders and creditors. These laws and regulations govern areas such as capital, permissible activities, allowance for loan and lease losses, loans and investments, interest rates that can be charged on loans, and consumer protection communications and disclosures. Certain elements of selected laws, rules, and regulations are described in the sections that follow. These descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the laws, rules, and regulations.
Limestone Bancorp. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As such, the Company must file with the Federal Reserve Board annual and quarterly reports and other information regarding the Company’s business operations and the business operations of the Company’s subsidiaries. The Company is also subject to examination by the Federal Reserve Board and to operational guidelines established by the Federal Reserve Board. The Company is subject to the Bank Holding Company Act and other federal laws on the types of activities in which it may engage, and to other supervisory requirements, including regulatory enforcement actions for violations of laws and regulations.
Acquisitions. As a bank holding company, the Company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of more than 5% of any class of voting stock or all or substantially all of the assets of a bank, before merging or consolidating with any other bank holding company, and before engaging, or acquiring a company that is not a bank and is engaged in certain non-banking activities. For any acquisition transaction structured as a merger of the Bank, the approval of the Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky Department of Financial Institutions (“KDFI”) would be required.
The Bank Holding Company Act and the Change in Bank Control Act prohibit a person or group of persons from acquiring “control” of a bank holding company without notifying the Federal Reserve Board in advance and obtaining the Federal Reserve Board’s approval of, or non-objection to, the proposed transaction. The Federal Reserve Board has established a rebuttable presumptive standard that the acquisition of 10% or more of any class of voting securities of a bank holding company that has registered securities under Section 12 of the Securities Exchange Act of 1934 (such as the Company) constitutes an acquisition of control of the bank holding company for purposes of the Change in Bank Control Act. An acquisition of 25% of any class of voting securities of a bank holding company will conclusively be deemed to be an acquisition of control under the Change in Bank Control Act.
Permissible Activities. The Company is generally permitted under the Bank Holding Company Act to own up to 5% of the voting shares of a company and, subject to the receipt of any required approval by the Federal Reserve Board, to engage in or acquire direct or indirect control of more than 5% of the voting shares of any bank, bank holding company or company engaged in any activity that the Federal Reserve Board determines to be so closely related to banking as to be a proper incident to the business of banking.
Under current federal law, a bank holding company may elect to become a financial holding company, which enables the holding company to conduct activities that are “financial in nature,” incidental to financial activity, or complementary to financial activity that do 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, dealing and market making in securities; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve Board has determined to be closely related to banking. No prior regulatory approval or notice is required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. The Company has not filed an election to become a financial holding company.
Source of Financial Strength. Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to, and to commit resources to support, its bank subsidiaries. This support may be required at times when, absent such a policy, the bank holding company may not be inclined to provide it. In addition, any capital loans by the bank holding company to its bank subsidiaries are subordinate in right of payment to depositors and to certain other indebtedness of the bank subsidiary. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of subsidiary banks will be assumed by the bankruptcy trustee and entitled to a priority of payment. The Federal Reserve’s “Source of Financial Strength” policy was codified in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”).
Dividends. Under Federal Reserve Board policy, bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not declare a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.
The Company is a legal entity separate and distinct from the Bank. Historically, the majority of the Company’s revenue has been from dividends paid to it by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. If, in the opinion of a federal regulatory agency, an institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the agency may require, after notice and hearing, that the institution cease such practice. The federal banking agencies have indicated that paying dividends that deplete an institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Bank is prohibited from paying any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized, and it must maintain a sufficient capital conservation buffer under the capital adequacy guidelines in order to avoid limitations on dividends. Moreover, the Federal Reserve and the FDIC have issued policy statements providing that bank holding companies and banks should generally pay dividends only out of current operating earnings. A bank holding company may still declare and pay a dividend if it does not have current operating earnings if the bank holding company expects profits for the entire year and the bank holding company obtains the prior consent of the Federal Reserve.
Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. The KDFI must approve the declaration of dividends if the total dividends to be declared by a bank for any calendar year would exceed the bank’s total net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. Additionally, retained earnings must be positive. The Company is also subject to the Kentucky Business Corporation Act, which generally prohibits dividends to the extent they result in the insolvency of the corporation from a balance sheet perspective or if the corporation is unable to pay its debts as they come due.
Based on these regulations, the Bank was eligible to pay $6.5 million of dividends as of December 31, 2021. The Bank paid the Company $2.0 million of dividends during 2021.
Limestone Bank. The Bank, a Kentucky chartered commercial bank, is subject to regular bank examinations and other supervision and regulation by both the FDIC and the KDFI. Kentucky’s banking statutes contain a “super-parity” provision that permits a well-rated Kentucky banking corporation to engage in any banking activity which could be engaged in by a national bank operating in Kentucky; a state bank, a thrift or savings bank operating in any other state; or a federal chartered thrift or federal savings association meeting the qualified thrift lender test and operating in any state could engage, provided the Kentucky bank first obtains a legal opinion specifying the statutory or regulatory provisions that permit the activity.
Capital Adequacy Requirements. The Company and the Bank are required to comply with capital adequacy guidelines. Guidelines are established by the Federal Reserve Board for the Company and the FDIC for the Bank. Both the Federal Reserve Board and the FDIC have substantially similar risk based and leverage ratio guidelines for banking organizations, which are intended to ensure that banking organizations have adequate capital related to the risk levels of assets and off-balance sheet instruments. The capital adequacy guidelines are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
The minimum capital level requirements applicable to the Company and the Bank are a common equity Tier 1 capital ratio of 4.5%, a Tier 1 risk-based capital ratio of 6%, a total risk-based capital ratio of 8%, and a Tier 1 leverage ratio of 4% for all institutions. The rules also require a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. Including this buffer, the required ratios are: a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%.
An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible capital that can be utilized for such actions.
Under the capital rules, Tier 1 capital generally consists of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. Tier 2 capital may consist of subordinated debt, certain hybrid capital instruments, qualifying preferred stock, and a limited amount of the allowance for loan losses. Proceeds of trust preferred securities are excluded from Tier 1 capital unless issued before 2010 by an institution with less than $15 billion of assets. Total capital is the sum of Tier 1 and Tier 2 capital.
Prompt Corrective Action. Pursuant to the Federal Deposit Insurance Act (“FDIA”), the FDIC must take prompt corrective action to resolve the problems of undercapitalized institutions. FDIC regulations define the levels at which an insured institution would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”. A bank is “undercapitalized” if it fails to meet any one of the ratios required to be adequately capitalized. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating. The degree of regulatory scrutiny increases and the permissible activities of a bank decrease as the bank moves downward through the capital categories. Depending on a bank’s level of capital, an institution may be required to submit a capital restoration plan, and its holding company must guarantee compliance with the capital restoration plan up to 5% of the institution’s assets at the time it became undercapitalized.
Deposit Insurance Assessments. The deposits of the Bank are insured by the Deposit Insurance Fund (“DIF”) of the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which calculates a bank’s premium assessment by multiplying its risk-based assessment rate by its assessment base. As required by the Dodd-Frank Act, a bank’s assessment base is determined by its consolidated total assets less average tangible equity rather than deposits.
Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to these matters. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of FDIA. See “Prompt Corrective Actions” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Incentive Compensation. The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets, such as the Company and the Bank, that encourage inappropriate risks by providing an executive officer, employee, director, or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, but the regulations have not been finalized. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which the Company may structure compensation for its executives.
In June 2010, the Federal Reserve, OCC, and FDIC issued comprehensive final guidance on incentive compensation policies of banking organizations intended to ensure that these policies do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. These three principles are incorporated into the proposed joint compensation regulations under the Dodd-Frank Act, discussed above.
The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.
Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
Branching. Kentucky law permits Kentucky chartered banks to establish a banking office in any county in Kentucky. A Kentucky bank may also establish a banking office outside of Kentucky. Well capitalized Kentucky banks that have been in operation at least three years and satisfy certain criteria relating to, among other things, their composite and management ratings, may establish a banking office in Kentucky without the approval of the KDFI upon notice to the KDFI and any other state bank with its main office located in the county where the new banking office will be located. Otherwise, branching requires the approval of the KDFI, which must ascertain and determine that the public convenience and advantage will be served and promoted and that there is reasonable probability of the successful operation of the banking office. The transaction must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community, and consistency with corporate powers.
Section 613 of the Dodd-Frank Act effectively eliminated the interstate branching restrictions set forth in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Banks located in any state may now de novo branch in any other state, including Kentucky. Such unlimited branching power may increase competition within the markets in which the Company and the Bank operate.
Insider Credit Transactions. The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured depository institutions and their subsidiaries. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests, which may not exceed the institution’s total unimpaired capital and surplus.
Consumer Protection Laws. The Bank is subject to federal consumer protection statues and regulations promulgated under those laws, including, but not limited to, the:
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Truth-In-Lending Act and Regulation Z, governing disclosures of credit terms to consumer borrowers;
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Home Mortgage Disclosure Act and Regulation C, requiring financial institutions to provide certain information about home mortgage and refinanced loans;
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Real Estate Settlement Procedures Act (“RESPA”), requiring lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements and prohibiting certain abusive practices;
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Secure and Fair Enforcement for Mortgage Licensing Act (“S.A.F.E. Act”), requiring residential loan originators who are employees of financial institutions to meet registration requirements;
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Fair Credit Reporting Act and Regulation V, governing the provision of consumer information to credit reporting agencies and the use of consumer information;
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Equal Credit Opportunity Act and Regulation B, and the Fair Housing Act, prohibiting discrimination on the basis of race, religion, national origin, sex, and a variety of other prohibited factors in the extension of credit;
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Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
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Truth in Savings Act, which requires disclosure of deposit terms to consumers;
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Regulation CC, which relates to the availability of deposit funds to consumers;
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Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
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Electronic Funds Transfer Act and Regulation E, establishing rights, liabilities, and responsibilities of participants in electronic fund transfer systems such as automated teller machine transfers, telephone bill-payment services, point-of-sale (POS) terminal transfers in stores, and preauthorized transfers from or to a consumer's account; and
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Automated Overdraft Payment Regulations, requiring financial institutions to provide customer notices, monitor overdraft payment programs, and prohibiting financial institutions from charging consumer fees for paying overdrafts on automated teller machine and one time debit card transactions unless a consumer consents, or opts in to the service for those types of transactions.
The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”), which has broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws. As a bank with less than $10 billion or more in assets, the Bank is subject to rules promulgated by the CFPB, but continues to be examined and supervised by the FDIC, its federal banking regulator for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive, or abusive acts or practices in connection with the offering of consumer financial products. The CFPB has established certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. The Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Economic Growth, Regulatory Relief and Consumer Protection Act created a qualified mortgage safe harbor for eligible loans that are originated and retained by a bank with total assets of less than $10 billion.
The Dodd-Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Loans to One Borrower. Under current limits, loans and extensions of credit outstanding at one time to a single borrower and not fully secured generally may not exceed 20% of an institution’s unimpaired capital and unimpaired surplus. Loans and extensions of credit fully secured by collateral may represent an additional 10% of unimpaired capital and unimpaired surplus.
Privacy. Federal law currently contains extensive customer privacy protection provisions. Under these provisions, the Bank must provide to its customers, at the inception of the customer relationship and annually thereafter, its policies and procedures regarding the handling of customers’ nonpublic personal financial information. Except for certain limited exceptions, the Bank may not provide such personal information to unaffiliated third parties unless it discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the FDIC to assess the Company’s record in meeting the credit needs of the communities the Bank serves, including low- and moderate-income neighborhoods and persons. The FDIC’s assessment of the Company’s record is made available to the public. The assessment also is part of the Federal Reserve Board’s and the FDIC’s consideration of applications to acquire, merge or consolidate with another banking institution or its holding company, to establish a new banking office or to relocate an office.
Bank Secrecy Act. The Bank Secrecy Act of 1970 (“BSA”) was enacted to deter money laundering, establish regulatory reporting standards for currency transactions, and improve detection and investigation of criminal, tax, and other regulatory violations. BSA and subsequent laws and regulations require steps to be taken to prevent the use of the Bank in the flow of illegal or illicit money, including, without limitation, ensuring effective management oversight, establishing sound policies and procedures, developing effective monitoring and reporting capabilities, ensuring adequate training, and establishing a comprehensive internal audit of BSA compliance activities. Rules issued under the BSA require the Bank to identify the beneficial owners who own or control certain legal entity customers at the time an account is opened and to include in its anti-money laundering program risk-based procedures for conducting ongoing customer due diligence.
USA Patriot Act. The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers, and certain other financial institutions. The Patriot Act requires financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism. This includes standards for verifying customer identification at account opening, as well as rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. It grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on the operations of financial institutions. In addition, the Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.
The Dodd-Frank Act. The Dodd-Frank Act imposed new restrictions and requirements and an expanded framework of regulatory oversight for financial institutions, including depository institutions and their holding companies. The implementation of the Dodd-Frank Act has resulted in greater compliance costs and higher fees paid to regulators. The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 provided some regulatory relief to banking organizations, primarily small, community banking organizations, by adjusting thresholds at which certain increased regulatory requirements imposed under the Dodd-Frank Act begin to apply. As a result, traditional community banking organizations with assets of less than $10 billion, such as the Company, are exempt from the Volker Rule under the Dodd-Frank Act, which places limits and restrictions on trading and hedging activities. In addition, community banking organizations with assets of less than $10 billion are now subject to reduced reporting requirements and, effective January 1, 2020, an optional simplified capital adequacy measure is available to those that have a leverage ratio greater than 9%. The Bank has not elected to use this optional capital adequacy measure.
Effect on Economic Environment. The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on the operating results of bank holding companies and bank subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits. Their use may affect interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the Company’s business and earnings and those of the Company’s subsidiaries cannot be predicted.
Legislative and Regulatory Initiatives. From time to time various laws, regulations, and governmental programs affecting financial institutions and the financial industry are introduced in Congress or otherwise promulgated by regulatory agencies. Such measures may change the environment in which the Company and its subsidiaries operate in substantial and unpredictable ways. The nature and extent of future legislative, regulatory, or other changes affecting financial institutions are unpredictable at this time. Future legislation, policies, and the effects thereof might have a significant influence on overall growth and distribution of loans, investments, and deposits. They also may affect interest rates charged on loans or paid on time and savings deposits. New legislation and policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors
FACTORS THAT MAY AFFECT FUTURE RESULTS
An investment in the Company’s common stock is subject to certain risks, which are particular to the Company, as well as the industry and markets in which the Company operates. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this filing. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially and adversely affect its business, financial condition, and results of operations in the future. The value or market price of the Company’s common stock could decline due to any of these identified or other risks, and an investor could lose all or part of their investment.
There are factors, many beyond the Company’s control, which may significantly change the results or expectations of the Company. Some of these factors are described below, however, many are described in the other sections of this Annual Report on Form 10-K.
Pandemic
The COVID-19 pandemic creates significant risks and uncertainties for the Company’s business.
In March 2020, the World Health Organization declared novel coronavirus disease 2019 (“COVID-19”) as a global pandemic. The COVID-19 pandemic has created economic and financial disruptions that have adversely affected, and are likely to continue to adversely affect, the business, financial condition, and results of operations of the Company and its customers. The COVID-19 pandemic caused changes in the behavior of customers, businesses, and their employees, including illness, quarantines, social distancing practices, cancellation of events and travel, business and school shutdowns, reduction in commercial activity and financial transactions, supply chain interruptions, increased unemployment, and overall economic and financial market instability.
Future effects, including further actions taken by federal, state, and local governments to contain COVID-19 or treat its impact, are unknown. In addition, federal governmental actions are meaningfully influencing the interest-rate environment. If these actions are sustained, it may adversely impact several industries within the Company’s geographic footprint and impair the ability of the Company’s customers to fulfill their contractual obligations. This could cause the Company to experience a material adverse effect on business operations, liquidity, asset valuations, results of operations, and financial condition, as well as its regulatory capital and liquidity ratios. Material adverse impacts may include all or a combination of valuation impairments on the Company’s intangible assets, investments, loans, or deferred tax assets.
Bank Lending, Allowance for Loan Losses and Other Real Estate Owned
The Company’s business may be adversely affected by conditions in the financial markets and by economic conditions generally.
Weakness in business and economic conditions generally or specifically in the Company’s markets may have one or more of the following adverse effects on the Company’s business:
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A decrease in the demand for loans and other products and services the Bank offers;
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A decrease in the value of collateral securing the Bank’s loans; and
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An increase in the number of customers who become delinquent, file for protection under bankruptcy laws, or default on their loans.
Adverse conditions in the general business environment have had an adverse effect on the Company’s business in the past. Certain economic indicators, such as real estate asset values, rents, and unemployment, may vary between geographic markets. These economic indicators typically affect the real estate and financial services industries, in which the Bank has a significant number of customers, more significantly than other economic sectors. Furthermore, the Bank has a substantial lending business that depends upon the ability of borrowers to make debt service payments on loans. Should economic conditions experience stress, the Company’s business, financial condition, or results of operations could be adversely affected.
The Bank’s profitability depends significantly on local economic conditions.
Most of the Bank’s business activities are conducted in Kentucky and contiguous states and most of its credit exposure is in that region. The Bank is at risk from adverse economic or business developments affecting this area, including declining regional and local business and employment activity, a downturn in real estate values and agricultural activities, and natural disasters. To the extent the economy weakens, delinquency rates, foreclosures, bankruptcies, and losses in the Bank’s loan portfolio will likely increase. Moreover, the value of real estate or other collateral that secures the loans could be adversely affected by the economic downturn or a localized natural disaster. Events that adversely affect business activity and real estate values have had in the past and may in the future have a negative impact on the Bank’s business, financial condition, results of operations, and future prospects.
Small to medium-sized business portfolio may have fewer resources to weather a downturn in the economy.
The loan portfolio includes loans to small and medium-sized businesses and other commercial enterprises. Small and medium-sized businesses frequently have smaller market shares than their competitors, may be more vulnerable to economic downturns, often need additional capital to expand or compete, and may experience variations in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small or medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability, or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay the loan. A continued economic downturn may have a more pronounced negative impact on the target market, causing the Bank to incur substantial credit losses that could materially harm operating results.
The Bank’s decisions regarding credit risk may not be accurate, and its allowance for loan losses may not be sufficient to cover actual losses, which could adversely affect its business, financial condition, and results of operations.
The Bank maintains an allowance for loan losses at a level management believes is adequate to absorb probable incurred losses in the loan portfolio based on historical loan loss experience, economic and environmental factors, specific problem loans, value of underlying collateral, and other relevant factors. If management’s assessment of these factors is ultimately inaccurate, the allowance may not be sufficient to cover actual future loan losses, which would adversely affect operating results. Management’s estimates are subjective, and their accuracy depends on the outcome of future events. Changes in economic, operating, and other conditions that are generally beyond the Bank’s control could cause actual loan losses to increase significantly. In addition, bank regulatory agencies, as an integral part of their supervisory functions, periodically review the adequacy of the allowance for loan losses. Regulatory agencies may require an increase in provision for loan losses or to recognize additional loan charge-offs when their judgment differs. Any of these events could have a material negative impact on operating results.
Levels of classified loans and non-performing assets may increase in the future if economic conditions cause borrowers to default. Furthermore, the value of the collateral underlying a given loan, and the realizable value of such collateral in a foreclosure sale, may decline, making it less likely to realize a full recovery if a borrower defaults on a loan. Any increases in the level of non-performing assets, loan charge-offs or provision for loan losses, or the inability to realize the estimated net value of underlying collateral in the event of a loan default, could negatively affect the Bank’s business, financial condition, results of operations, and the trading price of the Company’s common shares.
If the Bank experiences greater credit losses than anticipated, its operating results would be adversely affected.
As a lender, the Bank is exposed to the risk that borrowers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse effect on operating results. Credit risk with respect to the real estate and construction loan portfolio will relate principally to the creditworthiness of borrowers and the value of the real estate serving as security for the repayment of loans. Credit risk with respect to the commercial and consumer loan portfolio will relate principally to the general creditworthiness of businesses and individuals within the local markets.
Management makes various assumptions and judgments about the collectability of its loan portfolio and provides an allowance for estimated loss losses based on a number of factors. Management believes the Bank’s allowance for loan losses is adequate. However, if assumptions or judgments are wrong, the allowance for loan losses may not be sufficient to cover actual loan losses. Management may have to increase the allowance in the future at the request of one of the Bank’s primary regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of the loan portfolio. The actual amount of future provisions for loan losses cannot be determined at this time and may vary from the amounts of past provisions.
A large percentage of the Bank’s loans are collateralized by real estate, and any prolonged weakness in the real estate market may result in losses and adversely affect profitability.
Approximately 70.7% of the Bank’s loan portfolio as of December 31, 2021, was comprised of commercial and residential loans collateralized by real estate. Adverse economic conditions could decrease demand for real estate and depress real estate values in the Company’s markets. Persistent weakness in the real estate market could significantly impair the value of loan collateral and the ability to sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it will become more likely that management would be required to increase the Bank’s allowance for loan losses. If during a period of depressed real estate values, management was required to liquidate the collateral securing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce the Bank’s profitability and adversely affect its financial condition.
The Bank offers real estate construction and development loans, which carry a higher degree of risk than other real estate loans.
Approximately 7.5% of the Company’s loan portfolio as of December 31, 2021 consisted of real estate construction and development loans, down from 9.7% at December 31, 2020 and up from 7.0% at December 31, 2019. These loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and permanent financing or sale of the property. If the Bank is forced to foreclose on a project prior to its completion, it may not be able to recover the entire unpaid portion of the loan or it may be required to fund additional money to complete the project, or hold the property for an indeterminate period of time. Any of these outcomes may result in losses and adversely affect profitability and financial condition.
The CECL accounting standard will result in a significant change in how the Company recognizes credit losses and may have a material impact on the Company’s financial condition or results of operations.
In June 2016, the FASB issued ASU, “Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model. Whereas the incurred loss model delays recognition of loss on financial instruments until it is probable a loss has occurred, the expected loss model will recognize a loss at the time the loan is first added to the balance sheet. As result of this differing methodology, the Company expects adoption of the CECL model will materially affect the determination of the allowance and could require a significant increase to the allowance. Any material increase to the required level of loan loss allowance could adversely affect the Company’s business, financial condition, and results of operations. The CECL standard will become effective for the Company for fiscal years beginning January 1, 2023. See Note 1, “New Accounting Standards” for discussion regarding the standard. Adoption will likely result in a one-time cumulative-effect adjustment to the allowance and stockholders’ equity. Interagency guidance issued in December 2018 allows for a three-year phase-in of the cumulative-effect adjustment for regulatory capital reporting.
The Bank may acquire or hold from time to time OREO properties, which could increase operating expenses and result in future losses to the Company.
While there were no OREO properties held by the Bank at December 31, 2021, the Bank may acquire and dispose of a significant amount of real estate as a result of foreclosure or by deed in lieu of foreclosure that is listed on the balance sheet as other real estate owned (“OREO”). An increase in the OREO portfolio increases the expenses incurred to manage and dispose of these properties, which sometimes includes funding construction required to facilitate sale.
Interest Rates, Asset-Liability Management, Liquidity, and Common Stock
Profitability is vulnerable to fluctuations in interest rates.
Changes in interest rates could harm financial condition or results of operations. The results of operations depend substantially on net interest income, the difference between interest earned on interest-earning assets (such as investments and loans) and interest paid on interest-bearing liabilities (such as deposits and borrowings). Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic or international economic or political conditions. Factors beyond the Company’s control, such as inflation, recession, unemployment, and money supply may also affect interest rates. If, as a result of decreasing interest rates, interest-earning assets mature or reprice more quickly than interest-bearing liabilities in a given period, net interest income may decrease. Likewise, net interest income may decrease if interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period as a result of increasing interest rates.
Fixed-rate loans increase the exposure to interest rate risk in a rising rate environment because interest-bearing liabilities may be subject to repricing before assets become subject to repricing. Fixed rate investment securities are subject to fair value declines as interest rates rise. Adjustable-rate loans decrease the risk associated with rising interest rates but involve other risks, such as the inability of borrowers to make higher payments in an increasing interest rate environment. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as the borrowers refinance their loans at lower interest rates, which could reduce net interest income and harm results of operations.
The planned phasing out of the LIBOR as a financial benchmark presents risks to the financial instruments originated or held by the Company.
The LIBOR is the reference rate used for many transactions, including lending and borrowing, as well as the derivatives that may be used to manage risk related to such transactions. Effective January 1, 2022, LIBOR ceased to exist as a published rate for one-week and two-month dollar settings and will cease for remaining U.S. dollar settings after June 30, 2023. The expected discontinuation of LIBOR could have a significant impact on the financial markets and market participants such as the Company. As of December 31, 2021, the Company had approximately $80.4 million in variable rate loans with interest rates tied to LIBOR, as well as certain investment securities and debt obligations tied to LIBOR, all of which have maturity dates beyond June 30, 2023.
The Federal Reserve Bank, through the Alternative Reference Rate Committee, has recommended a replacement benchmark rate, the Secured Overnight Financing Rate (SOFR). All loan contracts extending beyond 2023 will need to be managed effectively to ensure appropriate benchmark rate replacements are provided for and adopted.
Failure to identify a replacement benchmark rate and/or update data processing systems could result in future interest rate changes not being correctly captured, which could result in interest rate risk not being mitigated as intended, or interest earned being miscalculated, which could adversely impact the Company’s business, financial condition, and results of operations. Uncertainty regarding LIBOR and the taking of discretionary actions or negotiations of fallback provisions could result in pricing volatility, adverse tax or accounting impacts, or additional compliance, legal and operational costs.
If the Bank cannot obtain adequate funding, it may not be able to meet the cash flow requirements of its depositors and borrowers, or meet the operating cash needs of the Company.
The Company’s liquidity policies and limits are established by the Board of Directors of the Bank, with operating limits managed and monitored by the Asset Liability Committee (“ALCO”), based upon analyses of the ratio of loans to deposits and the percentage of assets funded with non-core or wholesale funding. The ALCO regularly monitors the overall liquidity position of the Bank and the Company to ensure that various alternative strategies exist to meet unanticipated events that could affect liquidity. Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. If the Company’s liquidity policies and strategies do not work as well as intended, the Bank may be unable to make loans and repay deposit liabilities as they become due or are demanded by customers. The ALCO follows established board approved policies and monitors guidelines to diversify the Company’s wholesale funding sources to avoid concentrations in any one-market source. Wholesale funding sources include Federal funds purchased, securities sold under repurchase agreements, and Federal Home Loan Bank (“FHLB”) advances that are collateralized with mortgage-related assets.
The Bank maintains a portfolio of securities that can be used as a secondary source of liquidity. There are other available sources of liquidity, including additional collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or common shares in public or private transactions. If the Bank is unable to access any of these funding sources when needed, it might not be able to meet the needs of customers, which could adversely impact its financial condition, its results of operations, cash flows, and its level of regulatory-qualifying capital.
As a bank holding company, the Company depends on dividends and distributions paid to it by its banking subsidiary.
The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. The principal source of cash flow, from which it would fund any dividends paid to shareholders, has historically been dividends the Company receives from the Bank. Regulations of the FDIC and the KDFI govern the ability of the Bank to pay dividends and other distributions to the Company, and regulations of the Federal Reserve govern the ability to pay dividends or make other distributions to shareholders. During 2021, the Bank returned to a positive retained earnings position. Based on these regulations, the Bank was eligible to pay $6.5 million of dividends at December 31, 2021. The Bank paid the Company $2.0 million of dividends during 2021. See the “Item 1. Business” “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Dividends.”
The Company may sell capital stock in the future to raise additional capital or for additional liquidity. Future sales or other dilution of equity may adversely affect the market price of the Company’s common shares.
The issuance of additional common shares or securities convertible into common shares would dilute the ownership interest of the Company’s existing common shareholders. The market price of the Company’s common shares could decline as a result of such an offering as well as other sales of a large block of shares of common shares or similar securities in the market after such an offering, or the perception that such sales could occur. The Company’s common shares have traded from time-to-time at a price below book value per share. A sale of common shares at or below book value would be dilutive to current shareholders. The sale of shares at a price below market value could negatively impact the market price of the Company’s common shares.
Deferred Tax Assets
The Company may not be able to realize the value of its deferred tax assets.
Due to losses in prior years, the Company has a net operating loss carry-forward of $19.3 million, credit carry-forwards of $208,000, and other net deferred tax assets of $2.0 million. In order to realize the benefit of these tax losses, credits, and deductions, the Company must generate substantial taxable income in future periods. Deferred tax assets are calculated using a federal corporate tax rate of 21% and a state corporate tax rate of 5%. Changes in tax laws and rates may affect deferred tax assets in the future. If higher federal corporate tax rates are enacted, net deferred tax assets would be increased commensurate with the rate increase. Federal net operating loss carry-forwards begin to expire in 2032 and state net operating loss carryforwards begin to expire in 2026. Additionally, should the Company need to raise additional capital by issuing new common shares or securities convertible into common shares, then depending on the number of common share equivalents issued, it could trigger a “change in control,” as defined by Section 382 of the Internal Revenue Code. Such an event could negatively impact or limit the ability to utilize net operating loss carry-forwards, credit loss carry-forwards, and other net deferred tax assets, and result in an impairment of these deferred tax assets for financial reporting purposes.
Acquisitions
Acquisitions may not produce revenue enhancements or cost savings at levels or within time frames originally anticipated and may result in unforeseen integration difficulties.
The Company regularly explores opportunities to acquire banks, branches, financial institutions, or other financial services businesses or assets. The Company cannot predict the number, size, or timing of acquisitions. Difficulty in integrating an acquired business or company may cause the Company not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of the Company’s business or the business of the acquired company, or otherwise adversely affect the Company’s ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also, the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected. The Company may also issue equity securities in connection with acquisitions, which could cause ownership and economic dilution to current shareholders.
Litigation
Risk related to legal proceedings.
From time to time, the Company is involved in judicial, regulatory, and arbitration proceedings concerning matters arising from the Company’s business activities and fiduciary responsibilities. The Company establishes reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The Company may still incur legal costs for a matter even if a reserve has not been established. In addition, the actual cost of resolving a legal claim may be substantially higher than any amounts reserved for that matter. The ultimate resolution of a pending or future legal proceeding, depending on the remedy sought and granted, could materially adversely affect results of operations and financial condition.
Deposit Insurance Expense
FDIC deposit insurance premiums and assessments can impact non-interest expense.
The Bank’s deposits are insured by the FDIC up to legal limits and, accordingly, the Bank is subject to FDIC deposit insurance premiums and assessments. FDIC assessments for deposit insurance are based on the average total consolidated assets of the insured institution during the assessment period, less the average tangible equity of the institution during the assessment period. Any increase in assessment rates may adversely affect the Bank’s business, financial condition, or results of operations.
Competition, Management
The Bank faces strong competition from other financial institutions and financial service companies, which could adversely affect the results of operations and financial condition.
The Bank competes with other financial institutions in attracting deposits and making loans. The competition in attracting deposits comes principally from other commercial banks, credit unions, savings and loan associations, securities brokerage firms, insurance companies, money market funds, and other mutual funds. The competition in making loans comes principally from other commercial banks, credit unions, farm credit associations, savings and loan associations, mortgage banking firms, and consumer finance companies. In addition, competition for business in the Louisville and Lexington metropolitan areas has grown in recent years as changes in banking law have allowed banks to enter those markets by establishing new branches.
Competition in the banking industry may also limit the ability to attract and retain banking clients. The Bank maintains smaller staffs of associates and has fewer financial and other resources than larger institutions with which it competes. Financial institutions that have far greater resources and greater efficiencies than the Bank may have several marketplace advantages resulting from their ability to:
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offer higher interest rates on deposits and lower interest rates on loans than the Bank can;
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offer a broader range of services than the Bank does;
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maintain more branch locations than the Bank does; and
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mount extensive promotional and advertising campaigns.
In addition, banks and other financial institutions with larger capitalization and other financial intermediaries may not be subject to the same regulatory restrictions and may have larger lending limits. Some of the Company’s current commercial banking clients may seek alternative banking sources as they develop needs for credit facilities larger than the Bank can accommodate. If the Bank is unable to attract and retain customers, it may not be able to maintain growth and the results of operations and financial condition may otherwise be negatively impacted.
The Company depends on its senior management team, and the unexpected loss of one or more of the senior executives could impair relationships with customers and adversely affect business and financial results.
Future success significantly depends on the continued services and performance of key management personnel. Future performance will depend on the ability to motivate and retain these and other key officers. The Dodd-Frank Act, and the policies of bank regulatory agencies have placed restrictions on executive compensation practices. Such restrictions and standards may further impact the ability to compete for talent with other businesses that are not subject to the same limitations. The loss of the services of members of senior management or other key officers or the inability to attract additional qualified personnel as needed could materially harm its business.
Accounting Estimates, Internal Controls, Cybersecurity
Reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates.
Accounting policies and assumptions are fundamental to the reported financial condition and results of operations. Management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner in which to report the financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in reporting materially different results than would have been reported under a different alternative.
Certain accounting policies require management to make difficult, subjective, or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These accounting policies include the valuation of securities, allowance for loan losses, and valuation of net deferred income tax asset. Because of the uncertainty of estimates involved in these matters, the Company may be required, among other things, to recognize other-than-temporary impairment on securities, significantly increase the allowance for credit losses, sustain credit losses that are higher than the reserve provided, or permanently impair deferred tax assets.
While management continually monitors and improves the system of internal controls, data processing systems, and corporate wide processes and procedures, the Company may suffer losses from operational risk in the future.
Management maintains internal operational controls and has invested in technology to help process large volumes of transactions. However, the Company may not be able to continue processing at the same or higher levels of transactions. If systems of internal controls should fail to work as expected, if systems were to be used in an unauthorized manner, or if employees were to subvert the system of internal controls, significant losses could occur.
The Company processes large volumes of transactions on a daily basis exposing it to numerous types of operational risk, which could cause it to incur substantial losses. Operational risk resulting from inadequate or failed internal processes, people, and systems includes the risk of fraud by employees or persons outside of the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.
The Company establishes and maintains systems of internal operational controls that provide management with timely and accurate information about its level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost effective levels. The Company has also established procedures that are designed to ensure policies relating to conduct, ethics and business practices are followed. Nevertheless, the Company experiences loss from operational risk from time to time, including the effects of operational errors, and these losses may be substantial.
Information systems may experience an interruption or security breach.
Failure in or breach of operational or security systems or infrastructure, or those of third party vendors and other service providers, including as a result of cyber-attacks, could disrupt the Bank’s businesses, result in the disclosure or misuse of confidential or proprietary information, damage its reputation, increase costs, and cause losses. As a financial institution, the Bank depends on its ability to process, record, and monitor a large number of customer transactions on a continuous basis. As customer, public and regulatory expectations regarding operational and information security have increased, operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Business, financial, accounting, data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond the Bank’s control. For example, there could be sudden increases in customer transaction volume, electrical or telecommunications outages, natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics, events arising from local or larger scale political or social matters, including terrorist acts, and, as described below, cyber-attacks. Although the Bank has business continuity plans and other safeguards in place, its business operations may be adversely affected by significant and widespread disruption to its physical infrastructure or operating systems that support its businesses and customers.
Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. As noted above, the Bank’s operations rely on the secure processing, transmission, and storage of confidential information in its computer systems and networks. In addition, to access the Bank’s products and services, its customers may use personal smartphones, tablet PC’s, and other mobile devices that are beyond its control systems. Although the Bank believes it has appropriate information security procedures and controls, its technologies, systems, networks, and its customers’ devices may become the target of cyber-attacks or information security breaches. These events could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of the Bank’s customers’ confidential, proprietary, and other information or that of its customers, or otherwise disrupt the business operations of the Bank, its customers, or other third parties.
Third parties with which the Bank does business or that facilitate its business activities could also be sources of operational and information security risk to the Bank, including from breakdowns or failures of their own systems or capacity constraints. Although to date the Bank has not experienced any material losses relating to cyber-attacks or other information security breaches, the Bank can give no assurance that it will not suffer such losses in the future. Risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats and the prevalence of Internet and mobile banking. As cyber threats continue to evolve, the Bank may be required to expend significant additional resources to continue to modify or enhance its protective measures or to investigate and remediate any information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support the Bank’s businesses and customers, or cyber-attacks or security breaches of the networks, systems, or devices that the Bank’s customers use to access its products and services could result in customer attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect the Bank’s business, results of operations, or financial condition.
Bank Regulation
The Company operates in a highly regulated environment and, as a result, is subject to extensive regulation and supervision that could adversely affect financial performance and ability to implement growth and operating strategies.
The Company is subject to examination, supervision, and comprehensive regulation by federal and state regulatory agencies, as described under “Item 1 - Business-Supervision and Regulation.” Regulatory oversight of banks is primarily intended to protect depositors, the federal deposit insurance funds, and the banking system as a whole, and not shareholders. Compliance with these regulations is costly and may make it more difficult to operate profitably.
Federal and state banking laws and regulations govern numerous matters including the payment of dividends, the acquisition of other banks, and the establishment of new banking offices. The Company must also meet specific regulatory capital requirements. Failure to comply with these laws, regulations, and policies or to maintain required capital could affect the ability to pay dividends on common shares, the ability to grow through the development of new offices, make acquisitions, and remain independent. These limitations may prevent the Company from successfully implementing growth and operating strategies.
In addition, the laws and regulations applicable to banks could change at any time, which could significantly impact the Company’s business and profitability. For example, new legislation or regulation could limit the manner in which the Company may conduct its business, including its ability to attract deposits and make loans. Events that may not have a direct impact on us, such as the bankruptcy or insolvency of a prominent U.S. corporation, can cause legislators and banking regulators and other agencies such as the Consumer Financial Protection Bureau, the SEC, the Public Company Accounting Oversight Board, and various taxing authorities to respond by adopting and or proposing substantive revisions to laws, regulations, rules, standards, policies, and interpretations. The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations may have a material impact on the Company’s business and results of operations. Changes in regulation may cause the Company to devote substantial additional financial resources and management time to compliance, which may negatively affect operating results.
Changes in banking laws could have a material adverse effect.
The Bank is subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and monetary policies. Management cannot predict whether any of these changes could adversely and materially affect us. The current regulatory environment for financial institutions entails significant potential increases in compliance requirements and associated costs. Federal and state banking regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums, and limitations on the Bank’s activities that could have a material adverse effect on its business and profitability.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments
Not applicable.

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ITEM 2. PROPERTIES
Item 2. Properties
The Bank operates 20 banking offices in Kentucky. The following table shows the location, square footage, and ownership of each property. Management believes that each of these locations is adequately insured. Support operations are located at the main office in Louisville and in Canmer.
Markets
Square Footage
Owned/Leased
Frankfort/Franklin County
Frankfort Office: 100 Highway 676, Frankfort
3,000
Leased
Elizabethtown/Hardin County
Elizabethtown Office: 1690 Ring Road, Suite 100, Elizabethtown
4,000
Leased
Louisville/Jefferson, Bullitt and Henry Counties
Main Office: 2500 Eastpoint Parkway, Louisville
30,000
Owned
Eminence Office: 646 Elm Street, Eminence
1,500
Owned
Hillview Office: 6890 North Preston Highway, Hillview
3,500
Owned
Pleasureville Office: 5440 Castle Highway, Pleasureville
10,000
Owned
Conestoga Office: 155 Conestoga Parkway, Shepherdsville
3,900
Owned
St. Matthews Office: 4304 Shelbyville Road, Louisville
3,400
Leased
Lexington/Fayette County
Lexington Office: 3880 Fountainblue Lane, Suite 120, Lexington
3,000
Leased
City Center Office: 130 West Main Street, Lexington
2,400
Leased
South Central Kentucky
Brownsville Office: 113 East Main Cross Street, Brownsville
8,500
Owned
Greensburg Office: 202 North Main Street, Greensburg
11,000
Owned
Horse Cave Office: 201 East Main Street, Horse Cave
5,000
Owned
Morgantown Office: 112 West G.L. Smith Street, Morgantown
7,500
Owned
Munfordville Office: 949 South Dixie Highway, Munfordville
9,000
Owned
Beaver Dam Office: 1300 North Main Street, Beaver Dam
3,200
Owned
Owensboro/Daviess County
Owensboro Frederica Office: 3500 Frederica Street, Owensboro
5,000
Owned
Owensboro Villa Point: 3332 Villa Point Drive, Owensboro
2,000
Leased
Southern Kentucky
Campbell Lane Office: 751 Campbell Lane, Bowling Green
7,500
Owned
Glasgow Office: 1006 West Main Street, Glasgow
12,000
Owned
Other Properties
Office Building: 2708 North Jackson Highway, Canmer
3,500
Owned

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings
In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amount of damages. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur.
The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated.
The Company is not currently involved in any material litigation.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosure
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
The Company’s common shares are traded on the Nasdaq Capital Market under the ticker symbol “LMST”.
As of January 31, 2022, the Company’s common shares were held by approximately 1,439 shareholders, including 323 shareholders of record and approximately 1,116 beneficial owners whose shares are held in “street” name by securities broker-dealers or other nominees, and the Company’s non-voting common shares were held by one holder.
Dividends
As a bank holding company, the Company’s ability to declare and pay dividends depends on various federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.
The principal source of revenue with which to pay dividends on common shares are dividends the Bank may declare and pay out of funds legally available for payment of dividends. A Kentucky chartered bank may declare a dividend of an amount of the bank’s net profits as the board deems appropriate. The approval of the KDFI is required if the total of all dividends declared by a bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt.
Purchase of Equity Securities by Issuer
On October 20, 2021, the Board of Directors of the Company approved a share repurchase program authorizing the repurchase of up to $3.0 million of the Company’s common shares over time. The share repurchase program is scheduled to expire December 31, 2022. During the fourth quarter of 2021, the Company did not repurchase any of its common shares.
Equity Compensation Plan Information
The following table provides information about the Company’s equity compensation plans as of December 31, 2021:
Plan category
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column 1)
Equity compensation plans approved by shareholders
-
-
166,375
Equity compensation plans not approved by shareholders
-
-
-
Total
-
-
166,375
At December 31, 2021, 166,375 common shares remain available for issuance under the Company’s 2018 Omnibus Equity Compensation Plan.

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. Reserved

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis of financial condition and results of operations analyzes the consolidated financial condition and results of operations of Limestone Bancorp, Inc. (the “Company”) and its wholly owned subsidiary, Limestone Bank, Inc. (the “Bank”). The Company is a Louisville, Kentucky-based bank holding company that operates banking offices in 14 Kentucky counties. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Bullitt and Henry. The Bank serves south central, southern, and western Kentucky from banking offices in Barren, Butler, Daviess, Edmonson, Green, Hardin, Hart, Ohio, and Warren Counties. The Bank also has an office in Lexington, the second largest city in the state, and Frankfort, the state capital. The Bank is a traditional community bank with a wide range of personal and business banking products and services.
Selected Consolidated Financial Data
As of and for the Years Ended December 31,
(Dollars in thousands except per share data)
Income Statement Data:
Interest income
$ 49,915
$ 50,753
$ 49,584
$ 43,461
$ 37,522
Interest expense
5,693
10,152
14,234
9,790
6,405
Net interest income
44,222
40,601
35,350
33,671
31,117
Provision (negative provision) for loan losses
1,150
4,400
-
(500 )
(800 )
Non-interest income (1)
8,439
6,844
5,918
5,779
5,404
Non-interest expense (2)
31,971
32,416
30,270
29,126
30,767
Income before income taxes
19,540
10,629
10,998
10,824
6,554
Income tax expense (benefit) (3)
4,631
1,624
2,030
(31,899 )
Net income
14,909
9,005
10,518
8,794
38,453
Less:
Earnings allocated to participating securities
Net income attributable to common
$ 14,690
$ 8,937
$ 10,412
$ 8,650
$ 37,486
Common Share Data:
Basic earnings per common share
$ 1.96
$ 1.20
$ 1.41
$ 1.23
$ 6.15
Diluted earnings per common share
1.96
1.20
1.41
1.23
6.15
Cash dividends declared per common share
-
-
-
-
-
Book value per common share
17.24
15.47
14.15
12.34
11.17
Tangible book value per common share (4)
16.16
14.34
12.98
12.34
11.17
Balance Sheet Data (at period end): (2)
Total assets
$ 1,415,692
$ 1,312,302
$ 1,245,779
$ 1,069,692
$ 970,801
Debt obligations:
FHLB advances
20,000
20,623
61,389
46,549
11,797
Junior subordinated debentures
21,000
21,000
21,000
21,000
21,000
Subordinated capital notes
25,000
25,000
17,000
-
2,250
Senior debt
-
-
5,000
10,000
10,000
Average Balance Data: (2)
Average assets
$ 1,363,397
$ 1,294,934
$ 1,112,388
$ 1,026,310
$ 947,961
Average loans
958,549
964,088
801,813
743,352
667,474
Average deposits
1,164,355
1,099,383
936,243
860,825
864,278
Average FHLB advances
20,152
34,101
35,038
43,363
9,184
Average junior subordinated debentures
21,000
21,000
21,000
21,000
21,000
Average subordinated capital notes
25,000
20,366
7,545
2,805
Average senior debt
-
2,896
7,781
10,000
5,068
Average stockholders’ equity
123,942
109,958
100,126
84,860
37,851
(1)
In 2021, the Company recognized a $191,000 gain on the sale of OREO and a $465,000 gain on the call of a corporate bond from the Company’s available for sale securities portfolio.
(2)
On November 15, 2019, the Company completed a four branch acquisition. The purchase included $126.8 million in performing loans and $1.5 million in premises and equipment, as well as $131.8 million in customer deposits. Acquisition related costs totaled $775,000, or $0.08 per common share after taxes.
(3)
Effective January 1, 2021, the Commonwealth of Kentucky eliminated the bank franchise tax, which was previously reported as a non-interest expense, and implemented a state income tax at a statutory rate of 5%. State income tax was $939,000 for 2021. For 2020 and 2019, income tax expense benefitted $478,000 and $1.6 million, respectively, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during 2019. Income tax expense for 2017 benefitted $54.0 million from the reversal of the deferred tax valuation allowance offset by $20.3 million of income tax expense related to the revaluation of the deferred tax asset to 21%.
(4)
Tangible book value per common share is a non-GAAP financial measure derived from GAAP based amounts. Tangible book value is calculated by excluding the balance of intangible assets from common stockholders’ equity. Tangible book value per common share is calculated by dividing tangible common equity by common shares outstanding, as compared to book value per common share, which is calculated by dividing common stockholders’ equity by common shares outstanding. Management believes this is consistent with bank regulatory agency treatment, which excludes tangible assets from the calculation of risk-based capital.
As of and for the Years Ended December 31,
Tangible Book Value Per Share
(in thousands, except share and per share data)
Common stockholder’s equity
$ 130,959
$ 116,024
$ 105,750
$ 92,097
$ 69,902
Less: Goodwill
6,252
6,252
6,252
-
-
Less: Intangible assets
1,989
2,244
2,500
-
-
Tangible common equity
122,718
107,528
96,998
92,097
69,902
Shares outstanding
7,594,749
7,498,865
7,471,975
7,462,720
6,259,864
Tangible book value per common share
$ 16.16
$ 14.34
$ 12.98
$ 12.34
$ 11.17
Book value per common share
17.24
15.47
14.15
12.34
11.17
The following discussion should be read in conjunction with the Company’s consolidated financial statements and accompanying notes and other schedules presented elsewhere in the report.
Overview
For the year ended December 31, 2021, the Company reported net income of $14.9 million compared with net income of $9.0 million for the year ended December 31, 2020 and net income of $10.5 million for the year ended December 31, 2019. Basic and diluted income per common share were $1.96 for the year ended December 31, 2021, compared with $1.20 for 2020, and $1.41 for 2019.
Net income before taxes was $19.5 million for the year ended December 31, 2021, compared to $10.6 million for the year ended December 31, 2020, and $11.0 million for the year ended December 31, 2019. Income tax expense was $4.6 million for 2021, $1.6 million for 2020, and $480,000 for 2019. Effective January 1, 2021, the Commonwealth of Kentucky eliminated the bank franchise tax, which was previously recorded as non-interest expense, and implemented a state income tax at a statutory rate of 5%. State income tax expense was $939,000 for 2021, compared to an income tax benefit of $478,000 for 2020, and an income tax benefit of $1.6 million for 2019.
The following significant items are of note for the year ended December 31, 2021:
●
Average loans receivable decreased approximately $5.5 million, or 0.6%, to $958.5 million for the year ended December 31, 2021, compared with $964.1 million for the year ended December 31, 2020. SBA Paycheck Protection Program (“PPP”) loans averaged $15.5 million and $22.5 million for the year ended December 31, 2021 and 2020, respectively. After forgiveness and paydowns, PPP loans declined to $1.2 million at December 31, 2021, compared to $20.3 million at December 31, 2020.
●
Net interest margin increased 12 basis points to 3.48% for the year ended 2021 compared with 3.36% for the year ended December 31, 2020. The yield on earning assets decreased to 3.92% in 2021, compared to 4.20% in 2020. The yield on earning assets was negatively impacted by falling interest rates on the Bank’s fed funds, certain floating rate investment securities, loans with variable rate pricing features, and new loans originated in the lower interest rate environment, including PPP loans which carry a rate of 1.0%.
●
The negative impact of falling rates was offset by $2.8 million in fees earned on PPP loans during 2021, compared to $1.1 million during 2020. PPP fees during the year ended December 31, 2021 represented 21 basis points, compared to 10 basis points of earning asset yield and net interest margin for the year ended December 31, 2020, respectively.
●
The cost of interest-bearing liabilities decreased to 0.59% in 2021 from 1.05% in 2020 as a result of decreases in short-term interest rates during 2020, the continued downward repricing of deposits, and continued improvement in deposit mix.
●
A provision for loan losses of $1.2 million was recorded in 2021, compared to $4.4 million in 2020. The 2021 loan loss provision was attributable to net loan charge-offs impacting historical loss percentages and growth within the portfolio during the year, while the 2020 provision was largely attributable to the uncertainty surrounding the COVID-19 pandemic related economic and business disruptions. Net loan charge-offs were $2.1 million for 2021, compared to net loan charge-offs of $333,000 for 2020, and net loan charge-offs of $504,000 for 2019.
●
Deposits were $1.21 billion at December 31, 2021, compared with $1.12 billion at December 31, 2020. Non-interest bearing demand deposits increased $31.1 million, or 12.8%, to $274.1 million compared with $243.0 million at December 31, 2020. Interest checking accounts increased $96.6 million, or 50.7%, to $287.2 million at December 31, 2021, compared with $190.6 million at December 31, 2020. Money market accounts increased $42.2 million or 24.0% to $217.9 million compared with $175.8 million at December 31, 2020. Savings accounts increased $20.8 million, or 14.6%, to $163.4 million compared with $142.6 million at December 31, 2020. Certificate of deposit balances decreased $101.5 million, or 27.6%, to $266.0 million at December 31, 2021, from $367.6 million at December 31, 2020 due to liquidity management considerations and planned reduction in higher cost deposits.
●
On October 20, 2021, the Board of Directors approved a share repurchase program authorizing the Company to purchase up to $3.0 million of the Company’s Common Shares over time. Subject to applicable rules and regulations, the shares may be purchased from time to time in the open market or in privately negotiated transactions. Such purchases will be at times and in amounts as the Company deems appropriate, based on factors such as availability of shares, market conditions, the trading price of the shares, the Company’s financial performance and liquidity, legal and regulatory capital requirements, and other business conditions. The repurchase program does not obligate the Company to acquire any particular number of common shares, and it may be modified, terminated, or suspended at any time at the Company’s discretion. The share repurchase program expires on December 31, 2022.
These items are discussed in further detail throughout this Item 7.
Application of Critical Accounting Policies
The Company’s accounting and reporting policies comply with GAAP and conform to general practices within the banking industry. Management believes the following significant accounting policies may involve a higher degree of management assumptions and judgments that could result in materially different amounts to be reported if conditions or underlying circumstances were to change.
Allowance for Loan Losses - The Bank maintains an allowance for loan losses believed to be sufficient to absorb probable incurred credit losses existing in the loan portfolio. The Board of Directors evaluates the adequacy of the allowance for loan losses on a quarterly basis. Management evaluates the adequacy of the allowance using, among other things, historical loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral, and current economic conditions and trends. The allowance may be allocated for specific loans or loan categories, but the entire allowance is also available for any loan. The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated and measured for impairment. The general component is based on historical loss experience adjusted for qualitative environmental factors. Management develops allowance estimates based on actual loss experience adjusted for current economic conditions and trends. Allowance estimates are a prudent measurement of the risk in the loan portfolio applied to individual loans based on loan type. If the mix and amount of future charge-off percentages differ significantly from the assumptions used by management in making its determination, management may be required to materially increase its allowance for loan losses and provision for loan losses, which could adversely affect results.
Results of Operations
The following table summarizes components of income and expense and the change in those components for 2021 compared with 2020:
For the
Years Ended December 31,
Change from Prior Period
Amount
Percent
(dollars in thousands)
Gross interest income
$ 49,915
$ 50,753
$ (838 )
(1.7 )%
Gross interest expense
5,693
10,152
(4,459 )
(43.9 )
Net interest income
44,222
40,601
3,621
8.9
Provision for loan losses
1,150
4,400
(3,250 )
(73.9 )
Non-interest income
7,979
6,849
1,130
16.5
Gain (loss) on sales and calls of securities, net
(5 )
NM
Non-interest expense
31,971
32,416
(445 )
(1.4 )
Net income before taxes
19,540
10,629
8,911
83.8
Income tax expense
4,631
1,624
3,007
185.2
Net income
14,909
9,005
5,904
65.6
NM: Not Meaningful
Net income of $14.9 million for the year ended December 31, 2021 increased by $5.9 million from net income of $9.0 million for 2020. Net interest income increased $3.6 million for 2021 as a result of $1.7 million in increased PPP fee recognition connected to the forgiveness and payoff of PPP loans, partially offset by declining yields on earning assets, and a $4.5 million decrease in the cost of interest-bearing liabilities primarily due to downward repricing within the time deposit portfolio, and a reduction in the size of the time deposit portfolio. Provision for loan losses of $1.2 million was recorded in 2021, compared to a $4.4 million provision for loan losses in 2020. The 2021 loan loss provision was attributable to net loan charge-offs impacting historical loss percentages and growth trends within the portfolio during the year, while the provision for 2020 was largely attributable to the uncertainty surrounding the COVID-19 pandemic related economic and business disruptions.
Non-interest income increased $1.6 million during 2021. The increase was primarily due to an increase in bank card interchange fees of $740,000 as a result of an increase in debit card transactions, a $191,000 gain on the sale of OREO, and a $465,000 gain on the call of a corporate bond from the Bank’s available for sale securities portfolio.
Non-interest expense decreased $445,000 during 2021. The decrease was primarily attributable to a decrease of $1.1 million in deposit and state franchise tax expense as a result of the elimination of the Kentucky bank franchise tax discussed below. This decrease was partially offset by an increase in salaries and employee benefits of $381,000 attributable to moderate merit increases in compensation and performance-based incentive compensation partially offset in 2021 by year over year average FTE reductions. Additionally, deposit account related expense increased $268,000 due to an increase in debit card transactions and the related processing costs.
Income tax expense was $4.6 million and $1.6 million for the year ended December 31, 2021 and 2020, respectively. Effective January 1, 2021, the Commonwealth of Kentucky eliminated the bank franchise tax and implemented a state income tax at a statutory rate of 5%. State income tax expense was $939,000 for the year ended December 31, 2021, compared to a state income tax benefit of $478,000 for the year ended December 31, 2020 related to the establishment of a net deferred tax asset due to the tax law change.
The following table summarizes components of income and expense and the change in those components for 2020 compared with 2019:
For the
Years Ended December 31,
Change from Prior Period
Amount
Percent
(dollars in thousands)
Gross interest income
$ 50,753
$ 49,584
$ 1,169
2.4 %
Gross interest expense
10,152
14,234
(4,082 )
(28.7 )
Net interest income
40,601
35,350
5,251
14.9
Provision for loan losses
4,400
-
4,400
100.0
Non-interest income
6,849
5,923
15.6
Loss on sales and calls of securities, net
(5 )
(5 )
-
-
Non-interest expense
32,416
30,270
2,146
7.1
Net income before taxes
10,629
10,998
(369 )
(3.4 )
Income tax expense
1,624
1,144
238.3
Net income
9,005
10,518
(1,513 )
(14.4 )
Net income of $9.0 million for the year ended December 31, 2020 decreased by $1.5 million from net income of $10.5 million for 2019. Net interest income increased $5.3 million for 2020 as a result of PPP fee recognition of $1.1 million connected to the forgiveness and payoff of PPP loans and a decrease in the cost of interest-bearing liabilities due to downward repricing within the time deposit portfolio, as well as a reduction in the size of the time deposit portfolio. A provision for loan losses of $4.4 million was recorded in 2020, compared to no provision for loan losses expense in 2019. The 2020 loan loss provision was attributable to the net loan charge-offs during the year, trends within the portfolio during the year, and primarily to changes in the economic and business environment attributable to COVID-19.
Non-interest income increased $926,000 during 2020. There was an increase of $938,000 in bank card interchange fees, primarily as a result of the deposit accounts acquired in the branch purchase transaction.
Non-interest expense increased $2.1 million during 2020 due primarily to an increase in salaries and employee benefits of $1.5 million, $666,000 in deposit account related expense, and $479,000 in occupancy expense. The Bank added sales talent and customer facing associates during the latter half of 2019 and branch staff in connection with its purchase of four branches in November 2019. These increases were muted somewhat by efforts in 2020 to reduce FTEs from 248 at March 31, 2020 to 219 as of December 31, 2020 through attrition and workforce reduction. The increase in deposit account related expense and occupancy expense is the result of the branch purchase transaction.
Income tax expense for 2020 and 2019 benefitted $478,000 and $1.6 million, respectively, from the establishment of a state net deferred tax asset related to the 2019 tax law enactments. The new laws eliminate the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax went into effect on January 1, 2021.
Net Interest Income - The interest rate environment changed in a downward direction in early 2020 as the Federal Reserve lowered the federal funds target rate by 50 basis points on March 6, 2020 and 100 basis points on March 15, 2020. In particular, the Federal Reserve’s actions served to lower rates on the short end of the yield curve impacting yields on fed funds, certain floating rate investment securities, loans with variable rate pricing features, and the production rates for new loan originations.
Net interest income was $44.2 million for the year ended December 31, 2021, an increase of $3.6 million, or 8.9%, compared with $40.6 million for the same period in 2020. Net interest spread and margin were 3.33% and 3.48%, respectively, for 2021, compared with 3.15% and 3.36%, respectively, for 2020.
The yield on earning assets decreased to 3.92% for the year ended December 31, 2021, as compared to 4.20% for the year ended December 31, 2020 due to the lower interest rate environment. Average interest-earning assets increased $67.4 million during 2021 primarily attributable to an increase in investment securities. Average loans decreased approximately $5.5 million during 2021. PPP loans averaged $15.5 million and $22.5 million for the year ended December 31, 2021 and 2020, respectively. Interest revenue in 2021 declined $390,000 due to lower interest rates on new and renewed loans, the downward repricing of variable rate loans, and lower rates on securities purchased over the past eight quarters, as compared to 2020. Total interest income decreased 1.7%, or $838,000, in 2021 compared to 2020.
Loan fee income can meaningfully impact net interest income, loan yields, and net interest margin. The amount of loan fee income included in total interest income was $4.3 million and $2.1 million for the years ended December 31, 2021 and 2020, respectively. This represents 33 basis points of yield on earning assets and net interest margin for the year ended December 31, 2021 as compared to 18 basis points for the year ended December 31, 2020. Loan fee income for 2021 included $2.8 million in fees earned on PPP loans, compared to $1.1 million in 2020, which represents 21 basis points and 10 basis points of earning asset yield and net interest margin for those years, respectively.
The cost of interest-bearing liabilities decreased to 0.59% for the year ended December 31, 2021, as compared to 1.05% for the year ended December 31, 2020 primarily based on downward repricing of time and other interest-bearing deposits and reduction in the size of the time deposit portfolio, as well as a shift in deposit mix. Average interest-bearing liabilities decreased by $4.1 million during 2021 primarily due to a $13.9 million decrease in FHLB advances. Total interest expense decreased by 43.9% to $5.7 million for the year ended December 31, 2021 as compared to $10.2 million for the year ended December 31, 2020. As of December 31, 2021, time deposits comprise $266.0 million of the Company’s liabilities with $161.9 million, or 61%, set to reprice or mature within one year of which, $55.0 million with a current average rate of 0.33% reprice or mature within the first quarter of 2022.
Net interest income was $40.6 million for the year ended December 31, 2020, an increase of $5.3 million, or 14.9%, compared with $35.4 million for the same period in 2019. Net interest spread and margin were 3.15% and 3.36%, respectively, for 2020, compared with 3.10% and 3.40%, respectively, for 2019.
The yield on earning assets decreased to 4.20% for the year ended December 31, 2020, as compared to 4.76% for the year ended December 31, 2019. The yield on earning assets was negatively impacted by falling interest rates on the Bank’s fed funds, certain floating rate investment securities, loans with variable rate repricing features, and new loan production during the year. Average loans increased approximately $162.3 million during 2020. Average loans were positively impacted from the branch purchase transaction on November 15, 2019, along with loan growth during 2019 and 2020, as well as PPP loan originations. The increase in average loans resulted in an increase in interest revenue volume of approximately $7.9 million for 2020, which was partially offset by a decrease in interest revenue to due declining rates of $5.0 million, as compared to 2019. Loan fee income can meaningfully impact net interest income, loan yields, and net interest margin. The amount of loan fee income included in total interest income represents 18 basis points of yield on earning assets and net interest margin for the year ended December 31, 2020 as compared to 11 basis points for the year ended December 31, 2019. Loan fee income for 2020 included $1.1 million in fees earned on PPP loans. Total interest income increased 2.4%, or $1.2 million, for 2020 as compared 2019.
The cost of interest-bearing liabilities decreased to 1.05% for the year ended December 31, 2020, as compared to 1.66% for the year ended December 31, 2019 primarily based on the downward repricing of time deposits. Average interest-bearing liabilities increased by $106.3 million during 2020 due to deposit growth and the completion of the branch purchase transaction in 2019. Total interest expense decreased by 28.7% to $10.2 million for the year ended December 31, 2020 as compared to $14.2 million for the year ended December 31, 2019. The cost of interest-bearing liabilities for 2020 was also impacted by the subordinated debt issuances and senior debt repayments in July 2019 and July 2020. As of December 31, 2020, time deposits comprise $367.6 million of the Company’s liabilities with $272.0 million, or 74%, set to reprice or mature within one year of which $104.9 million with a current average rate of 0.99% reprice or mature within the first quarter of 2021.
Average Balance Sheets
The following table sets forth the average daily balances, the interest earned or paid on such amounts, and the weighted average yield on interest-earning assets and weighted average cost of interest-bearing liabilities for the periods indicated. Dividing income or expense by the average daily balance of assets or liabilities, respectively, derives such yields and costs for the periods presented.
For the Years Ended December 31,
Average
Balance
Interest
Earned/Paid
Average
Yield/Cost
Average
Balance
Interest
Earned/Paid
Average
Yield/Cost
(dollars in thousands)
ASSETS
Interest-earning assets:
Loans receivables (1)
Real estate
$ 675,791
$ 30,615
4.53 %
$ 684,447
$ 32,572
4.76 %
Commercial
211,573
10,266
4.85
200,260
8,398
4.19
Consumer
34,041
1,608
4.72
39,931
2,051
5.14
Agriculture
36,596
1,945
5.31
38,833
2,058
5.30
Other
2.01
2.27
U.S. Treasury and agencies
25,657
2.11
20,239
2.43
Mortgage-backed securities
81,829
1,561
1.91
82,330
1,863
2.26
Collateralized loan obligations
44,396
1.87
45,595
1,234
2.71
State and political subdivision securities (non-taxable)
26,509
3.23
14,139
3.31
State and political subdivision securities (taxable)
16,971
2.50
16,301
3.03
Corporate bonds
35,340
1,253
3.55
23,572
4.07
FHLB stock
5,493
2.09
6,208
2.30
Federal funds sold
-
-
-
-
Interest-bearing deposits in other financial institutions
83,736
0.12
38,525
0.27
Total interest-earning assets
1,278,515
49,915
3.92 %
1,211,069
50,753
4.20 %
Less: Allowance for loan losses
(12,714 )
(9,819 )
Non-interest-earning assets
97,596
93,684
Total assets
$ 1,363,397
$ 1,294,934
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Certificates of deposit and other time deposits
$ 311,140
$ 1,788
0.57 %
$ 436,083
$ 5,802
1.33 %
Interest checking and money market deposits
423,938
1,289
0.30
336,596
1,464
0.43
Savings accounts
157,283
0.28
111,559
0.48
FHLB advances
20,152
0.76
34,101
1.09
Junior subordinated debentures
21,000
2.48
21,000
3.14
Subordinated capital notes
25,000
1,500
6.00
20,366
1,206
5.92
Senior debt
-
-
-
2,896
4.11
Total interest-bearing liabilities
958,513
5,693
0.59 %
962,601
10,152
1.05 %
Non-interest-bearing liabilities
Non-interest-bearing deposits
271,994
215,145
Other liabilities
8,948
7,230
Total liabilities
1,239,455
1,184,976
Stockholders’ equity
123,942
109,958
Total liabilities and stockholders’ equity
$ 1,363,397
$ 1,294,934
Net interest income
$ 44,222
$ 40,601
Net interest spread
3.33 %
3.15 %
Net interest margin
3.48 %
3.36 %
Ratio of average interest-earning assets to average interest-bearing liabilities
133.39 %
125.81 %
(1)
Includes loan fees in both interest income and the calculation of yield on loans.
For the Years Ended December 31,
Average
Balance
Interest
Earned/Paid
Average
Yield/Cost
Average
Balance
Interest
Earned/Paid
Average
Yield/Cost
(dollars in thousands)
ASSETS
Interest-earning assets:
Loans receivables (1)
Real estate
$ 684,447
$ 32,572
4.76 %
$ 576,441
$ 30,139
5.23 %
Commercial
200,260
8,398
4.19
134,735
6,660
4.94
Consumer
39,931
2,051
5.14
51,001
2,863
5.61
Agriculture
38,833
2,058
5.30
39,116
2,480
6.34
Other
2.27
2.12
U.S. Treasury and agencies
20,239
2.43
23,263
2.40
Mortgage-backed securities
82,330
1,863
2.26
91,609
2,495
2.72
Collateralized loan obligations
45,595
1,234
2.71
49,881
2,015
4.04
State and political subdivision securities (non-taxable)
14,139
3.31
11,759
3.51
State and political subdivision securities (taxable)
16,301
3.03
18,270
3.19
Corporate bonds
23,572
4.07
11,376
5.43
FHLB stock
6,208
2.30
6,691
5.20
Federal funds sold
-
-
2.20
Interest-bearing deposits in other financial institutions
38,525
0.27
27,809
1.74
Total interest-earning assets
1,211,069
50,753
4.20 %
1,042,653
49,584
4.76 %
Less: Allowance for loan losses
(9,819 )
(8,786 )
Non-interest-earning assets
93,684
78,521
Total assets
$ 1,294,934
$ 1,112,388
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Certificates of deposit and other time deposits
$ 436,083
$ 5,802
1.33 %
$ 483,222
$ 9,564
1.98 %
Interest checking and money market deposits
336,596
1,464
0.43
265,687
2,026
0.76
Savings accounts
111,559
0.48
36,035
0.19
FHLB advances
34,101
1.09
35,038
2.31
Junior subordinated debentures
21,000
3.14
21,000
1,005
4.79
Subordinated capital notes
20,366
1,206
5.92
7,545
5.74
Senior debt
2,896
4.11
7,781
4.23
Total interest-bearing liabilities
962,601
10,152
1.05 %
856,308
14,234
1.66 %
Non-interest-bearing liabilities
Non-interest-bearing deposits
215,145
151,299
Other liabilities
7,230
4,655
Total liabilities
1,184,976
1,012,262
Stockholders’ equity
109,958
100,126
Total liabilities and stockholders’ equity
$ 1,294,934
$ 1,112,388
Net interest income
$ 40,601
$ 35,350
Net interest spread
3.15 %
3.10 %
Net interest margin
3.36 %
3.40 %
Ratio of average interest-earning assets to average interest-bearing liabilities
125.81 %
121.76 %
(1)
Includes loan fees in both interest income and the calculation of yield on loans.
Rate/Volume Analysis
The table below sets forth information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.
Year Ended December 31, 2021 vs. 2020
Year Ended December 31, 2020 vs. 2019
Increase (decrease)
due to change in
Increase (decrease)
due to change in
Rate
Volume
Net
Change
Rate
Volume
Net
Change
(in thousands)
Interest-earning assets:
Loan receivables
$ (390 )
$ (258 )
$ (648 )
$ (4,982 )
$ 7,922
$ 2,940
U.S. Treasury and agencies
(69 )
(73 )
(67 )
Mortgage-backed securities
(291 )
(11 )
(302 )
(395 )
(237 )
(632 )
Collateralized loan obligations
(372 )
(31 )
(403 )
(620 )
(161 )
(781 )
State and political subdivision securities
(128 )
(57 )
(45 )
Corporate bonds
(137 )
(186 )
FHLB stock
(13 )
(15 )
(28 )
(182 )
(23 )
(205 )
Federal funds sold
-
-
-
(3 )
(1 )
(4 )
Interest-bearing deposits in other financial institutions
(81 )
(5 )
(516 )
(379 )
Total increase (decrease) in interest income
(1,481 )
(838 )
(6,935 )
8,104
1,169
Interest-bearing liabilities:
Certificates of deposit and other time deposits
(2,668 )
(1,346 )
(4,014 )
(2,899 )
(863 )
(3,762 )
Interest checking and money market accounts
(502 )
(175 )
(1,014 )
(562 )
Savings accounts
(262 )
(89 )
FHLB advances
(91 )
(126 )
(217 )
(418 )
(21 )
(439 )
Junior subordinated debentures
(139 )
-
(139 )
(345 )
-
(345 )
Subordinated capital notes
Senior debt
(59 )
(60 )
(119 )
(9 )
(201 )
(210 )
Total increase (decrease) in interest expense
(3,705 )
(754 )
(4,459 )
(4,474 )
(4,082 )
Increase (decrease) in net interest income
$ 2,224
$ 1,397
$ 3,621
$ (2,461 )
$ 7,712
$ 5,251
Non-interest Income - The following table presents for the periods indicated the major categories of non-interest income:
For the Years Ended
December 31,
(in thousands)
Service charges on deposit accounts
$ 2,256
$ 2,268
$ 2,381
Bank card interchange fees
4,116
3,376
2,438
Income from bank owned life insurance
Gain on sale of other real estate owned
-
-
Gain (loss) on sales and calls of securities, net
(5 )
(5 )
Other
Total non-interest income
$ 8,439
$ 6,844
$ 5,918
Non-interest Income Comparison - 2021 to 2020
Non-interest income increased by $1.6 million for 2021 to $8.4 million compared with $6.8 million for the year ended December 31, 2020. This increase was primarily related to bank card interchange fees of $740,000 as a result of an increase in debit card transactions, a $191,000 gain on the sale of OREO, and a $465,000 gain on the call of a corporate bond from the Bank’s available for sale securities portfolio.
Non-interest Income Comparison - 2020 to 2019
Non-interest income increased by $926,000 for 2020 to $6.8 million compared with $5.9 million for the year ended December 31, 2019. This increase was primarily related to bank card interchange fees of $938,000 as a result of the deposit accounts acquired in the branch purchase transaction on November 15, 2019.
Non-interest Expense - The following table presents the major categories of non-interest expense:
For the Years Ended
December 31,
(in thousands)
Salary and employee benefits
$ 18,132
$ 17,751
$ 16,233
Occupancy and equipment
4,041
4,001
3,522
Deposit account related expense
2,158
1,890
1,224
Data processing expense
1,512
1,502
1,259
FDIC insurance
Marketing expense
Deposit and state franchise tax
1,475
1,210
Professional fees
Communications
Insurance expense
Postage and delivery
Acquisition costs
-
-
Other
1,968
2,091
2,399
Total non-interest expense
$ 31,971
$ 32,416
$ 30,270
Non-interest Expense Comparison - 2021 to 2020
Non-interest expense for the year ended December 31, 2021 of $32.0 million represented a $445,000, or 1.4%, decrease from $32.4 million for 2020. The decrease in non-interest expense was primarily due to a $1.1 million decrease in deposit and state franchise tax expense as a result of the elimination of the Kentucky bank franchise tax discussed below. This decrease was partially offset by an increase in salaries and employee benefits of $381,000 attributable to moderate merit increases in compensation and performance-based incentive compensation partially offset in 2021 by year over year average FTE reductions. Additionally, deposit account related expense increased $268,000 due to an increase in debit card transactions.
Non-interest Expense Comparison - 2020 to 2019
Non-interest expense for the year ended December 31, 2020 of $32.4 million represented a $2.1 million, or 7.1%, increase from $30.3 million for 2019. The increase in non-interest expense was primarily due to an increase in salaries and employee benefits of $1.5 million. The Bank added sales talent and customer facing associates during the latter half of 2019 and branch staff in connection with the branch purchase transaction in November 2019. These increases were muted somewhat by efforts in 2020 to reduce FTEs from 248 at March 31, 2020 to 219 as of December 31, 2020 through attrition and workforce reduction. Deposit account related expense increased by $666,000 and occupancy expense increased by $479,000 as a result of the branch purchase transaction. Franchise tax expense increased by $265,000 as a function of growth in the Bank’s taxable capital. These increases were offset by a decrease in OREO expenses of $305,000 due to lower valuation write-downs and operating expenses in 2020 compared to 2019. Non-interest expense for 2019 also included $775,000 of acquisition expenses associated with the branch purchase transaction.
Income Tax Expense - Effective tax rates differ from the federal statutory rate applied to income before income taxes due to the following:
(in thousands)
Federal statutory tax rate
%
%
%
Federal statutory rate times financial statement income
$ 4,103
$ 2,232
$ 2,310
Effect of:
State income taxes
-
-
Tax-exempt interest income
(123 )
(73 )
(66 )
Establish state deferred tax asset
-
(478 )
(1,577 )
Non-taxable life insurance income
(111 )
(89 )
(86 )
Restricted stock vesting
(10 )
(137 )
Other, net
Total income tax expense
$ 4,631
$ 1,624
$
Effective January 1, 2021, the Commonwealth of Kentucky eliminated the bank franchise tax, which was previously recorded as non-interest expense, and implemented a state income tax at a statutory rate of 5%. State income tax expense was $939,000 for 2021. For 2020 and 2019, income tax expense benefitted $478,000 and $1.6 million, respectively, from the establishment of a net deferred tax assets related to a change in Kentucky tax law enacted during 2019.
See Note 12, “Income Taxes”, to the financial statements for additional discussion of the Company’s income taxes.
Analysis of Financial Condition
Total assets at December 31, 2021 were $1.42 billion compared with $1.31 billion at December 31, 2020, an increase of $103.4 million or 7.9%. This increase was primarily attributable to an increase in investment securities of $56.8 million, as well as $40.7 million in net loans.
Total assets at December 31, 2020 were $1.31 billion compared with $1.25 billion at December 31, 2019, an increase of $66.5 million or 5.3%. This increase was primarily attributable to an increase in net loans of $31.7 million, as well as $34.9 million in interest-bearing deposits in banks.
Investment Securities - The securities portfolio serves as a source of liquidity and earnings and contributes to the management of interest rate risk. Investments are made in various types of liquid assets, including U.S. Treasury obligations and securities of various federal agencies, obligations of states and political subdivisions, corporate bonds, and collateralized loan obligations. The investment portfolio increased by $56.8 million, or 27.9%, to $260.7 million at December 31, 2021, compared with $203.9 million at December 31, 2020.
The following table sets forth the carrying value of the Bank’s securities portfolio at the dates indicated.
December 31, 2021
December 31, 2020
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
(dollars in thousands)
Securities available for sale
U.S. Government and federal agencies
$ 26,075
$
$ (133 )
$ 26,243
$ 18,811
$
$ -
$ 19,617
Agency mortgage-backed: residential
93,650
1,339
(970 )
94,019
71,582
2,777
(26 )
74,333
Collateralized loan obligations
50,227
-
(78 )
50,149
44,730
-
(1,578 )
43,152
State and municipal
-
-
-
-
34,759
1,296
-
36,055
Corporate bonds
43,432
(202 )
43,802
31,635
(1,402 )
30,705
Total available for sale
$ 213,384
$ 2,212
$ (1,383 )
$ 214,213
$ 201,517
$ 5,351
$ (3,006 )
$ 203,862
Amortized
Cost
Gross
Unrecognized
Gains
Gross
Unrecognized
Losses
Fair
Value
Amortized
Cost
Gross
Unrecognized
Gains
Gross
Unrecognized
Losses
Fair
Value
Securities held to maturity
State and municipal
$ 46,460
$
$ (338 )
$ 46,280
$ -
$ -
$ -
$ -
Total held to maturity
$ 46,460
$
$ (338 )
$ 46,280
$ -
$ -
$ -
$ -
During March 2021, to better manage interest rate risk, management changed the classification of all the municipal securities in the portfolio from available for sale (“AFS”) to held to maturity (“HTM”). These municipal securities had a book value of approximately $34.7 million, a market value of approximately $35.8 million, and a net unrealized gain of approximately $1.1 million. The transfer occurred at fair value. The related net unrealized gain included in other comprehensive income remained in other comprehensive income and is being amortized from other comprehensive income with an offsetting entry to interest income as a yield adjustment through earnings over the remaining term of the securities. No gain or loss was recorded at the time of transfer. This transfer was completed after careful consideration of the intent and ability to hold these securities to maturity.
The Bank owns Collateralized Loan Obligations (CLOs), which are debt securities secured by professionally managed portfolios of senior-secured loans to corporations. CLO are typically $300 million to $1 billion in size, contain one hundred or more loans and have five to six credit tranches with credit ratings ranging from AAA, AA, A, BBB, BB, B and equity tranche. Interest and principal are paid first to the AAA tranche then to the next lower rated tranche. Losses are borne first by the equity tranche then by the subsequently higher rated tranche. CLOs may be less liquid than government securities from time to time and volatility in the CLO market may cause the value of these investments to decline.
The market value of CLOs may be affected by, among other things, changes in composition of the underlying loans, changes in the cash flows from the underlying loans, defaults and recoveries on the underlying loans, capital gains and losses on the underlying loans, prepayments on the underlying loans, and other conditions or economic factors. At December 31, 2021, $30.0 million and $20.1 million of the Bank’s CLOs were risk rated AA and A rated, respectively. None of the CLOs were subject to ratings downgrade during the year ended December 31, 2021.
The corporate bond portfolio consists of 15 subordinated debt securities and two senior debt security of U.S. banks and bank holding companies with maturities ranging from 2024 to 2037. The securities are either initially fixed rate for five years converting to floating rate at an index over LIBOR or SOFR, or floating rate at an index over LIBOR or SOFR from inception. Management regularly monitors the financial condition of these corporate issuers by reviewing their regulatory and public filings.
The following table sets forth the contractual maturities, carrying values and weighted-average yields for the Bank’s investment securities held at December 31, 2021:
Due Within
One Year
After One Year
But Within
Five Years
After Five Years
But Within
Ten Years
After Ten Years
Total
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Available for sale
U.S. Government and federal agencies
$ -
- %
$ 2,775
2.19 %
$ 8,470
2.08 %
$ 14,998
1.96 %
$ 26,243
2.02 %
Agency mortgage-backed: residential
-
-
4,066
2.34
10,508
2.25
79,445
1.43
94,019
1.56
Collateralized loan obligations
-
-
-
-
40,114
1.81
10,035
1.69
50,149
1.79
Corporate bonds
-
-
1,586
4.02
35,357
3.36
6,859
3.01
43,802
3.33
Total available for sale
$ -
- %
$ 8,427
2.61 %
$ 94,449
2.46 %
$ 111,337
1.62 %
$ 214,213
2.02 %
Held to maturity
State and municipal
$ 2,325
0.61 %
$ 9,690
1.15 %
$ 3,824
2.03 %
$ 30,621
2.64 %
$ 46,460
2.18 %
Total available for sale
$ 2,325
0.61 %
$ 9,690
1.15 %
$ 3,824
2.03 %
$ 30,621
2.64 %
$ 46,460
2.18 %
Average yields in the table above were calculated on a tax equivalent basis. Mortgage-backed securities are securities that have been developed by pooling a number of real estate mortgages. These securities are issued by federal agencies such as Ginnie Mae, Fannie Mae and Freddie Mac, as well as non-agency company issuers. These securities are deemed to have high credit ratings, and minimum regular monthly cash flows of principal and interest. Cash flows from agency backed mortgage-backed securities are guaranteed by the issuing agencies.
Unlike U.S. Treasury and U.S. government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide cash flows from regular principal and interest payments and principal prepayments throughout the lives of the securities. Mortgage-backed securities that are purchased at a premium will generally return decreasing net yields as interest rates drop because home owners tend to refinance their mortgages. Thus, the premium paid must be amortized over a shorter period. Therefore, those securities purchased at a discount will obtain higher net yields in a decreasing interest rate environment. As interest rates rise, the opposite will generally be true. During a period of increasing interest rates, fixed rate mortgage-backed securities generally do not experience increasing prepayments of principal and, consequently, average life will not be shortened. When interest rates fall, prepayments will generally increase. Non-agency issuer mortgage-backed securities do not carry a government guarantee. Management limits purchases of these securities to bank qualified issues with high credit ratings. At this time, there are no holdings of this type in the portfolio. At December 31, 2021, 84.5% of the Bank’s agency mortgage-backed securities had contractual final maturities of more than ten years with a weighted maturity of 22.3 years.
Loans Receivable - Loans receivable increased $39.8 million, or 4.1%, during the year ended December 31, 2021, to $1.0 billion. At December 31, 2021, the Bank had $1.2 million in loans outstanding under the SBA Paycheck Protection Program. The Bank’s commercial and commercial real estate portfolios increased by an aggregate of $72.1 million, or 11.3%, during 2021 and comprised 70.9% of the total loan portfolio at December 31, 2021. The residential real and consumer portfolios decreased by an aggregate of $26.0 million, or 9.2%, during 2021 and comprised 25.5% of the total loan portfolio at December 31, 2021.
Loans receivable increased $35.8 million, or 3.9%, during the year ended December 31, 2020, to $962.1 million. At December 31, 2020, the Bank had $20.3 million in loans outstanding under the SBA Paycheck Protection Program. The Bank’s commercial and commercial real estate portfolios increased by an aggregate of $92.8 million, or 17.0%, during 2020 and comprised 66.3% of the total loan portfolio at December 31, 2020.
Loan Portfolio Composition - The following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in the Bank’s portfolio and other than the categories noted, there is no concentration of loans in any industry exceeding 10% of total loans.
As of December 31,
Amount
Percent
Amount
Percent
(dollars in thousands)
Commercial (1)
$ 220,826
22.04 %
$ 208,244
21.65 %
Commercial Real Estate:
Construction
74,806
7.47
92,916
9.66
Farmland
68,388
6.83
70,272
7.30
Nonfarm nonresidential
345,893
34.53
266,394
27.69
Residential Real Estate:
Multi-family
50,224
5.01
61,180
6.36
1-4 Family
168,873
16.86
188,955
19.64
Consumer
36,440
3.64
31,429
3.27
Agriculture
35,924
3.59
42,044
4.37
Other
0.03
0.06
Total loans
$ 1,001,840
100.00 %
$ 962,081
100.00 %
(1) Includes PPP loans of $1.2 million and $20.3 million at December 31, 2021 and 2020, respectively.
As of December 31,
Amount
Percent
Amount
Percent
Amount
Percent
(dollars in thousands)
Commercial
$ 145,551
15.71 %
$ 129,368
16.91 %
$ 113,771
15.98 %
Commercial Real Estate:
Construction
64,911
7.01
86,867
11.35
57,342
8.05
Farmland
79,118
8.54
77,937
10.18
88,320
12.40
Nonfarm nonresidential
255,459
27.58
172,177
22.50
156,724
22.01
Residential Real Estate:
Multi-family
70,950
7.66
49,757
6.50
56,588
7.94
1-4 Family
226,629
24.47
175,761
22.97
179,222
25.17
Consumer
47,790
5.16
39,104
5.11
18,439
2.59
Agriculture
35,064
3.79
33,737
4.41
41,154
5.78
Other
0.08
0.07
0.08
Total loans
$ 926,271
100.00 %
$ 765,244
100.00 %
$ 712,115
100.00 %
Lending activities are subject to a variety of lending limits imposed by state and federal law. The Bank’s statutory secured legal lending limit to a single borrower or guarantor was approximately $50.7 million at December 31, 2021 as measured at 30% of the Bank’s unimpaired capital and surplus.
The Bank had 22 and 18 loan relationships each with aggregate extensions of credit in excess of $10.0 million at year end 2021 and 2020, respectively. The aggregate extension of credit to these relationships totaled $310.7 million and $217.6 million at year end 2021 and 2020, respectively. With respect to these large loan relationships, all 22 were classified as pass by the Bank’s internal loan review process at December 31, 2021 and 17 were classified as pass and one classified as watch at December 31, 2020. At December 31, 2021, the largest relationship totaled $27.4 million, of which, $17.2 million was secured by a multi-family development currently under construction, and $10.2 million was secured by a combination of commercial real estate currently under development and income producing commercial real estate.
As of December 31, 2021, the Bank had $85.2 million of loan participations purchased from, and $12.8 million of loan participations sold to, other banks. As of December 31, 2020, the Bank had $74.3 million of loan participations purchased from, and $21.3 million of loan participations sold to, other banks.
Loan Maturity Schedule - The following table sets forth at December 31, 2021, the dollar amount of loans, net of deferred loan fees, maturing in the loan portfolio based on their contractual terms to maturity:
As of December 31, 2021
Maturing
Within
One Year
Maturing
1 through
5 Years
Maturing
5 through
15 Years
Maturing
Over 15
Years
Total
Loans
(dollars in thousands)
Loans with fixed rates:
Commercial
$ 5,310
$ 51,315
$ 61,428
$ -
$ 118,053
Commercial Real Estate:
Construction
6,762
12,227
11,631
-
30,620
Farmland
1,975
19,305
11,462
1,216
33,958
Nonfarm nonresidential
6,369
111,284
117,847
235,732
Residential Real Estate:
Multi-family
16,989
15,695
-
33,528
1-4 Family
5,081
20,113
25,963
37,925
89,082
Consumer
1,375
21,702
24,154
Agriculture
2,141
6,648
-
9,453
Other
-
-
-
Total fixed rate loans
$ 29,857
$ 260,049
$ 245,117
$ 40,023
$ 575,046
Loans with floating rates:
Commercial
$ 25,241
$ 54,709
$ 22,823
$ -
$ 102,773
Commercial Real Estate:
Construction
16,894
22,649
2,007
2,636
44,186
Farmland
9,540
8,923
15,799
34,430
Nonfarm nonresidential
1,046
44,765
37,630
26,720
110,161
Residential Real Estate:
Multi-family
10,994
4,936
16,696
1-4 Family
4,371
8,325
38,543
28,552
79,791
Consumer
12,000
-
12,286
Agriculture
24,934
1,258
-
26,471
Other
-
-
-
-
-
Total floating rate loans
$ 84,979
$ 152,392
$ 115,275
$ 74,148
$ 426,794
Loan Portfolio by Risk Category - The Bank follows a loan grading program designed to evaluate the credit risk in the loan portfolio. Through this loan grading process, an internally classified watch list is maintained which helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate risk rating for loans, management considers, among other factors, the borrower’s ability to repay, the borrower’s repayment history, the current delinquency status, the estimated value of the underlying collateral, and the capacity and willingness of a guarantor to satisfy the obligation. As a result of this process, loans are categorized as pass, watch, special mention, substandard or doubtful.
Loans categorized as “watch” show warning elements where the present status exhibits one or more deficiencies that require attention in the short-term or where pertinent ratios of the loan account have weakened warranting more frequent monitoring. These loans do not have all of the characteristics of a classified loan (substandard or doubtful), but show weakened elements as compared with those of a satisfactory credit.
Loans classified as “special mention” do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies that warrant special attention and which corrective action, such as accelerated collection practices, may remedy.
Loans classified as “substandard” are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition that may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that the Bank will sustain some losses if the deficiencies are not corrected.
Loans classified as “doubtful” are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.
The following table presents a summary of the loan portfolio at the dates indicated, by risk category.
As of December 31,
(in thousands)
Pass
$ 977,962
$ 926,025
$ 888,707
$ 745,604
$ 673,033
Watch
7,856
18,879
27,522
13,164
25,715
Special Mention
-
-
-
Substandard
16,022
17,177
10,042
6,363
13,203
Doubtful
-
-
-
-
-
Total
$ 1,001,840
$ 962,081
$ 926,271
$ 765,244
$ 712,115
Loans receivable increased $39.8 million, or 4.1%, during the year ended December 31, 2021. Since December 31, 2020, the pass category increased approximately $51.9 million, the watch category decreased approximately $11.0 million, and the substandard category decreased approximately $1.2 million. The $1.2 million decrease in loans classified as substandard was primarily driven by $4.5 million in principal payments received, $2.5 million in charge-offs, and $325,000 in loans upgraded from substandard, offset by $6.1 million in loans moved to substandard during 2021. These trends were considered during the evaluation of qualitative trends in the portfolio when establishing the general component of the allowance for loan losses.
Loan Delinquency - The following table presents a summary of loan delinquencies at the dates indicated.
As of December 31,
(in thousands)
Past Due Loans:
30-59 Days
$
$ 1,537
$ 1,747
$ 1,593
$ 1,478
60-89 Days
90 Days and Over
-
-
-
-
Total Loans Past Due 30-90+ Days
1,909
2,417
1,924
1,650
Nonaccrual Loans
3,124
1,676
1,528
1,991
5,457
Total Past Due and Nonaccrual Loans
$ 3,890
$ 3,585
$ 3,945
$ 3,915
$ 7,107
The trend in delinquency levels is considered during the evaluation of qualitative trends in the portfolio when establishing the general component of the Bank’s allowance for loan losses.
Nonaccrual loans increased $1.4 million from December 31, 2020 to December 31, 2021. This increase was primarily driven by $2.9 million in loans placed on non-accrual, offset by $1.3 million in paydowns and $203,000 in charge-offs. The $3.1 million in nonaccrual loans at December 31, 2021 were primarily secured by commercial real estate loans. The $1.7 million in nonaccrual loans at December 31, 2020 were generally secured by residential real estate loans. Management believes it has established adequate loan loss reserves for these credits.
Troubled Debt Restructuring - A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession to a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. TDRs are considered to be impaired loans, and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.
The Bank generally does not have a formal loan modification program. If a borrower is unable to make contractual payments, management reviews the particular circumstances of that borrower’s situation and determine whether or not to negotiate a revised payment stream. The goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash flow constraints so that the credit may return to performing status over time. If a borrower fails to perform under the modified terms, the loan(s) are placed on nonaccrual status and collection actions are initiated.
At December 31, 2021, the Bank had three restructured loans totaling $405,000 with borrowers who experienced deterioration in financial condition compared with four restructured loans totaling $480,000 at December 31, 2020. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. At December 31, 2021 and December 31, 2020, the Bank had no restructured loans that had been granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans, although partial charge-offs have been recorded for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential properties or commercial real estate properties. At December 31, 2021 and December 31, 2020, 84% and 100%, respectively, of the TDRs were performing according to their modified terms.
There was one modification granted during 2021 and 2020 that resulted in a loan being identified as TDRs. See “Note 3 - Loans,” to the financial statements for additional disclosure related to troubled debt restructuring.
Non-TDR Loan Modifications due to COVID-19 - The Bank has elected to account for eligible loan modifications under Section 4013 of the Coronavirus Aid Relief and Economic Security Act (“CARES Act”). To be an eligible loan under Section 4013 of the CARES Act, a loan modification must be (1) related to the COVID-19 pandemic; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020 and the earlier of (A) 60 days after the date of termination of the national emergency declared by the President on March 13, 2020 concerning the COVID-19 outbreak (the “national emergency”) or (B) December 31, 2020. On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (“Economic Aid Act”) extended eligible loan modifications under Section 4013 of the CARES Act from December 31, 2020 to January 1, 2022. Eligible loan modifications are not required to be classified as TDRs and will not be reported as past due provided that they are performing in accordance with the modified terms. Interest income will continue to be recognized in accordance with GAAP unless the loan is placed on nonaccrual status.
Loans subject to CARES Act modifications that had not returned to normal payment terms declined to $2.2 million as of December 31, 2021, as compared to $15.3 million at December 31, 2020. At the beginning of the fourth quarter of 2021, the Bank had one remaining commercial real estate loan secured by a retail entertainment facility subject to a CARES Act modification. This loan totaled $4.4 million, had been graded substandard, evaluated under ASC -310-10, and allocated a specific reserve of $2.2 million since December 2020. Given the uncertainty of the borrower’s ability to return to amortizing principal and interest payments, this loan was placed on nonaccrual during the fourth quarter of 2021 and a partial charge-off of the specifically allocated $2.2 million reserve was recognized.
Non-Performing Assets - Non-performing assets consist of certain restructured loans for which interest rate or other terms have been renegotiated, loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets. Loans, including impaired loans, are placed on nonaccrual status when they become past due 90 days or more as to principal or interest, unless they are adequately secured and in the process of collection. Loans are considered impaired if full principal or interest payments are not anticipated in accordance with the contractual loan terms. Impaired loans are carried at the present value of expected future cash flows discounted at the loan’s effective interest rate or at the fair value of the collateral less cost to sell if the loan is collateral dependent. Loans are reviewed on a regular basis and normal collection procedures are implemented when a borrower fails to make a required payment on a loan. If the delinquency on a mortgage loan exceeds 120 days and is not cured through normal collection procedures or an acceptable arrangement is not agreed to with the borrower, management institutes measures to remedy the default, including commencing a foreclosure action. Consumer loans generally are charged off when a loan is deemed uncollectible and often before any available collateral has been disposed. Commercial business and real estate loan delinquencies are handled on an individual basis, generally with the advice of legal counsel.
Interest income on loans is recognized on the accrual basis except for those loans placed on nonaccrual status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers’ financial condition is such that collection of interest is doubtful, which typically occurs after the loan becomes 90 days delinquent. When interest accrual is discontinued, existing accrued interest is reversed and interest income is subsequently recognized only to the extent cash payments are received on well-secured loans.
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until such time as it is sold. New and used automobiles and other motor vehicles acquired as a result of foreclosure are classified as repossessed assets until they are sold. When such property is acquired it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent gains and losses are included in non-interest expense.
The following table sets forth information with respect to non-performing assets as of the dates indicated:
As of December 31,
(dollars in thousands)
Loans on nonaccrual status
$ 3,124
1,676
1,528
1,991
5,457
Troubled debt restructurings on accrual
1,217
Past due 90 days or more still on accrual
-
-
-
-
Total non-performing loans and TDRs on accrual
3,464
2,156
2,003
2,901
6,675
Real estate acquired through foreclosure
-
1,765
3,225
3,485
4,409
Other repossessed assets
-
-
-
-
-
Total non-performing assets and TDRs on accrual
$ 3,464
$ 3,921
$ 5,228
$ 6,386
$ 11,084
Nonaccrual loans to total loans
0.31 %
0.17 %
0.17 %
0.26 %
0.77 %
Non-performing loans and TDRs on accrual to total loans
0.35 %
0.22 %
0.22 %
0.38 %
0.94 %
Non-performing assets and TDRs on accrual to total assets
0.24 %
0.30 %
0.42 %
0.60 %
1.14 %
Allowance for loan losses to nonaccrual loans
369.11 %
742.42 %
548.17 %
446.01 %
150.30 %
Allowance for non-performing loans
$
$
$
$
$
Allowance for non-performing loans to non-performing loans and TDRs on accrual
0.35 %
1.02 %
2.40 %
2.86 %
1.62 %
Interest income that would have been recorded if nonaccrual loans were on a current basis in accordance with their original terms was $287,000, $288,000, and $315,000 for the years ended December 31, 2021, 2020, and 2019, respectively. Nonperforming loans at December 31, 2021, were $3.5 million, or 0.35% of total loans, at December 31, 2021, and $2.2 million, or 0.22% of total loans, at December 31, 2020.
Allowance for Loan Losses and Provision for Loan Losses - The allowance for loan losses is established to provide for probable losses on loans that may not be fully repaid. It is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses. Based on its assessment of the loan portfolio, management presents a quarterly review of the allowance for loan losses to the Bank’s Board of Directors, indicating any change in the allowance for loan losses since the last review and any recommendations as to adjustments in the allowance for loan losses. The allowance for loan losses is adjusted through charges to earnings in the form of a provision for loan losses. This assessment is an estimate and is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as events change.
Management utilizes loan grading procedures that result in specific allowance allocations for the estimated risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.
A significant portion of the portfolio is comprised of loans secured by real estate. A decline in the value of the real estate serving as collateral for loans may impact the Bank’s ability to collect those loans. In general, management obtains updated appraisals on property securing the Bank’s loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. Management uses qualified licensed appraisers approved by the Company’s Board of Directors. These appraisers possess prerequisite certifications and knowledge of the local and regional marketplace.
General Reserve - A general reserve is maintained for each loan type in the loan portfolio. In determining the amount of the general reserve portion of the allowance for loan losses, management considers factors such as the Bank’s historical loan loss experience, the growth, composition and diversification of its loan portfolio, current delinquency levels, loan quality grades, the results of recent regulatory examinations, and general economic conditions. Based on these factors, management applies estimated loss percentages to the various categories of loans, not including any loan that has a specific allowance allocated to it.
Specific Reserve - A loan is considered impaired when, based on current information, it is probable that the Bank will not receive all amounts due in accordance with the contractual terms of the loan agreement. Once a loan has been identified as impaired, management measures impairment in accordance with ASC 310-10, “Impairment of a Loan.” Generally, all loans identified as impaired are reviewed individually on a quarterly basis in order to determine whether a specific allowance is required. Additionally, specific reserves may be carried for accruing TDRs in compliance with restructured terms. When management’s measured value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve or charged-off if the loan is deemed collateral dependent. Loans for which specific reserves have been provided are excluded from the general reserve calculations described above.
The following table sets forth an analysis of loan loss experience as of and for the periods indicated:
As of December 31,
(dollars in thousands)
Balances at beginning of period
$ 12,443
$ 8,376
$ 8,880
$ 8,202
$ 8,967
Loans charged-off:
Real estate
2,332
Commercial
Consumer
Agriculture
Other
-
-
-
-
Total charge-offs
2,526
1,288
Recoveries:
Real estate
1,437
Commercial
Consumer
Agriculture
Other
-
Total recoveries
1,794
Net charge-offs (recoveries)
2,062
(1,178 )
(35 )
Provision (negative provision) for loan losses
1,150
4,400
-
(500 )
(800 )
Balance at end of period
$ 11,531
$ 12,443
$ 8,376
$ 8,880
$ 8,202
Allowance for loan losses to period-end loans
1.15 %
1.29 %
0.90 %
1.16 %
1.15 %
Net charge-offs (recoveries) to average loans
0.22 %
0.03 %
0.06 %
(0.16 )%
(0.01 )%
Allowance for loan losses to non-performing loans and TDRs on accrual
332.88 %
577.13 %
418.17 %
306.10 %
122.88 %
The loan loss reserve, as a percentage of total loans at December 31, 2021, was 1.15% compared to 1.29% at December 31, 2020. The allowance for loan losses to non-performing loans was 332.88% at December 31, 2021, compared with 577.13% at December 31, 2020.
At the beginning of the fourth quarter of 2021, the Bank had one remaining commercial real estate loan secured by a retail entertainment facility that remained subject to an eligible loan modification under Section 4013 of the CARES Act. This loan totaled $4.4 million, had been graded substandard, evaluated under ASC-310-10, and allocated a specific reserve of $2.2 million since December 2020. Given the uncertainty of the borrower’s ability to return to amortizing principal and interest payments, this loan was placed on nonaccrual during the fourth quarter of 2021 and a partial charge-off of the specifically allocated $2.2 million reserve was recognized. The remaining balance of this loan was $2.2 million at December 31, 2021. Net loan charge-offs were $2.1 million for 2021, compared to net loan charge-offs of $333,000 in 2020 and net loan charge-offs of $504,000 in 2019.
A provision for loan losses of $1.2 million was recorded for the year ended December 31, 2021, compared to provision for loan losses of $4.4 million for 2020, and no provision for loan losses for 2019. The 2021 loan loss provision was attributable to net loan charge-offs impacting historical loss percentages and growth trends within the portfolio during the year, while the provision for 2020 was largely attributable to the uncertainty surrounding the COVID-19 pandemic related economic and business disruptions.
While the U.S. Government’s economic responses to the COVID-19 pandemic through monetary policy and fiscal stimulus have provided meaningful support to the economy, management deemed it prudent to continue to maintain its qualitative environmental factor in the allowance for loan losses to account for the continued uncertainty surrounding the COVID-19 pandemic.
The following table depicts management’s allocation of the allowance for loan losses by loan type based on the factors previously discussed. Since these factors and management’s assumptions are subject to change, the allocation is not necessarily predictive of future portfolio performance. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of loans.
Allocation of Allowance for Credit Losses
As of December 31,
Amount of
Allowance
Percent of
Loans to
Total
Loans
Amount of
Allowance
Percent of
Loans to
Total
Loans
(dollars in thousands)
Commercial
$ 2,888
22.04 %
$ 2,529
21.65 %
Commercial Real Estate:
Construction
1,011
7.47
1,158
9.66
Farmland
6.83
7.30
Nonfarm nonresidential
4,328
34.53
5,117
27.69
Residential Real Estate:
Multi-family
5.01
6.36
1-4 Family
1,062
16.86
1,417
19.64
Consumer
3.64
3.27
Agriculture
3.59
4.37
Other
0.03
0.06
Total
$ 11,531
100.0 %
$ 12,443
100.0 %
As of December 31,
Amount of
Allowance
Percent of
Loans to
Total
Loans
Amount of
Allowance
Percent of
Loans to
Total
Loans
Amount of
Allowance
Percent of
Loans to
Total
Loans
(dollars in thousands)
Commercial
$ 1,710
15.71 %
$ 1,299
16.91 %
$
15.98 %
Commercial Real Estate:
Construction
7.01
11.35
8.05
Farmland
8.54
10.18
12.40
Nonfarm nonresidential
3,063
27.58
3,714
22.50
3,282
22.01
Residential Real Estate:
Multi-family
7.66
6.50
7.94
1-4 Family
1,265
24.47
2,049
22.97
2,273
25.17
Consumer
5.16
5.11
2.59
Agriculture
3.79
4.41
5.78
Other
0.08
0.07
0.08
Total
$ 8,376
100.0 %
$ 8,880
100.0 %
$ 8,202
100.0 %
Foreclosed Properties - There were no foreclosed properties at December 31, 2021, compared with $1.8 million at December 31, 2020. See “Note 6 - Other Real Estate Owned,” to the financial statements.
OREO is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. When foreclosed properties are acquired, management obtains a new appraisal or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management typically obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listing price is lowered below the appraisal amount.
Net activity relating to OREO during the years indicated is as follows:
(in thousands)
OREO Activity
OREO as of January 1
$ 1,765
$ 3,225
$ 3,485
Real estate acquired
-
-
-
Valuation adjustment write-downs
-
-
(260 )
Gain on sale
-
-
Proceeds from sale of properties
(1,956 )
(1,600 )
-
Improvements
-
-
OREO as of December 31
$ -
$ 1,765
$ 3,225
There were no acquisitions of OREO during 2021 or 2020. The Bank sold properties totaling $2.0 million and $1.6 million during 2021 and 2020, respectively. There were no fair value write-downs recorded during 2021 or 2020. Fair value write-downs of $260,000 were recorded in 2019. Fair value write-downs reflect updated appraisals, changes in marketing strategies, or reductions in listing prices for certain properties. The Bank recognized gain on sales of OREO of $191,000 for the year ended December 31, 2021, compared to no gain on sales of OREO during the year ended December 31, 2020 or 2019. Certain nonaccrual loans may be resolved through the acquisition and sale of the underlying real estate collateral.
Operating expenses for OREO totaled $13,000 for the year ended December 31, 2021, compared with operating expenses of $63,000 in 2020, and write-downs and operating expenses of $368,000 in 2019.
Deposits - The Bank attracts both short-term and long-term deposits from the general public by offering a wide range of deposit accounts and interest rates.
The Bank primarily relies on its banking office network to attract and retain deposits in its local markets, as well as deposit listing services, deposit gathering networks, and the online channel to attract both in and out-of-market deposits. Market interest rates and rates on deposit products offered by competing financial institutions can significantly affect the Bank’s ability to attract and retain deposits. During 2021, total deposits increased $89.1 million compared with 2020. The increase in deposits for 2021 was primarily in interest-bearing demand deposit account balances, as well as money market and non-interest demand deposit accounts. During 2020, total deposits increased $92.6 million compared with 2019. The increase in deposits for 2020 was primarily in savings account balances, as well as non-interest and interest-bearing demand deposit accounts.
The Bank continues to offer attractively priced deposit products along its product line to allow it to retain deposit customers and reduce interest rate risk during various rising and falling interest rate cycles. The Bank offers savings accounts, interest checking accounts, money market accounts and fixed rate certificates with varying maturities. The flow of deposits is influenced significantly by general economic conditions, changes in interest rates and competition. Management adjusts interest rates, maturity terms, service fees and withdrawal penalties on the Bank’s deposit products periodically. The variety of deposit products allows the Bank to compete more effectively in obtaining funds and to respond with more flexibility to the flow of funds away from depository institutions into outside investment alternatives. However, the ability to attract and maintain deposits at acceptable rates will continue to be significantly affected by market conditions.
The following table sets forth the average daily balances and weighted average rates paid for deposits for the periods indicated:
For the Years Ended December 31,
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Average
Balance
Average
Rate
(dollars in thousands)
Demand
$ 271,994
$ 215,145
$ 151,299
Interest Checking
233,844
0.27 %
169,808
0.32 %
104,077
0.30 %
Money Market
190,094
0.34
166,788
0.55
161,610
1.06
Savings
157,283
0.28
111,559
0.48
36,035
0.19
Certificates of Deposit
311,140
0.57
436,083
1.33
483,222
1.98
Total Deposits
$ 1,164,355
$ 1,099,383
$ 936,243
Weighted Average Rate
0.30 %
0.71 %
1.25 %
The following table shows at December 31, 2021 the amount of the Bank’s time deposits of $250,000 or more by time remaining until maturity:
Maturity Period
(in thousands)
Three months or less
$ 6,120
Three months through six months
6,185
Six months through twelve months
5,561
Over twelve months
15,534
Total
$ 33,400
The Bank maintains competitive pricing on its deposit products, which management believes allows it to retain a substantial percentage of the Bank’s customers when their time deposits mature.
Borrowing - Deposits are the primary source of funds for lending activities, investment activities, and for general business purposes. The Bank also uses borrowings from the FHLB of Cincinnati to supplement the pool of lendable funds, meet deposit withdrawal requirements and manage the terms of liabilities. FHLB borrowings are secured by the Bank’s stock in the FHLB, substantially all of its first mortgage residential loans, as well as its outstanding PPP loans. At December 31, 2021, the Bank had $20.0 million in outstanding borrowings from the FHLB and the capacity to increase borrowings by an additional $62.5 million. The FHLB of Cincinnati functions as a central reserve bank providing credit for member financial institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to borrow on the security of such stock and certain of its home mortgages and other assets (principally, securities that are obligations of, or guaranteed by, the United States) provided that it meets certain standards related to creditworthiness.
The following table sets forth information about the Bank’s FHLB borrowings as of and for the periods indicated:
December 31,
(dollars in thousands)
Average balance outstanding
$ 20,152
$ 34,101
$ 35,038
Maximum amount outstanding at any month-end during the period
20,620
71,376
61,389
End of period balance
20,000
20,623
61,389
Weighted average interest rate:
At end of period
0.77 %
0.75 %
1.70 %
During the period
0.76 %
1.09 %
2.31 %
Junior Subordinated Debentures - At December 31, 2021, the Company had four issues of junior subordinated debentures outstanding totaling $21.0 million as shown in the table below.
Description
Liquidation
Amount
Trust
Preferred
Securities
Issuance Date
Interest Rate (1)
Junior
Subordinated
Debt and
Investment
in Trust
Maturity Date
(dollars in thousands)
Statutory Trust I
$ 3,000
2/13/2004
3-month LIBOR + 2.85%
$ 3,093
2/13/2034
Statutory Trust II
5,000
2/13/2004
3-month LIBOR + 2.85%
5,155
2/13/2034
Statutory Trust III
3,000
4/15/2004
3-month LIBOR + 2.79%
3,093
4/15/2034
Statutory Trust IV
10,000
12/14/2006
3-month LIBOR + 1.67%
10,435
3/01/2037
$ 21,000
$ 21,776
(1)
As of December 31, 2021, the 3-month LIBOR was 0.21%.
The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated debentures at maturity or their earlier redemption at the liquidation preference. The subordinated debentures are redeemable before the maturity date at the Company’s option at their principal amount plus accrued interest.
The Company has the option to defer interest payments on the subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. A deferral period may begin at the Company’s discretion so long as interest payments are current. At December 31, 2021, the Company is current on all interest payments.
The Federal Reserve Board rules allow trust preferred securities issued prior to May 19, 2010 to be included in Tier 1 capital, subject to quantitative and qualitative limits. Currently, no more than 25% of the Company’s Tier 1 capital can consist of trust preferred securities and qualifying perpetual preferred stock. To the extent the amount of the Company’s trust preferred securities exceeds the 25% limit, the excess would be includable in Tier 2 capital. As of December 31, 2021, all of the Company’s trust preferred securities were included in and comprised 17% of Tier 1 capital.
Each of the trusts issuing the trust preferred securities holds junior subordinated debentures issued with an original maturity of 30 years. In the last five years before the junior subordinated debentures mature, the associated trust preferred securities are excluded from Tier 1 capital and included in Tier 2 capital. In addition, the trust preferred securities during this five-year period are amortized out of Tier 2 capital by one-fifth each year and excluded from Tier 2 capital completely during the year before maturity.
Subordinated Capital Notes - The Company’s subordinated notes mature on July 31, 2029. The notes carry interest at a fixed rate of 5.75% until July 30, 2024 and then convert to variable at three-month LIBOR plus 395 basis points until maturity. The subordinated capital notes qualify as Tier 2 regulatory capital. On July 31, 2020, the Company completed the issuance of an additional $8.0 million in subordinated notes under the July 23, 2019 indenture with the same terms and with the additional commitment by the Company to extend the optional prepayment date to July 31, 2025 so long as the additional notes qualify as Tier 2 regulatory capital. The Company used the net proceeds from the issuance of the additional notes to retire its senior debt and retained the remaining balance for general corporate purposes. The subordinated capital notes qualify as Tier 2 regulatory capital.
Capital
Stockholders’ equity increased $14.9 million to $131.0 million at December 31, 2021, compared with $116.0 million at December 31, 2020. The increase was due primarily to current year net income of $14.9 million.
The following table shows the ratios of common equity Tier 1, Tier 1 capital, total capital to risk-adjusted assets, and Tier 1 leverage for the Bank at December 31, 2021:
Regulatory
Minimums
Well-Capitalized
Minimums
Basel III Plus Conservation
Buffer
Limestone
Bank
Common equity Tier 1 capital
4.5 %
6.5 %
7.0 %
12.35 %
Tier 1 capital
6.0
8.0
8.5
12.35
Total risk-based capital
8.0
10.0
10.5
13.31
Tier 1 leverage ratio
4.0
5.0
-
10.84
Failure to meet minimum capital requirements could result in discretionary actions by regulators that, if taken, could have a materially adverse effect on the Company’s financial condition.
The Basel III rules require a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum Basel III levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions without prior regulatory approval.
Liquidity and Capital Resource Management
Liquidity risk arises from the possibility the Company may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that the Company meets the cash flow requirements of depositors and borrowers, as well as operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that cash flow needs are met at a reasonable cost. Management maintains an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. The Asset Liability Committee regularly monitors and reviews the Company’s liquidity position.
Funds are available to the Bank from a number of sources, including the sale of securities in the available for sale investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, and other wholesale funding.
The Bank also borrows from the FHLB to supplement funding requirements. At December 31, 2021, the Bank had an unused borrowing capacity with the FHLB of $62.5 million. Advances are collateralized by first mortgage residential loans, as well as its outstanding PPP loans. Borrowing capacity is based on the underlying book value of eligible pledged loans.
The Bank also has available on an unsecured basis federal funds borrowing line from a correspondent bank totaling $5.0 million. Management believes the sources of liquidity are adequate to meet expected cash needs for the foreseeable future. Historically, the Bank has also utilized brokered and wholesale deposits to supplement its funding strategy. At December 31, 2021, the Bank had no brokered deposits.
The Company uses cash on hand to service the subordinated capital notes, junior subordinated debentures, and to provide for operating cash flow needs. The Company’s primary source of funding to meet its obligations is dividends from the Bank. At December 31, 2021, the Bank was eligible to pay $6.5 million of dividends. The Bank paid the Company $2.0 million of dividends during 2021.
Additionally, the Company also may issue common equity, preferred equity and debt to support cash flow needs and liquidity requirements.
Material Cash Requirements and Obligations
The following table summarizes key obligations by maturity date or scheduled payment date and other commitments to make future payments as of December 31, 2021:
One year
or less
More than 1
year but less
than 3 years
3 years or
more but less
than 5 years
5 years or
more
Total
(dollars in thousands)
Time deposits
$ 161,917
$ 75,360
$ 28,196
$
$ 266,011
FHLB borrowing (1)
-
-
-
20,000
20,000
Operating leases
7,161
8,907
Junior subordinated debentures
-
-
-
21,000
21,000
Subordinated capital notes
-
-
-
25,000
25,000
Total
$ 162,280
$ 76,091
$ 28,848
$ 73,699
$ 340,918
(1) Fixed rate borrowing at 0.77%, maturing in 2030, and callable quarterly at the option of the FHLB.
Off-Balance Sheet Arrangements
In the normal course of business, the Bank enters into various transactions, which, in accordance with GAAP, are not included in the Company’s consolidated balance sheets. The Bank enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.
The commitments associated with outstanding standby letters of credit and commitments to extend credit as of December 31, 2021 are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the Bank’s actual future cash funding requirements:
One year
or less
More than 1
year but less
than 3 years
3 years or
more but less
than 5 years
5 years
or more
Total
(dollars in thousands)
Commitments to extend credit
$ 61,531
$ 75,966
$ 74,125
$ 55,818
$ 267,440
Standby letters of credit
-
-
Total
$ 62,419
$ 75,966
$ 74,129
$ 55,818
$ 268,332
Commitments to Extend Credit - The Bank enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of the Bank’s commitments to extend credit are contingent upon borrowers maintaining specific credit standards at the time of loan funding. The Bank minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.
Standby Letters of Credit - Standby letters of credit are written conditional commitments the Bank issues to guarantee the performance of a borrower to a third party. If the borrower does not perform in accordance with the terms of the agreement with the third party, the Bank may be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the Bank would be entitled to seek recovery from the borrower. The Bank’s policies generally require that standby letter of credit arrangements be underwritten in a manner consistent with a loan of similar characteristics.
Risk Participation Agreements - In connection with the purchase of loan participations, the Bank has entered into risk participation agreements, which had notional amounts totaling $12.1 million at December 31, 2021 and $26.6 million at December 31, 2020.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results in historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
The Bank has an asset and liability structure that is essentially monetary in nature. As a result, interest rates have a more significant impact on performance than the effects of general levels of inflation. Periods of high inflation are often accompanied by relatively higher interest rates, and periods of low inflation are accompanied by relatively lower interest rates. As market interest rates rise or fall in relation to the rates earned on loans and investments, the value of these assets decreases or increases respectively. Inflation can also impact core non-interest expenses associated with delivering the Bank’s services.

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
To minimize the volatility of net interest income and exposure to economic loss that may result from fluctuating interest rates, the Bank manages its exposure to adverse changes in interest rates through asset and liability management activities within guidelines established by the Asset Liability Committee (“ALCO”). The ALCO, which is comprised of senior officers, has the responsibility for approving and ensuring compliance with asset/liability management policies. Interest rate risk is the exposure to adverse changes in the net interest income as a result of market fluctuations in interest rates. The ALCO, on an ongoing basis, monitors interest rate and liquidity risk in order to implement appropriate funding and balance sheet strategies. Management considers interest rate risk to be the Bank’s most significant market risk.
The Company utilizes an earnings simulation model to analyze net interest income sensitivity. It then evaluates potential changes in market interest rates and their subsequent effects on net interest income. The model projects the effect of instantaneous movements in interest rates of both 100 and 200 basis points that are sustained for one year. Assumptions based on the historical behavior of the Company’s deposit rates and balances in relation to changes in interest rates are also incorporated into the model. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results may differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
Given an instantaneous 100 basis point increase in interest rates, the base net interest income would decrease by an estimated 1.3% at December 31, 2021 compared with an increase of 0.8% at December 31, 2020. Given an instantaneous 100 basis point decrease in interest rates, the base net interest income would decrease by an estimated 0.8% at December 31, 2021 compared with a decrease of 2.9% at December 31, 2020.
The following table indicates the estimated impact on net interest income under various interest rate scenarios for the year ended December 31, 2021, as calculated using the static shock model approach:
Change in Future
Net Interest Income
Dollar Change
Percentage
Change
(dollars in thousands)
+ 200 basis points
$ (903 )
(2.0 )%
+ 100 basis points
(576 )
(1.3 )
- 100 basis points
(340 )
(0.8 )
- 200 basis points
(1,438 )
(3.2 )
Implementation of strategies to mitigate the risk of changing interest rates in the future, could lessen the Company’s forecasted “base case” net interest income in the event of no interest rate changes. Interest sensitivity at any point in time will be affected by a number of factors. These factors include the mix of interest sensitive assets and liabilities as well as their relative pricing schedules. It is also influenced by market interest rates, deposit growth, loan growth, deposit decay rates and asset prepayment speed assumptions.

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements and reports are included in this section:
Report of Independent Registered Public Accounting Firm (PCAOB ID: 173)
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Change in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Crowe LLP
Independent Member Crowe Global
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors of Limestone Bancorp, Inc.
Louisville, Kentucky
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Limestone Bancorp, Inc. (the "Company") as of December 31, 2021 and 2020, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosures to which it relates.
Allowance for Loan Losses - Qualitative Risk Factors
As described in Notes 1 and 3 to the consolidated financial statements, the Company’s allowance for loan losses represents management’s best estimate of probable incurred credit losses inherent in the held for investment loan portfolio as of the balance sheet date. Management assesses the risk inherent in the loan portfolio based on qualitative and quantitative risk factors. The allowance for loan losses consists of two components: the valuation allowance for loans that are individually classified as impaired and separately identified for impairment (“specific component”), totaling $0 as of December 31, 2021 and the valuation allowance for loans not considered impaired and collectively evaluated for impairment (“general component”), totaling $11,531,000 as of December 31, 2021.
The general component covers non-impaired loans and is based on historical loss rates adjusted for current factors. The historical loss rates are determined by loan portfolio segment and based on actual loss history realized over the most recent five years with equal weighting. This actual loss experience is supplemented with other qualitative risk factors based on the risks present for each portfolio segment. The qualitative risk factor identification and analysis requires significant judgment and allows management to adjust the estimate of losses based on the most recent information available and to address other limitations in the historical loss rates. The Company’s qualitative risk factors include the changes in lending policies, procedures and practices, effects of any change in risk selection and underwriting standards, national and local economic trends and conditions, industry conditions, trends in volume and terms of loans, experience, ability and depth of lending management and other relevant staff, levels of and trends in delinquencies and impaired loans, levels of and trends in charge-offs and recoveries, and effects of changes in credit concentrations. The evaluation of these qualitative risk factors contributes significantly to the general component of the estimate of the allowance for loan losses.
We identified auditing the qualitative risk factors of the allowance for loan losses of the general component as a critical audit matter because of the necessary judment applied by us to evaluate management’s significant estimates and subjective assumptions related to the following:
●
Adjustments to the historical loss rates using qualitative risk factors including the selection of qualitative risk factors and the magnitude of each adjustment based on management’s judgments regarding factors which impact asset quality.
The primary procedures performed to address the critical audit matter included:
●
Testing the effectiveness of controls over the evaluation of the allowance for loan losses related to the qualitative risk factors, including controls addressing:
o
Management’s review over the qualitative risk factors used in the allowance for loan losses calculation, including data used as the basis for adjustments and the reasonableness of the adjustments and assumptions related to the qualitative risk factors.
o
Data inputs including the completeness and accuracy of loan data used in the qualitative risk factor computations.
●
Substantively testing management’s process, including evaluating their judgments and assumptions for developing the qualitative risk factors which included:
o
Evaluation of the reasonableness of management’s judgments and assumptions related to the qualitative risk factors. Our evaluation considered the weight of evidence from internal and external sources and loan portfolio performance.
o
Evaluation of the relevance and reliability of data, including completeness and accuracy of data used to develop the qualitative risk factors.
o
Evaluation of management’s methodology to ensure it was consistently applied year over year.
Crowe LLP
We have served as the Company's auditor since 1998.
Louisville, Kentucky
February 25, 2022
LIMESTONE BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
(Dollar amounts in thousands except share data)
Assets
Cash and due from banks
$ 10,493 $ 10,830
Interest bearing deposits in banks
67,110 56,863
Cash and cash equivalents
77,603 67,693
Securities available for sale
214,213 203,862
Securities held to maturity (fair value of $46,280)
46,460 -
Loans, net of allowance of $11,531 and $12,443, respectively
990,309 949,638
Premises and equipment, net
21,575 18,533
Premises held for sale
310 1,060
Other real estate owned
- 1,765
Federal Home Loan Bank stock
5,116 5,887
Bank owned life insurance
23,946 23,441
Deferred taxes, net
21,583 25,714
Goodwill
6,252 6,252
Other intangible assets, net
1,989 2,244
Accrued interest receivable and other assets
6,336 6,213
Total assets
$ 1,415,692 $ 1,312,302
Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing
$ 274,083 $ 243,022
Interest bearing
934,585 876,585
Total deposits
1,208,668 1,119,607
Federal Home Loan Bank advances
20,000 20,623
Accrued interest payable and other liabilities
10,065 10,048
Junior subordinated debentures
21,000 21,000
Subordinated capital notes
25,000 25,000
Total liabilities
1,284,733 1,196,278
Commitments and contingent liabilities (Note 15)
- -
Stockholders’ equity
Common stock, no par, 39,000,000 shares authorized, 6,594,749 and 6,498,865 voting, and 1,000,000 and 1,000,000 non-voting shares issued and outstanding, respectively
140,639 140,639
Additional paid-in capital
25,625 25,013
Retained deficit
(31,769 )
(46,678 )
Accumulated other comprehensive loss
(3,536 )
(2,950 )
Total common stockholders’ equity
130,959 116,024
Total liabilities and stockholders’ equity
$ 1,415,692 $ 1,312,302
See accompanying notes.
LIMESTONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
(Dollar amounts in thousands except per share data)
Interest income
Loans, including fees
$ 44,445 $ 45,093 $ 42,153
Taxable securities
4,612 5,042 6,269
Tax exempt securities
643 370 326
Federal funds sold and other
215 248 836
49,915 50,753 49,584
Interest expense
Deposits
3,518 7,796 11,657
Federal Home Loan Bank advances
154 371 810
Senior debt
- 119 329
Junior subordinated debentures
521 660 1,005
Subordinated capital notes
1,500 1,206 433
5,693 10,152 14,234
Net interest income
44,222 40,601 35,350
Provision for loan losses
1,150 4,400 -
Net interest income after provision for loan losses
43,072 36,201 35,350
Non-interest income
Service charges on deposit accounts
2,256 2,268 2,381
Bank card interchange fees
4,116 3,376 2,438
Income from bank owned life insurance
526 424 410
Gain on sale of other real estate owned
191 - -
Gain (loss) on sales and calls of securities, net
460 (5 )
(5 )
Other
890 781 694
8,439 6,844 5,918
Non-interest expense
Salaries and employee benefits
18,132 17,751 16,233
Occupancy and equipment
4,041 4,001 3,522
Deposit account related expense
2,158 1,890 1,224
Data processing expense
1,512 1,502 1,259
Professional fees
952 937 769
Marketing expense
727 629 908
FDIC insurance
405 229 211
Deposit and state franchise tax
375 1,475 1,210
Communications expense
681 856 772
Insurance expense
415 428 444
Postage and delivery
605 627 544
Acquisition costs
- - 775
Other
1,968 2,091 2,399
31,971 32,416 30,270
Income before income taxes
19,540 10,629 10,998
Income tax expense
4,631 1,624 480
Net income
14,909 9,005 10,518
Basic and diluted income per common share
$ 1.96 $ 1.20 $ 1.41
See accompanying notes.
LIMESTONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31,
(in thousands)
Net income
$ 14,909 $ 9,005 $ 10,518
Other comprehensive income (loss):
Unrealized gain (loss) on securities:
Unrealized gain (loss) arising during the period
25 1,012 3,773
Amortization during period of net unrealized gain transferred to held to maturity
(346 )
- -
Less reclassification adjustment for losses included in net income
460 (5 )
(5 )
Net unrealized gain (loss) recognized in comprehensive income
(781 )
1,017 3,778
Tax effect
195 (253 )
(864 )
Other comprehensive income (loss)
(586 )
764 2,914
Comprehensive income
$ 14,323 $ 9,769 $ 13,432
See accompanying notes.
LIMESTONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2021
(Dollar amounts in thousands except share and per share data)
Shares
Amount
Common
Non-Voting Common
Total
Common
Common and
Non-Voting
Common
Additional
Paid-In Capital
Retained Deficit
Accumulated Other Comprehensive Loss
Total
Balances, December 31, 2018
6,242,720
1,220,000
7,462,720
$ 140,639
$ 24,287
$ (66,201 )
$ (6,628 )
$ 92,097
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon vesting
13,503
-
13,503
-
(314 )
-
-
(314 )
Forfeited unvested stock
(4,248 )
-
(4,248 )
-
-
-
-
-
Stock-based compensation expense
-
-
-
-
-
-
Net income
-
-
-
-
-
10,518
-
10,518
Net change in accumulated other comprehensive loss, net of taxes
-
-
-
-
-
-
2,914
2,914
Balances, December 31, 2019
6,251,975
1,220,000
7,471,975
$ 140,639
$ 24,508
$ (55,683 )
$ (3,714 )
$ 105,750
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon vesting
28,248
-
28,248
-
(75 )
-
-
(75 )
Forfeited unvested stock
(1,358 )
-
(1,358 )
-
-
-
-
-
Stock-based compensation expense
-
-
-
-
-
-
Non-voting shares converted to voting
220,000
(220,000 )
-
-
-
-
-
-
Net income
-
-
-
-
-
9,005
-
9,005
Net change in accumulated other comprehensive income, net of taxes
-
-
-
-
-
-
Balances, December 31, 2020
6,498,865
1,000,000
7,498,865
$ 140,639
$ 25,013
$ (46,678 )
$ (2,950 )
$ 116,024
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon vesting
104,220
-
104,220
-
(87 )
-
-
(87 )
Forfeited unvested stock
(8,336 )
-
(8,336 )
-
-
-
-
-
Stock-based compensation expense
-
-
-
-
-
-
Net income
-
-
-
-
-
14,909
-
14,909
Net change in accumulated other comprehensive income, net of taxes
-
-
-
-
-
-
(586 )
(586 )
Balances, December 31, 2021
6,594,749
1,000,000
7,594,749
$ 140,639
$ 25,625
$ (31,769 )
$ (3,536 )
$ 130,959
See accompanying notes to unaudited consolidated financial statements.
LIMESTONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(in thousands)
Cash flows from operating activities
Net income
$ 14,909 $ 9,005 $ 10,518
Adjustments to reconcile net income (loss) to net cash from operating activities
Depreciation, amortization and accretion, net
4,677 2,986 1,669
Provision for loan losses
1,150 4,400 -
Net amortization on securities
594 655 700
Stock-based compensation expense
699 580 535
Deferred taxes, net
4,326 1,798 653
Net realized gain on sales of other real estate owned
(191 )
- -
Net write-down of other real estate owned
- - 260
Net realized (gain) loss on sales and calls of investment securities
(460 )
5 5
Net realized (gain) loss on sales of premises and equipment
1 - (1 )
Net write-down on premises held for sale
45 150 150
Increase in cash surrender value of life insurance, net of premium expense
(505 )
(404 )
(391 )
Amortization of operating lease right-of-use assets
374 593 185
Net change in accrued interest receivable and other assets
(3,346 )
(106 )
(302 )
Net change in accrued interest payable and other liabilities
17 1,383 (763 )
Net cash from operating activities
22,290 21,045 13,218
Cash flows from investing activities
Purchases of available for sale securities
(91,189 )
(38,416 )
(29,169 )
Proceeds from sales and calls of available for sale securities
7,500 9,030 5,351
Proceeds from maturities and prepayments of available for sale securities
37,038 34,881 19,083
Purchases of held to maturity securities
(16,444 )
- -
Proceeds from calls of held to maturity securities
1,704 - -
Proceeds from maturities and prepayments of held to maturity securities
3,665 - -
Proceeds from sale of other real estate owned
1,956 1,600 -
Improvements to other real estate owned
- (140 )
-
Purchases of Federal Home Loan Bank stock
- (600 )
-
Proceeds from mandatory redemption of Federal Home Loan Bank stock
771 950 996
Net changes in loans
(45,164 )
(37,772 )
(35,538 )
Proceeds from sale of premises and equipment
1 - 1
Proceeds from sale of premises held for sale
705 - -
Purchases of premises and equipment
(1,274 )
(879 )
(1,321 )
Net cash paid for acquisition
- - (5,280 )
Purchase of bank owned life insurance
- (7,000 )
-
Net cash from investing activities
(100,731 )
(38,346 )
(45,877 )
Cash flows from financing activities
Net change in deposits
89,061 92,632 975
Repayment of Federal Home Loan Bank advances
(623 )
(145,766 )
(160,160 )
Advances from Federal Home Loan Bank
- 105,000 175,000
Proceeds from issuance of subordinated capital notes
- 8,000 17,000
Repayment of senior debt
- (5,000 )
(5,000 )
Common shares withheld for taxes
(87 )
(75 )
(314 )
Net cash from financing activities
88,351 54,791 27,501
Net change in cash and cash equivalents
9,910 37,490 (5,158 )
Beginning cash and cash equivalents
67,693 30,203 35,361
Ending cash and cash equivalents
$ 77,603 $ 67,693 $ 30,203
Supplemental cash flow information:
Interest paid
$ 5,788 $ 10,422 $ 13,763
Income taxes paid (refunded)
370 (346 )
(346 )
Supplemental non-cash disclosure:
Transfer from loans to other real estate
- $ - $ -
Transfer from premises and equipment to premises held for sale
- 310 -
Transfer of available for sale to held to maturity securities
34,741 - -
AOCI component of transfer from available for sale to held to maturity
1,081 - -
Financed sales of other real estate owned
- 1,360 -
Initial recognition of right-of-use lease assets
- - 507
See accompanying notes.
LIMESTONE BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2021, 2020 and 2019
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Nature of Operations - The consolidated financial statements include Limestone Bancorp, Inc. (Company) and its wholly-owned subsidiary, Limestone Bank, Inc. (Bank). All significant intercompany transactions and accounts have been eliminated in consolidation.
The Bank, established in 1902, is a state chartered non-member financial institution providing financial services through its banking center locations in south central, southern, and western Kentucky, as well as Lexington, Louisville, and Frankfort.
Use of Estimates - To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.
In March 2020, the World Health Organization declared novel coronavirus disease 2019 (“COVID-19”) as a global pandemic. The COVID-19 pandemic has created economic and financial disruptions that have adversely affected, and are likely to continue to adversely affect, the business, financial condition, and results of operations of the Company and its customers. The COVID-19 pandemic caused changes in the behavior of customers, businesses, and their employees, including illness, quarantines, social distancing practices, cancellation of events and travel, business and school shutdowns, reduction in commercial activity and financial transactions, supply chain interruptions, increased unemployment, and overall economic and financial market instability.
Future effects, including further actions taken by federal, state, and local governments to contain COVID-19 or treat its impact, are unknown. In addition, federal governmental actions are meaningfully influencing the interest-rate environment. If these actions are sustained, it may adversely impact several industries within the Company’s geographic footprint and impair the ability of the Company’s customers to fulfill their contractual obligations. This could cause the Company to experience a material adverse effect on business operations, liquidity, asset valuations, results of operations, and financial condition, as well as its regulatory capital and liquidity ratios. Material adverse impacts may include all or a combination of valuation impairments on the Company’s intangible assets, investments, loans, or deferred tax assets.
Cash and Cash Equivalents - For the purpose of presentation in the statements of cash flows, the Company considers all cash and amounts due from depository institutions as well as interest bearing deposits in banks that mature within one year and are carried at cost to be cash equivalents.
Securities - Debt securities are classified as held to maturity and carried at amortized cost when management has the intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method anticipating prepayments on mortgage backed securities. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
In evaluating securities for other-than-temporary impairment (“OTTI”), management considers the length of time and extent to which fair value has been less than cost, the financial condition, and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into 1) OTTI related to credit loss, which is recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Loans - Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. The recorded investment in loans includes the outstanding principal balance and unamortized deferred origination costs and fees.
Interest income recognition on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well collateralized and in process of collection. Consumer loans are typically charged off no later than 90 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is not expected.
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such 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.
The Bank participated in the SBA Paycheck Protection Program (“PPP”) as a lender to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. Additionally, loan payments are deferred for the first six months of the loan term. No collateral or personal guarantees were required. PPP loans were considered in the provision for loan losses in 2021 and 2020, however, due to SBA guaranty the provision for loan losses impact was insignificant.
Allowance for Loan Losses - The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is deemed impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and are also treated as impaired.
Factors considered 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. The significance of payment delays and payment shortfalls is determined on a case-by-case basis, taking into consideration all 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.
If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment and are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported at the fair value of the collateral. For troubled debt restructurings that subsequently default, the amount of reserve is determined in accordance with the accounting policy for the allowance for loan losses.
The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on actual loss history experienced over the most recent five years with equal weighting. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: changes in lending policies, procedures, and practices; effects of any change in risk selection and underwriting standards; national and local economic trends and conditions; industry conditions; trends in volume and terms of loans; experience, ability and depth of lending management and other relevant staff; levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; and effects of changes in credit concentrations.
A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses. Management identified the following portfolio segments: commercial, commercial real estate, residential real estate, consumer, agricultural, and other.
●
Commercial loans are made to businesses and depend on the strength of the industries, related borrowers, and cash flow from the businesses. Commercial loans are advances for equipment purchases, or to provide working capital, or to meet other financing needs of business enterprises. These loans may be secured by accounts receivable, inventory, equipment or other business assets. Financial information is obtained from the borrowers to evaluate their ability to repay the loans.
●
Commercial real estate loans are affected by the local commercial real estate market and the local economy. Commercial real estate loans include loans on commercial properties occupied by borrowers and/or tenants. Construction and development loans are a component of this segment. These loans are generally secured by land under development or homes and commercial buildings under construction. Loans secured by farmland are also a component of this segment. Appraisals are obtained to support the loan amount. Financial information is obtained from the borrowers and/or the individual project to evaluate cash flows sufficiency to service the debt.
●
Residential real estate loans are affected by the local residential real estate market, local economy, and, for variable rate mortgages, movement in indices tied to these loans. For owner occupied residential loans, the borrowers’ repayment ability is evaluated through a review of credit scores and debt to income ratios. For non-owner occupied residential loans, such as rental real estate, financial information is obtained from the borrowers and/or the individual project to evaluate cash flows sufficiency to service the debt. Appraisals are obtained to support the determination of collateral value.
●
Consumer loans depend on local economies. Consumer loans are generally unsecured, but may be secured by consumer assets. Management evaluates the borrowers’ repayment ability through a review of credit scores and an evaluation of debt to income ratios. Consumer loans may be for consumer goods purchases, cash flow needs, or for student debt refinances.
●
Agriculture loans depend on the industries tied to these loans and are generally secured by livestock, crops, and/or equipment, but may be unsecured. Management evaluates the borrowers’ repayment ability through financial and business performance review.
●
Other loans include loans to municipalities, loans secured by stock, and overdrafts. For municipal loans, management evaluates the borrowers’ revenue streams as well as ability to repay form general funds. For loans secured by stock, management evaluates the market value of the stock securing the loan in relation to the loan amount. Overdrafts are funded based on pre-established criteria related to the deposit account relationship.
Management analyzes key relevant risk characteristics for each portfolio segment having determined that loans in each segment possess similar general risk characteristics that are analyzed in connection with loan underwriting processes and procedures. In determining the allocated allowance, the weighted average loss rates over the most recent five years are used with equal weighting. Commercial real estate qualitative adjustment considerations include trends in the markets for underlying collateral values, risks related to tenant rents, and economic factors such as decreased sales demand, elevated inventory levels, and declining collateral values. Residential real estate loan considerations include macro-economic factors such as unemployment rates, trends in vacancy rates, and home value trends. The commercial and agricultural portfolio qualitative adjustments are related to economic and portfolio performance trends. The agricultural, consumer and other portfolios are less significant in terms of size and risk is assessed based on the smaller dollar size of these loans and the geographical areas where the collateral is located.
Transfers of Financial Assets - Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, 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 the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Other Real Estate Owned (“OREO”) - Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value, less estimated costs to sell. If fair value declines subsequent to foreclosure, a write-down is recorded through expense. Costs after acquisition are expensed unless the expenditure is for a recoverable improvement, which may be capitalized.
Premises and Equipment - Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation and are depreciated using the straight-line method with useful lives generally ranging from 3 to 40 years. Leasehold improvements are amortized using the straight-line or accelerated method over terms of the related leases, including expected renewals, or over the useful lives of the improvements, whichever is shorter. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized.
Premises and equipment held for sale are recorded at fair value less estimated cost to sell at the time of transfer based upon independent third party appraisal. If fair value declines subsequent to transfer, write-downs are recorded through expense.
Premises and equipment are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are written down to fair value through a charge to earnings.
Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment. Because this stock is viewed as long term investment, impairment is based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Bank Owned Life Insurance - The Bank has purchased life insurance policies on certain key executives and associates. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Goodwill and Other Intangible Assets - Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed. The Bank has selected November 30 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the Bank’s balance sheet.
Other intangible assets consist of core deposit intangible assets arising from a branch acquisition, which were initially measured at fair value and then amortized on an accelerated method over the estimated useful life.
Benefit Plans - Employee 401(k) plan expense is the amount of matching contributions.
Stock-Based Compensation - Compensation cost is recognized for stock awards issued to employees, based on the fair value of these awards at the date of grant. The market price of the Company’s common stock at the date of grant is used for stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. The Company’s accounting policy is to recognize compensation cost net of forfeitures as they occur.
Income Taxes - Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Loan Commitments and Related Financial Instruments - Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer-financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded upon funding.
Comprehensive Income (Loss) - Comprehensive loss consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale, which are also recognized as a separate component of equity.
Earnings Per Common Share - Basic earnings per common share is net income attributable to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect, if any, of additional potential common shares issuable under stock options, warrants, and any convertible securities. Earnings and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements.
Earnings Allocated to Participating Securities - The Company has issued and outstanding unvested common shares to employees and directors through its equity compensation plan. Earnings are allocated to these participating securities based on their percentage of total issued and outstanding shares.
Loss Contingencies - Loss contingencies, including claims and legal actions arising in the normal course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.
Dividend Restrictions - Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to shareholders.
Fair Value of Financial Instruments - Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Derivatives - Derivative financial instruments are carried at fair value and reflect the estimated amounts that would have been received to terminate these contracts at the reporting date based upon pricing or valuation models applied to current market information.
As part of the asset/liability management program, the Company utilizes, from time to time, risk participation agreements to reduce its sensitivity to changing interest rates. These are derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets at fair value. Changes in the fair values of derivatives are reported in the consolidated statements of operations or other comprehensive income (“OCI”) depending on the use of the derivative and whether the instrument qualifies for hedge accounting. The key criterion for the hedge accounting is that the hedged relationship must be found to be effective as determined by FASB ASC 815 Derivatives and Hedging.
The risk participation agreements are not designated against specific assets or liabilities under ASC 815, and, therefore, do not qualify for hedge accounting. The derivatives are recorded on the balance sheet at fair value and changes in fair value of both the borrower and the offsetting swap agreements are recorded (and essentially offset) in non-interest income. The fair value of the derivative instruments incorporates a consideration of credit risk in accordance with ASC 820, resulting in some volatility in earnings each period.
To date, the Company has not entered into a cash flow hedge. For cash flow hedges, changes in the fair values of the derivative instruments are reported in OCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in OCI are reflected in the consolidated statements of income in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item. Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At inception of the hedge, a Company must establish the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized currently in the consolidated statements of operations and time value expiration of the hedge when measuring ineffectiveness is excluded.
New Accounting Standards - In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. Under the CECL model, certain financial assets that are carried at amortized cost, such as loans held for investment, held-to-maturity debt securities, and off-balance sheet credit exposures are required to be presented at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current GAAP, which delays recognition until it is probable a loss has been incurred. The change could materially affect how the allowance for loan losses is determined. Management is focused on refining assumptions, reviewing challenges to the model, analyzing forecast scenarios, and stress testing the volatility of the model. Additionally, management is implementing various accounting policies, developing processes and related controls, and considering various reporting disclosures. The impact of CECL model implementation is being evaluated, but it is expected that a one-time cumulative-effect adjustment to the allowance for loan losses will be recognized in retained earnings on the consolidated balance sheet as of the beginning of the first reporting period in which the new standard is effective, as is consistent with regulatory expectations set forth in interagency guidance. In December 2018, the OCC, The Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to the 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 adoption of the new accounting standard. In October 2019, the FASB voted to delay implementation for smaller reporting companies, private companies, and not-for-profit entities. The Company currently qualifies as a smaller reporting company and, as such, will be required to implement CECL for fiscal year and interim periods beginning after December 15, 2022.
In December 2019, the FASB issued ASU 2019-12, Income Taxes - Simplifying the Accounting for Income Taxes. The final standard removes specific exceptions to the general principles in Topic 740, improves financial statement preparers’ application of income tax-related guidance, and simplifies GAAP. Certain provisions under ASU 2019-12 require prospective application, some require modified retrospective adoption, while other provisions require retrospective application to all periods presented in the consolidated financial statements upon adoption. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, with early adoption permitted. Adoption of this new guidance did not have a material impact on the consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in this update provides optional guidance to ease the potential burden in accounting for reference rate reform on financial reporting. The new guidance provides optional expedients and exceptions for applying GAAP to contracts and hedging relationships, if certain criteria are met, that reference LIBOR or another reference rate expected to be discontinued. The amendments are effective for all entities as of March 12, 2020 through December 31, 2022. Adoption of this new guidance did not have a material impact on the consolidated financial statements.
NOTE 2 - SECURITIES
Securities are classified as available for sale (“AFS”) or held to maturity (“HTM”). AFS securities may be sold if needed for liquidity, asset liability management, or other reasons. AFS securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax. HTM securities are those securities the Bank has the intent and ability to hold until maturity and are reported at amortized cost.
The following table summarizes the amortized cost and fair value of AFS securities and HTM and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) and gross unrecognized gains and losses:
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
December 31, 2021
Available for sale
U.S. Government and federal agency
$ 26,075 $ 301 $ (133 )
$ 26,243
Agency mortgage-backed: residential
93,650 1,339 (970 )
94,019
Collateralized loan obligations
50,227 - (78 )
50,149
Corporate bonds
43,432 572 (202 )
43,802
Total available for sale
$ 213,384 $ 2,212 $ (1,383 )
$ 214,213
Amortized
Cost
Gross
Unrecognized Gains
Gross
Unrecognized Losses
Fair Value
Held to maturity
State and municipal
$ 46,460 $ 158 $ (338 )
$ 46,280
Total held to maturity
$ 46,460 $ 158 $ (338 )
$ 46,280
December 31, 2020
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
Available for sale
U.S. Government and federal agency
$ 18,811 $ 806 $ - $ 19,617
Agency mortgage-backed: residential
71,582 2,777 (26 )
74,333
Collateralized loan obligations
44,730 - (1,578 )
43,152
State and municipal
34,759 1,296 - 36,055
Corporate bonds
31,635 472 (1,402 )
30,705
Total available for sale
$ 201,517 $ 5,351 $ (3,006 )
$ 203,862
During March 2021, to better manage interest rate risk, management transferred from AFS to HTM all the municipal securities in the portfolio having a book value of approximately $34.7 million, a market value of approximately $35.8 million, and a net unrealized gain of approximately $1.1 million. The transfer occurred at fair value. The related net unrealized gain included in other comprehensive income remained in other comprehensive income and is being amortized from other comprehensive income with an offsetting entry to interest income as a yield adjustment through earnings over the remaining term of the securities. No gain or loss was recorded at the time of transfer. This transfer was completed after careful consideration of the intent and ability to hold these securities to maturity.
Sales and calls of securities were as follows:
(in thousands)
Proceeds
$ 9,204 $ 9,030 $ 5,351
Gross gains
465 - 1
Gross losses
5 5 6
The amortized cost and fair value of debt securities are shown by contractual maturity. Expected maturities may differ from actual maturities when borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are shown separately.
December 31, 2021
Amortized
Cost
Fair
Value
(in thousands)
Maturity
Available for sale
Within one year
$ - $ -
One to five years
4,253 4,361
Five to ten years
83,690 83,941
Beyond ten years
31,791 31,892
Agency mortgage-backed: residential
93,650 94,019
Total
$ 213,384 $ 214,213
Held to maturity
Within one year
$ 2,325 2,326
One to five years
9,690 $ 9,661
Five to ten years
3,824 3,793
Beyond ten years
30,621 30,500
Total
$ 46,460 $ 46,280
Securities pledged at year-end 2021 and 2020 had carrying values of approximately $155.4 million and $81.4 million, respectively, and were pledged to secure public deposits.
At December 31, 2021 and 2020, the Bank held securities issued by the Commonwealth of Kentucky or Kentucky municipalities having a book value of $35.7 million and $23.0 million, respectively. At year-end 2021, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.
The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. As of December 31, 2021, management does not believe any securities in the portfolio with unrealized losses should be classified as other than temporarily impaired.
The Bank owns Collateralized Loan Obligations (CLOs), which are debt securities secured by professionally managed portfolios of senior-secured loans to corporations. CLOs are typically $300 million to $1 billion in size, contain one hundred or more loans, have five to six credit tranches with credit ratings ranging from AAA, AA, A, BBB, BB, B and equity tranche. Interest and principal are paid first to the AAA tranche then to the next lower rated tranche. Losses are borne first by the equity tranche then by the subsequently higher rated tranche. CLOs may be less liquid than government securities from time to time and volatility in the CLO market may cause the value of these investments to decline.
The market value of CLOs may be affected by, among other things, changes in composition of the underlying loans, changes in the cash flows from the underlying loans, defaults and recoveries on the underlying loans, capital gains and losses on the underlying loans, prepayments on the underlying loans, and other conditions or economic factors. At December 31, 2021, $30.0 million and $20.1 million of the Bank’s CLOs were risk rated AA and A rated, respectively. None of the CLOs were subject to ratings downgrade during the year ended December 31, 2021.
The corporate bond portfolio consists of 15 subordinated debt securities and two senior debt security of U.S. banks and bank holding companies with maturities ranging from 2024 to 2037. The securities are either initially fixed rate for five years converting to floating rate at an index over LIBOR or SOFR, or floating rate at an index over LIBOR or SOFR from inception. Management regularly monitors the financial condition of these corporate issuers by reviewing their regulatory and public filings.
Securities with unrealized and unrecognized losses at December 31, 2021 and December 31, 2020, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows (in thousands):
Less than 12 Months
12 Months or More
Total
Description of Securities
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Available for sale
U.S. Government and federal agency
$ 11,645 $ (133 )
$ - $ - $ 11,645 $ (133 )
Agency mortgage-backed: residential
53,733 (960 )
642 (10 )
54,375 (970 )
Collateralized loan obligations
10,036 (7 )
16,514 (71 )
26,550 (78 )
Corporate bonds
22,548 (202 )
- - 22,548 (202 )
Total temporarily impaired
$ 97,962 $ (1,302 )
$ 17,156 $ (81 )
$ 115,118 $ (1,383 )
Less than 12 Months
12 Months or More
Total
Fair
Value
Unrecognized
Loss
Fair
Value
Unrecognized
Loss
Fair
Value
Unrecognized
Loss
Held to maturity
State and municipal
26,829 (338 )
- - 26,829 (338 )
Total temporarily impaired
$ 26,829 $ (338 )
$ - $ - $ 26,829 $ (338 )
Less than 12 Months
12 Months or More
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Available for sale
Agency mortgage-backed: residential
$ 4,772 $ (26 )
$ - $ - $ 4,772 $ (26 )
Collateralized loan obligations
8,794 (251 )
34,358 (1,327 )
43,152 (1,578 )
Corporate bonds
10,849 (1,402 )
- - 10,849 (1,402 )
Total temporarily impaired
$ 24,415 $ (1,679 )
$ 34,358 $ (1,327 )
$ 58,773 $ (3,006 )
NOTE 3 - LOANS
Loans net of unearned income, deferred loan origination costs, and net premiums on acquired loans by class were as follows:
(in thousands)
Commercial (1)
$ 220,826 $ 208,244
Commercial Real Estate:
Construction
74,806 92,916
Farmland
68,388 70,272
Nonfarm nonresidential
345,893 266,394
Residential Real Estate:
Multi-family
50,224 61,180
1-4 Family
168,873 188,955
Consumer
36,440 31,429
Agriculture
35,924 42,044
Other
466 647
Subtotal
1,001,840 962,081
Less: Allowance for loan losses
(11,531 )
(12,443 )
Loans, net
$ 990,309 $ 949,638
(1)
Includes PPP loans of $1.2 million and $20.3 million at December 31, 2021 and 2020, respectively.
The following table presents the activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2021, 2020, and 2019:
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Agriculture
Other
Total
December 31, 2021:
(in thousands)
Beginning balance
$ 2,529 $ 7,050 $ 1,899 $ 361 $ 600 $ 4 $ 12,443
Provision (negative provision)
206 1,314 (537 )
259 (91 )
(1 )
1,150
Loans charged off
(19 )
(2,302 )
(30 )
(131 )
(44 )
- (2,526 )
Recoveries
172 117 111 49 15 - 464
Ending balance
$ 2,888 $ 6,179 $ 1,443 $ 538 $ 480 $ 3 $ 11,531
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Agriculture
Other
Total
December 31, 2020:
(in thousands)
Beginning balance
$ 1,710 $ 4,080 $ 1,743 $ 485 $ 355 $ 3 $ 8,376
Provision (negative provision)
822 2,870 135 324 261 (12 )
4,400
Loans charged off
(32 )
(101 )
(130 )
(493 )
(46 )
- (802 )
Recoveries
29 201 151 45 30 13 469
Ending balance
$ 2,529 $ 7,050 $ 1,899 $ 361 $ 600 $ 4 $ 12,443
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Agriculture
Other
Total
December 31, 2019:
(in thousands)
Beginning balance
$ 1,299 $ 4,676 $ 2,452 $ 130 $ 321 $ 2 $ 8,880
Provision (negative provision)
342 (622 )
(958 )
943 297 (2 )
-
Loans charged off
(37 )
(47 )
(275 )
(663 )
(266 )
- (1,288 )
Recoveries
106 73 524 75 3 3 784
Ending balance
$ 1,710 $ 4,080 $ 1,743 $ 485 $ 355 $ 3 $ 8,376
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2021:
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Agriculture
Other
Total
(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment
$ - $ - $ 2 $ - $ - $ - $ 2
Collectively evaluated for impairment
2,888 6,179 1,441 538 480 3 11,529
Total ending allowance balance
$ 2,888 $ 6,179 $ 1,443 $ 538 $ 480 $ 3 $ 11,531
Loans:
Loans individually evaluated for impairment
$ - $ 2,878 $ 566 $ 12 $ 9 $ - $ 3,465
Loans collectively evaluated for impairment
220,826 486,209 218,531 36,428 35,915 466 998,375
Total ending loans balance
$ 220,826 $ 489,087 $ 219,097 $ 36,440 $ 35,924 $ 466 $ 1,001,840
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2020:
Commercial
Commercial
Real Estate
Residential
Real Estate
Consumer
Agriculture
Other
Total
(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment
$ - $ 2,176 $ 1 $ - $ - $ - $ 2,177
Collectively evaluated for impairment
2,529 4,874 1,898 361 600 4 10,266
Total ending allowance balance
$ 2,529 $ 7,050 $ 1,899 $ 361 $ 600 $ 4 $ 12,443
Loans:
Loans individually evaluated for impairment
$ - $ 5,361 $ 1,060 $ - $ 91 $ - $ 6,512
Loans collectively evaluated for impairment
208,244 424,221 249,075 31,429 41,953 647 955,569
Total ending loans balance
$ 208,244 $ 429,582 $ 250,135 $ 31,429 $ 42,044 $ 647 $ 962,081
Impaired Loans
Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss had been provided.
The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 2021:
Unpaid
Principal
Balance
Recorded
Investment
Allowance
For Loan
Losses
Allocated
Average
Recorded
Investment
Interest
Income
Recognized
Cash
Basis
Income
Recognized
(in thousands)
With No Related Allowance Recorded:
Commercial
$ 290 $ - $ - $ - $ - $ -
Commercial real estate:
Construction
- - - - - -
Farmland
302 215 - 520 55 55
Nonfarm nonresidential
7,755 2,663 - 4,430 302 25
Residential real estate:
Multi-family
- - - - 1 1
1-4 Family
1,408 501 - 764 135 126
Consumer
272 12 - 19 1 1
Agriculture
366 9 - 81 7 7
Other
- - - - - -
Subtotal
10,393 3,400 - 5,814 501 215
With An Allowance Recorded:
Commercial
- - - - - -
Commercial real estate:
Construction
- - - - - -
Farmland
- - - - - -
Nonfarm nonresidential
- - - - - -
Residential real estate:
Multi-family
- - - - - -
1-4 Family
65 65 2 95 2 -
Consumer
- - - - - -
Agriculture
- - - - - -
Other
- - - - - -
Subtotal
65 65 2 95 2 -
Total
$ 10,458 $ 3,465 $ 2 $ 5,909 $ 503 $ 215
The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 2020:
Unpaid
Principal
Balance
Recorded
Investment
Allowance
For Loan
Losses
Allocated
Average
Recorded
Investment
Interest
Income
Recognized
Cash
Basis
Income
Recognized
(in thousands)
With No Related Allowance Recorded:
Commercial
$ 308 $ - $ - $ 82 $ 16 $ 16
Commercial real estate:
Construction
- - - - - -
Farmland
555 456 - 326 45 45
Nonfarm nonresidential
1,323 549 - 501 44 15
Residential real estate:
Multi-family
- - - - - -
1-4 Family
1,883 954 - 894 86 83
Consumer
259 - - 55 3 3
Agriculture
393 91 - 27 - -
Other
- - - - - -
Subtotal
4,721 2,050 - 1,885 194 162
With An Allowance Recorded:
Commercial
- - - 5 - -
Commercial real estate:
Construction
- - - - - -
Farmland
- - - 198 4 -
Nonfarm nonresidential
6,465 4,356 2,176 901 263 -
Residential real estate:
Multi-family
- - - - - -
1-4 Family
106 106 1 102 9 -
Consumer
- - - - - -
Agriculture
- - - - - -
Other
- - - - - -
Subtotal
6,571 4,462 2,177 1,206 276 -
Total
$ 11,292 $ 6,512 $ 2,177 $ 3,091 $ 470 $ 162
The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 2019:
Unpaid
Principal
Balance
Recorded
Investment
Allowance
For Loan
Losses
Allocated
Average
Recorded
Investment
Interest
Income
Recognized
Cash
Basis
Income
Recognized
(in thousands)
With No Related Allowance Recorded:
Commercial
$ 138 $ 50 $ - $ 57 $ 3 $ 3
Commercial real estate:
Construction
- - - - - -
Farmland
380 293 - 179 23 23
Nonfarm nonresidential
1,057 489 - 295 34 3
Residential real estate:
Multi-family
- - - - - -
1-4 Family
1,679 745 - 1,402 219 191
Consumer
309 98 - 56 6 6
Agriculture
304 42 - 47 3 3
Other
- - - - - -
Subtotal
3,867 1,717 - 2,036 288 229
With An Allowance Recorded:
Commercial
24 24 3 15 2 -
Commercial real estate:
Construction
- - - - - -
Farmland
282 282 37 236 9 -
Nonfarm nonresidential
- - - - - -
Residential real estate:
Multi-family
- - - - - -
1-4 Family
183 147 2 459 6 -
Consumer
- - - - - -
Agriculture
- - - - - -
Other
- - - - - -
Subtotal
489 453 42 710 17 -
Total
$ 4,356 $ 2,170 $ 42 $ 2,746 $ 305 $ 229
Troubled Debt Restructuring
A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.
The following table presents the TDR loan modifications by portfolio segment outstanding as of December 31, 2021 and 2020:
TDRs
Performing to
Modified Terms
TDRs Not
Performing to
Modified Terms
Total
TDRs
(in thousands)
December 31, 2021
Commercial Real Estate:
Nonfarm nonresidential
$ 340 $ - $ 340
Residential Real Estate:
1-4 Family
- 65 65
Total TDRs
$ 340 $ 65 $ 405
TDRs
Performing to
Modified Terms
TDRs Not
Performing to
Modified Terms
Total
TDRs
(in thousands)
December 31, 2020
Commercial Real Estate:
Nonfarm nonresidential
$ 374 $ - $ 374
Residential Real Estate:
1-4 Family
106 - 106
Total TDRs
$ 480 $ - $ 480
At December 31, 2021 and 2020, 84% and 100%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $2,000 and $1,000 as of December 31, 2021 and 2020, respectively, in reserves to customers whose loan terms have been modified in TDRs. The Company has committed to lend no additional amounts as of December 31, 2021 or December 31, 2020 to customers with outstanding loans that are classified as TDRs.
During the years ended December 31, 2021, 2020, and 2019, no TDRs defaulted on their restructured loan within the twelve-month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.
The following table presents a summary of the TDR loan modifications by portfolio segment that occurred during the year ended December 31, 2021 and 2020:
TDRs
Performing to
Modified Terms
TDRs Not
Performing to
Modified Terms
Total
TDRs
(in thousands)
December 31, 2021
Residential Real Estate:
1-4 Family
$ 180 $ - $ 180
Total TDRs
$ 180 $ - $ 180
TDRs
Performing to
Modified Terms
TDRs Not
Performing to
Modified Terms
Total
TDRs
(in thousands)
December 31, 2020
Residential Real Estate:
1-4 Family
$ 33 $ - $ 33
Total TDRs
$ 33 $ - $ 33
The Company has not allocated any reserves to customers whose loan terms have been modified during 2021 and 2020. For modifications occurring during the twelve months ended December 31, 2021 and 2020, the post-modification balances approximate the pre-modification balances.
Non-TDR Loan Modifications due to COVID-19
The Bank has elected to account for eligible loan modifications under Section 4013 of the Coronavirus Aid Relief and Economic Security Act (“CARES Act”). To be an eligible loan under Section 4013 of the CARES Act, a loan modification must be (1) related to the COVID-19 pandemic; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020 and the earlier of (A) 60 days after the date of termination of the national emergency declared by the President on March 13, 2020 concerning the COVID-19 outbreak (the “national emergency”) or (B) December 31, 2020. On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (“Economic Aid Act”) extended eligible loan modifications under Section 4013 of the CARES Act from December 31, 2020 to January 1, 2022. Eligible loan modifications are not required to be classified as TDRs and will not be reported as past due provided that they are performing in accordance with the modified terms. Interest income will continue to be recognized in accordance with GAAP unless the loan is placed on nonaccrual status.
Loans subject to CARES Act modifications that had not returned to normal payment terms were $2.2 million as of December 31, 2021 and $15.3 million as of December 31, 2020. At the beginning of the fourth quarter of 2021, the Bank had one remaining commercial real estate loan secured by a retail entertainment facility subject to a CARES Act modification. This loan totaled $4.4 million, had been graded substandard, evaluated under ASC-310-10, and allocated a specific reserve of $2.2 million since December 2020. Given the uncertainty of the borrower’s ability to return to amortizing principal and interest payments, this loan was placed on nonaccrual during the fourth quarter of 2021 and a partial charge-off of the specifically allocated $2.2 million reserve was recognized.
The following table presents the aging of the recorded investment in past due loans by class as of December 31, 2021 and 2020:
30 - 59
Days
Past Due
60 - 89
Days
Past Due
90 Days
And Over
Past Due
Nonaccrual
Total
Past Due
And
Nonaccrual
(in thousands)
December 31, 2021
Commercial
$ 6 $ - $ - $ - $ 6
Commercial Real Estate:
Construction
- - - - -
Farmland
- - - 215 215
Nonfarm nonresidential
- 34 - 2,323 2,357
Residential Real Estate:
Multi-family
- - - - -
1-4 Family
513 148 - 566 1,227
Consumer
37 28 - 12 77
Agriculture
- - - 8 8
Other
- - - - -
Total
$ 556 $ 210 $ - $ 3,124 $ 3,890
30 - 59
Days
Past Due
60 - 89
Days
Past Due
90 Days
And Over
Past Due
Nonaccrual Total
Past Due
And
Nonaccrual
(in thousands)
December 31, 2020
Commercial
$ 20 $ - $ - $ - $ 20
Commercial Real Estate:
Construction
- - - - -
Farmland
325 53 - 456 834
Nonfarm nonresidential
- 26 - 175 201
Residential Real Estate:
Multi-family
- - - - -
1-4 Family
1,110 217 - 954 2,281
Consumer
59 49 - - 108
Agriculture
23 27 - 91 141
Other
- - - - -
Total
$ 1,537 $ 372 $ - $ 1,676 $ 3,585
Credit Quality Indicators
Management categorizes all loans into risk categories at origination based upon original underwriting. Thereafter, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed through internal and external loan review processes and are routinely analyzed through credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:
Watch - Loans classified as watch are those loans which have experienced or may experience a potentially adverse development which necessitates increased monitoring.
Special Mention - Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.
Substandard - Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful - Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of December 31, 2021 and 2020, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
Pass
Watch
Special
Mention
Substandard
Doubtful
Total
(in thousands)
December 31, 2021
Commercial
$ 207,729 $ 5,207 $ - $ 7,890 $ - $ 220,826
Commercial Real Estate:
Construction
74,806 - - - - 74,806
Farmland
65,836 170 - 2,382 - 68,388
Nonfarm nonresidential
341,780 413 - 3,700 - 345,893
Residential Real Estate:
Multi-family
50,224 - - - - 50,224
1-4 Family
164,850 2,038 - 1,985 - 168,873
Consumer
36,408 5 - 27 - 36,440
Agriculture
35,863 23 - 38 - 35,924
Other
466 - - - - 466
Total
$ 977,962 $ 7,856 $ - $ 16,022 $ - $ 1,001,840
Pass
Watch
Special
Mention
Substandard
Doubtful
Total
(in thousands)
December 31, 2020
Commercial
$ 201,240 $ 192 $ - $ 6,812 $ - $ 208,244
Commercial Real Estate:
Construction
92,916 - - - - 92,916
Farmland
65,556 3,714 - 1,002 - 70,272
Nonfarm nonresidential
258,665 1,605 - 6,124 - 266,394
Residential Real Estate:
Multi-family
50,732 10,448 - - - 61,180
1-4 Family
183,379 2,831 - 2,745 - 188,955
Consumer
31,387 3 - 39 - 31,429
Agriculture
41,503 86 - 455 - 42,044
Other
647 - - - - 647
Total
$ 926,025 $ 18,879 $ - $ 17,177 $ - $ 962,081
NOTE 4 - PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
(in thousands)
Land and buildings
$ 21,590 $ 21,214
Furniture and equipment
9,395 9,323
Leased right-of-use asset
5,326 2,477
36,311 33,014
Accumulated depreciation
(14,736 )
(14,481 )
$ 21,575 $ 18,533
Depreciation expense was $1.0 million, $1.1 million and $801,000 for 2021, 2020 and 2019, respectively.
NOTE 5 - LEASES
As of December 31, 2021, the Company leases real estate for seven branch offices or offsite ATM machines under various operating lease agreements. The lease agreements have maturity dates ranging from 2024 to 2046, including all expected extension periods. The weighted average remaining life of the lease term for these leases was 22 years as of December 31, 2021.
In determining the present value of lease payments, the Bank uses the implicit lease rate when readily determinable. As most of the Bank’s leases do not provide an implicit rate, the incremental borrowing rate based on the information available at commencement date is used. The incremental borrowing rate is the estimated rate of interest that the Bank would have to pay to borrow on a collateralized basis over a similar term in an amount equal to the lease payments in a similar economic environment. The weighted average discount rate for the leases was 4.18% as of December 31, 2021.
Total rental expense was $503,000 and $551,000 for the years ended December 31, 2021 and December 31, 2020, respectively. The right-of-use asset, included in premises and equipment, and lease liability, included in other liabilities, was $5.3 million as of December 31, 2021 and $2.5 million as of December 31, 2020.
Total estimated rental commitments for the operating leases were as follows as of December 31, 2021 (in thousands):
Thereafter
7,161
Total minimum lease payments
8,907
Discount effect of cash flows
(3,581 )
Present value of lease liabilities
$ 5,326
At December 31, 2021, the Company has one additional lease for a new branch office that has yet to commence. The right of use asset and lease liability for the lease yet to commence is estimated to be approximately $2.2 million and is expected to be recorded in the first quarter of 2022.
NOTE 6 - OTHER REAL ESTATE OWNED
Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less estimated cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.
The following table presents the major categories of OREO at the period-ends indicated:
(in thousands)
Commercial Real Estate:
Construction, land development, and other land
- 1,765
$ - $ 1,765
Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $47,000 and $35,000 at December 31, 2021 and December 31, 2020, respectively.
Activity relating to OREO during the years indicated is as follows:
(in thousands)
OREO Activity
OREO as of January 1
$ 1,765 $ 3,225 $ 3,485
Real estate acquired
- - -
Valuation adjustment write-downs
- - (260 )
Gain on sale
191 - -
Proceeds from sale of properties
(1,956 )
(1,600 )
-
Improvements
- 140 -
OREO as of December 31
$ - $ 1,765 $ 3,225
Expenses related to OREO include:
(in thousands)
Valuation adjustment write-downs
$ - $ - $ 260
Operating expense
13 63 108
Total
$ 13 $ 63 $ 368
Oreo expenses are reported in other non-interest expense.
NOTE 7 - GOODWILL AND INTANGIBLE ASSETS
The following table summarizes the Company’s acquired goodwill and intangible assets as of December 31, 2021 and December 31, 2020:
Gross
Carrying
Amount
Accumulated Amortization
Gross
Carrying
Amount
Accumulated Amortization
(in thousands)
Goodwill
$ 6,252 $ - $ 6,252 $ -
Core deposit intangibles
2,500 511 2,500 256
Outstanding, ending
$ 8,752 $ 511 $ 8,752 $ 256
During 2019, the Company recorded $6.3 million of goodwill related to a branch purchase transaction. Goodwill represents the excess of the total purchase price paid over the fair value of the identifiable assets acquired, net of the fair value of the liabilities assumed. Goodwill is not amortized but is evaluated for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Impairment exists when a reporting unit’s carrying amount exceeds its fair value. At November 30, 2021, the Company’s reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment. Since the annual impairment test on November 30, 2021, there have been no events or circumstances that would indicate it was more likely than not goodwill impairment exists. Goodwill is the only intangible asset with an indefinite life on the Company’s balance sheet.
The Company also has a core deposit intangible asset, which is amortized over the weighted average estimated life of the related deposits and is not estimated to have a significant residual value. Total amortization was $256,000 for the years ended December 31, 2021 and 2020.
The estimated amortization expense of the core deposit intangible for the next five years and thereafter is as follows (in thousands):
Amortization
Expense
$ 256
Thereafter
$ 1,989
NOTE 8 - DEPOSITS
The following table details deposits by category:
December 31,
December 31,
(in thousands)
Non-interest bearing
$ 274,083 $ 243,022
Interest checking
287,208 190,625
Money market
217,943 175,785
Savings
163,423 142,623
Certificates of deposit
266,011 367,552
Total
$ 1,208,668 $ 1,119,607
Time deposits of $250,000 or more were approximately $33.4 million and $50.7 million at year-end 2021 and 2020, respectively.
Scheduled maturities of time deposits for each of the next five years and thereafter are as follows (in thousands):
Total
$ 161,917
55,656
19,704
26,250
1,946
Thereafter
$ 266,011
NOTE 9 - ADVANCES FROM FEDERAL HOME LOAN BANK
At year-end, advances from the Federal Home Loan Bank were as follows:
December 31,
December 31,
(in thousands)
Short term advance
$ - $ 623
Long term advance (fixed rate 0.77%) maturing February 2030
20,000 20,000
Total advances from the Federal Home Loan Bank
$ 20,000 $ 20,623
FHLB advances had a weighted-average rate of 0.77% at December 31, 2021 and 0.75% at December 31, 2020. Each advance is payable per terms on agreement, with a prepayment penalty. No prepayment penalties were incurred during 2021 or 2020. The $20.0 million long term advance is callable quarterly at the FHLB’s option. Advances were collateralized by approximately $120.5 million and $133.7 million of first mortgage loans, under a blanket lien arrangement at December 31, 2021 and 2020, respectively, and $1.2 million and $20.3 million of loans originated under the SBA Payment Protection Plan at December 31, 2021 and 2020, respectively. At December 31, 2021, the Bank’s additional borrowing capacity with the FHLB was $62.5 million.
Scheduled principal payments during the next five years and thereafter (in thousands):
Advances
$ -
-
-
-
-
Thereafter
20,000
$ 20,000
At year-end 2021, the Company had a $5.0 million federal funds line of credit available on an unsecured basis from a correspondent institution.
NOTE 10 - BORROWINGS
Junior Subordinated Debentures - The junior subordinated debentures are redeemable at par prior to maturity at the option of the Company as defined within the trust indenture. The Company has the option to defer interest payments on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. A deferral period may begin at the Company’s discretion so long as interest payments are current. The Company is prohibited from paying dividends on preferred and common shares when interest payments are in deferral. At December 31, 2021, the Company is current on all interest payments.
A summary of the junior subordinated debentures is as follows:
Description
Issuance
Date
Interest Rate (1)
Junior
Subordinated
Debt Owed
To Trust
Maturity
Date (2)
Statutory Trust I
2/13/2004
3-month LIBOR + 2.85%
$ 3,000,000 2/13/2034
Statutory Trust II
2/13/2004
3-month LIBOR + 2.85%
5,000,000 2/13/2034
Statutory Trust III
4/15/2004
3-month LIBOR + 2.79%
3,000,000 4/15/2034
Statutory Trust IV
12/14/2006
3-month LIBOR + 1.67%
10,000,000 3/01/2037
$ 21,000,000
(1) As of December 31, 2021, the 3-month LIBOR was 0.21%.
(2) The debentures are callable at the Company’s option at their principal amount plus accrued interest.
Subordinated Capital Notes - The Company’s subordinated notes mature on July 31, 2029. The notes carry interest at a fixed rate of 5.75% until July 30, 2024 and then convert to variable at three-month LIBOR plus 395 basis points until maturity. The subordinated capital notes qualify as Tier 2 regulatory capital. On July 31, 2020, the Company completed the issuance of an additional $8.0 million in subordinated notes under the July 23, 2019 indenture with the same terms and with the additional commitment by the Company to extend the optional prepayment date to July 31, 2025 so long as the additional notes qualify as Tier 2 regulatory capital. The Company used the net proceeds from the issuance of the additional notes to retire its senior debt and retained the remaining balance for general corporate purposes. The subordinated capital notes qualify as Tier 2 regulatory capital.
NOTE 11 - OTHER BENEFIT PLANS
401(k) Plan - The Company’s 401(k) Savings Plan allows employees to contribute up to the annual limits as determined by the Internal Revenue Service, which is matched 100% of the first 1% of compensation contributed and 50% of the next 5% contributed by employees. The Company, at its discretion, may make additional contributions. Contributions made by the Company to the plan totaled approximately $373,000, $399,000 and $362,000 in 2021, 2020 and 2019, respectively.
NOTE 12 - INCOME TAXES
Income tax expense was as follows:
(in thousands)
Current
$ 305 $ (173 )
$ (173 )
Deferred
1,649 1,372 505
Net operating loss
2,677 903 1,725
Establish state deferred tax asset
- (478 )
(1,577 )
$ 4,631 $ 1,624 $ 480
Effective January 1, 2021, the Commonwealth of Kentucky eliminated the bank franchise tax, which was previously recorded as non-interest expense, and implemented a state income tax at a statutory rate of 5%. The Company recognized state income tax expense of $939,000 for the year ended December 31, 2021. For the years ended December 31, 2020 and 2019, the Company recognized a state income tax benefit of $478,000 and $1.6 million, respectively, due to the establishment of a net deferred tax asset.
Effective tax rates differ from the federal statutory rate applied to income before income taxes due to the following:
(in thousands)
Federal statutory tax rate
21 %
21 %
21 %
Federal statutory rate times financial statement income
$ 4,103 $ 2,232 $ 2,310
Effect of:
State income taxes
741 - -
Tax-exempt interest income
(123 )
(73 )
(66 )
Establish state deferred tax asset
- (478 )
(1,577 )
Non-taxable life insurance income
(111 )
(89 )
(86 )
Restricted stock vesting
(10 )
7 (137 )
Other, net
31 25 36
Total
$ 4,631 $ 1,624 $ 480
Year-end deferred tax assets and liabilities were due to the following:
(in thousands)
Deferred tax assets:
Net operating loss carry-forward
$ 19,335 $ 22,012
Allowance for loan losses
2,877 3,104
OREO write-down
- 914
Net assets from acquisitions
- 72
New market tax credit carry-forward
208 208
Nonaccrual loan interest
321 315
Accrued expenses
138 131
Lease liability
1,328 618
Other
202 332
24,409 27,706
Deferred tax liabilities:
FHLB stock dividends
415 478
Fixed assets
133 71
Deferred loan costs
176 172
Net unrealized gain on securities
390 585
Lease right-of-use assets
1,328 618
Net assets from acquisitions
108 -
Other
276 68
2,826 1,992
Net deferred tax assets
$ 21,583 $ 25,714
At December 31, 2021, the Company had net federal net operating loss carryforwards of $86.3 million, which will begin to expire in 2032, and state net operating loss carryforwards of $30.8 million, which will begin to expire in 2026.
The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the years ended December 31, 2021 or December 31, 2020 related to unrecognized tax benefits.
Under Section 382 of the Internal Revenue Code, as amended (“Section 382”), the Company’s net operating loss carryforwards and other deferred tax assets can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” as defined by Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's voting and non-voting common shares increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time.
In 2015, the Company took two measures to preserve the value of its NOLs. First, the Company adopted a tax benefits preservation plan designed to reduce the likelihood of an “ownership change” occurring as a result of purchases and sales of the Company's common shares. Upon adoption of this plan, the Company declared a dividend of one preferred stock purchase right for each common share outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, as amended November 25, 2019, the Board of Directors has the discretion to exempt certain transactions and certain persons whose acquisition of securities is determined by the Board not to jeopardize the Company's deferred tax assets. The rights plan was extended in May 2021 to expire upon the earlier of (i) June 30, 2024, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.
On September 23, 2015, the Company’s shareholders approved an amendment to its articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of the Company’s common shares that could result in an ownership change under Section 382. The transfer restrictions were extended in May 2021 by shareholder vote and will expire on the earlier of (i) May 19, 2024, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if the Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of the NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.
The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2018.
NOTE 13 - RELATED PARTY TRANSACTIONS
Loans to principal officers, directors, significant shareholders, and their affiliates in 2021 were as follows (in thousands):
Beginning balance
$ 14,295
New loans and advances
13,678
Repayments
(14,431 )
Ending balance
$ 13,542
Deposits from principal officers, directors, significant shareholders, and their affiliates at year-end 2021 and 2020 were $876,000 and $1.3 million, respectively.
Hogan Development Company and Hogan Real Estate Company periodically assist the Bank in managing and selling the Bank’s OREO. Both companies are owned by W. Glenn Hogan, a director of the Company and Bank. This arrangement was reviewed and evaluated by the Audit Committee in conjunction with the Board’s annual assessment of director independence. The Bank paid real estate management and sales fees to these companies of $45,000, $26,000, and $20,000 for the years ended December 31, 2021, 2020, and 2019, respectively.
NOTE 14 - REGULATORY CAPITAL MATTERS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can result in regulatory action.
The Basel III rules established a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. Including the capital conservation buffer, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions without prior regulatory approval.
As of December 31, 2021, the Company and Bank meet all capital adequacy requirements to which they are subject. At year end 2021 and 2020, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the institution’s category.
The following tables show the ratios (excluding capital conservation buffer) and amounts of common equity Tier 1, Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios for the Bank at the dates indicated (dollars in thousands):
Actual
Minimum Requirement for
Capital Adequacy
Purposes
Minimum Requirement
to be Well Capitalized
Under Prompt
Corrective Action
Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2021:
Total risk-based capital (to risk-weighted assets)
$ 160,700
13.31 %
$ 96,591
8.00 %
$ 120,738
10.00 %
Total common equity Tier 1 risk- based capital (to risk-weighted assets)
149,169
12.35
54,332
4.50
78,480
6.50
Tier 1 capital (to risk-weighted assets)
149,169
12.35
72,443
6.00
96,591
8.00
Tier 1 capital (to average assets)
149,169
10.84
55,057
4.00
68,822
5.00
Actual
Minimum Requirement
for Capital Adequacy
Purposes
Minimum Requirement
to be Well Capitalized
Under Prompt
Corrective Action
Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2020:
Total risk-based capital (to risk-weighted assets)
$ 142,449
13.20 %
$ 86,302
8.00 %
$ 107,878
10.00 %
Total common equity Tier 1 risk- based capital (to risk-weighted assets)
130,006
12.05
48,545
4.50
70,120
6.50
Tier 1 capital (to risk-weighted assets)
130,006
12.05
64,727
6.00
86,302
8.00
Tier 1 capital (to average assets)
130,006
10.21
50,908
4.00
63,636
5.00
Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. Based on these regulations, the Bank was eligible to pay $6.5 million of dividends as of December 31, 2021. The Bank paid the Company $2.0 million of dividends during 2021.
NOTE 15 - OFF-BALANCE SHEET RISKS, COMMITMENTS, AND CONTINGENT LIABILITIES
The Company, in the normal course of business, is party to financial instruments with off-balance sheet risk. The financial instruments include commitments to extend credit and standby letters of credit. The contract or notional amounts of these instruments reflect the potential future obligations of the Company pursuant to those financial instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with the Company’s credit policies. Collateral from the client may be required based on the Company’s credit evaluation of the client and may include business assets of commercial clients, as well as personal property and real estate of individual clients or guarantors.
An approved but unfunded loan commitment represents a potential credit risk and a liquidity risk, since the Company’s client(s) may demand immediate cash that would require funding. In addition, unfunded loan commitments represent interest rate risk as market interest rates may rise above the rate committed to the Company’s client. Since a portion of these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time may not require future funding. Commitments to make loans are generally made for periods of one year or less.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. In addition to credit risk, the Company also has liquidity risk associated with standby letters of credit because funding for these obligations could be required immediately. The Company does not deem this risk to be material. No liability is currently established for standby letters of credit.
The following table presents the contractual amounts of financial instruments with off-balance sheet risk for each year ended:
Fixed
Rate
Variable
Rate
Fixed
Rate
Variable
Rate
(in thousands)
Commitments to make loans
$ 85,294 $ 60,683 $ 20,990 $ 17,466
Unused lines of credit
12,828 108,635 5,964 144,790
Standby letters of credit
566 326 175 1,342
Commitments to make loans are generally made for periods of one year or less except for home equity loans, which generally have a term of 10 years.
In connection with the purchase of loan participations, the Bank entered into risk participation agreements, which had notional amounts totaling $12.1 million at December 31, 2021 and $26.6 million at December 31, 2020. The risk participation agreements are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging, and, therefore, do not qualify for hedge accounting. The derivatives are recorded in other liabilities on the balance sheet at fair value and changes in fair value of both the borrower and the offsetting swap agreements are recorded (and essentially offset) in non-interest income. The fair value of the derivative instruments incorporates a consideration of credit risk in accordance with ASC 820, resulting in some volatility in earnings each period. At December 31, 2021 and December 31, 2020, the fair value of the risk participation agreements were $67,000 and $188,000, respectively.
In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages.
The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated. The Company is not currently involved in any material litigation.
NOTE 16 - FAIR VALUES
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Various valuation techniques are used to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs.
Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, the fair value hierarchy is classified on the lowest level of input that is significant to the fair value measurement. The following methods and significant assumptions are used to estimate fair value.
Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.
Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.
Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Management routinely applies internal discounts to the value of appraisals used in the fair value evaluation of the Bank’s impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where the Bank’s appraisal date predates a likely change in market conditions. Management also applies discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment.
Impaired loans are evaluated quarterly for additional impairment. Management obtains updated appraisals on properties securing the Bank’s loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and the assessment of deterioration of real estate values in the market in which the property is located.
Financial assets measured at fair value on a recurring basis are summarized below:
Fair Value Measurements at December 31, 2021 Using
(in thousands)
Description
Carrying
Value
Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Available for sale securities
U.S. Government and federal agency
$ 26,243 $ - $ 26,243 $ -
Agency mortgage-backed: residential
94,019 - 94,019 -
Collateralized loan obligations
50,149 - 50,149 -
Corporate bonds
43,802 - 29,761 14,041
Total
$ 214,213 $ - $ 200,172 $ 14,041
Fair Value Measurements at December 31, 2020 Using
(in thousands)
Description
Carrying
Value
Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Available for sale securities
U.S. Government and federal agency
$ 19,617 $ - $ 19,617 $ -
Agency mortgage-backed: residential
74,333 - 74,333 -
Collateralized loan obligations
43,152 - 40,764 2,388
State and municipal
36,055 - 36,055 -
Corporate bonds
30,705 - 18,789 11,916
Total
$ 203,862 $ - $ 189,558 $ 14,304
There were no transfers between Level 1 and Level 2 during 2021 or 2020.
The Company’s policy is to transfer assets or liabilities from one level to another when the methodology to obtain the fair value changes such that there are more or fewer unobservable inputs as of the end of the reporting period.
The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2021 and 2020:
December 31, 2021
Collateralized
Loan Obligations
Corporate
Bonds
(in thousands)
Balance of recurring Level 3 assets at January 1, 2021
$ 2,388 $ 11,916
Total gains or losses for the year:
Included in earnings
- 465
Included in other comprehensive income
108 1,532
Calls
- (6,000 )
Transfers into Level 2
(2,496 )
(1,042 )
Transfers into Level 3
- 7,170
Balance of recurring Level 3 assets at December 31, 2021
$ - $ 14,041
December 31, 2020
Collateralized
Loan Obligations
Corporate
Bonds
(in thousands)
Balance of recurring Level 3 assets at January 1, 2020
$ - $ -
Total gains or losses for the year:
Included in other comprehensive income
- -
Transfers into Level 3
2,388 11,916
Balance of recurring Level 3 assets at December 31, 2020
$ 2,388 $ 11,916
The following table presents quantitative information about recurring level 3 fair value measurements at December 31, 2021 and 2020:
Fair Value Measurements at December 31, 2021
Fair Value
Valuation
Technique(s)
Unobservable Input(s)
Range (Weighted
Average)
(in thousands)
Corporate bonds
$ 10,049 Discounted cash flow
Constant prepayment rate
0%
Spread to benchmark yield 200% - 298% (235%)
Indicative broker bid 99% - 106% (103%)
Fair Value Measurements at December 31, 2020
Fair Value
Valuation
Technique(s)
Unobservable Input(s)
Range (Weighted
Average)
(in thousands)
Collateralized loan obligations
$ 2,388 Discounted cash flow
Constant prepayment rate
0%
Additional asset defaults 2% (2%)
Expected asset recoveries 49% (49%)
Corporate bonds
$ 11,916 Discounted cash flow
Constant prepayment rate
0%
Spread to benchmark yield 322% - 497% (381%)
Indicative broker bid 72% - 107% (80%)
Financial assets measured at fair value on a non-recurring basis are summarized below:
Fair Value Measurements at December 31, 2021 Using
(in thousands)
Description
Carrying
Value
Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired loans:
Residential real estate:
1-4 Family
$ 63 $ - $ - $ 63
Fair Value Measurements at December 31, 2020 Using
(in thousands)
Description
Carrying
Value
Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired loans:
Commercial real estate:
Nonfarm nonresidential
$ 2,180 $ - $ - $ 2,180
Residential real estate:
1-4 Family
105 - - 105
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $65,000, with a valuation allowance of $2,000, at December 31, 2021, resulting in no additional provision for loan losses for the year ended December 31, 2021. At December 31, 2020, impaired loans had a carrying amount of $4.5 million, with a valuation allowance of $2.2 million, at December 31, 2020, resulting in $2.1 million provision for loan losses for the year ended December 31, 2020.
The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2020:
Fair Value Measurements at December 31, 2020
Fair Value
Valuation
Technique(s)
Unobservable Input(s)
Range (Weighted
Average)
(in thousands)
Impaired loans - Commercial real estate
$ 2,180 Sales comparison approach
Adjustment for differences between the comparable sales
0% - 65% (33%)
Income approach Discount or capitalization rate 12% (12%)
Carrying amount and estimated fair values of financial instruments were as follows at year-end 2021:
Fair Value Measurements at December 31, 2021 Using
Carrying
Amount
Level 1
Level 2
Level 3
Total
(in thousands)
Financial assets
Cash and cash equivalents
$ 77,603 $ 77,603 $ - $ - $ 77,603
Securities available for sale
214,213 - 204,164 10,049 214,213
Securities held to maturity
46,460 - 46,280 - 46,280
Federal Home Loan Bank stock
5,116 N/A N/A N/A N/A
Loans, net
990,309 - - 981,995 981,995
Accrued interest receivable
3,870 - 1,022 2,848 3,870
Financial liabilities
Deposits
$ 1,208,668 $ 274,083 $ 935,768 $ - $ 1,209,851
Federal Home Loan Bank advances
20,000 - 20,046 - 20,046
Junior subordinated debentures
21,000 - - 19,500 19,500
Subordinated capital notes
25,000 - - 26,149 26,149
Accrued interest payable
764 - 136 628 764
Carrying amount and estimated fair values of financial instruments were as follows at year-end 2020:
Fair Value Measurements at December 31, 2020 Using
Carrying
Amount
Level 1
Level 2
Level 3
Total
(in thousands)
Financial assets
Cash and cash equivalents
$ 67,693 $ 67,693 $ - $ - $ 67,693
Securities available for sale
203,862 - 189,558 14,304 203,862
Federal Home Loan Bank stock
5,887 N/A N/A N/A N/A
Loans, net
949,638 - - 941,330 941,330
Accrued interest receivable
4,444 - 925 3,519 4,444
Financial liabilities
Deposits
$ 1,119,607 $ 243,022 $ 878,309 $ - $ 1,121,331
Federal Home Loan Bank advances
20,623 - 20,665 - 20,665
Junior subordinated debentures
21,000 - - 16,194 16,194
Subordinated capital notes
25,000 - - 25,207 25,207
Accrued interest payable
859 - 231 628 859
NOTE 17 - STOCK PLANS AND STOCK BASED COMPENSATION
Shares available for issuance under the 2018 Omnibus Equity Compensation Plan total 166,490. Shares issued to employees under the plan generally vest annually on the anniversary date of the grant over three or seven years. Shares issued annually to each non-employee director have a fair market value of $25,000 and vest on December 31 in the year of grant.
The fair value of the 2021 shares issued was $1.5 million, or $13.52 per weighted-average share. The Company recorded $699,000, $580,000, and $535,000 of stock-based compensation during 2021, 2020, and 2019, respectively, to salaries and employee benefits. Management expects substantially all of the unvested shares outstanding at the end of the period to vest according to the vesting schedule. A deferred tax benefit of $175,000, $122,000, and $112,000 was recognized related to this expense in 2021, 2020, and 2019, respectively.
The following table summarizes stock plan share activity as of and for the periods indicated for the Company’s equity compensation plan:
Twelve Months Ended
Twelve Months Ended
December 31, 2021
December 31, 2020
Weighted
Weighted
Average
Average
Grant
Grant
Shares
Price
Shares
Price
Outstanding, beginning
47,438 $ 15.34 57,774 $ 13.35
Granted
110,024 13.52 34,858 15.33
Vested
(37,590 )
15.13 (43,836 )
12.69
Forfeited
(8,336 )
13.66 (1,358 )
15.95
Outstanding, ending
111,536 $ 13.73 47,438 $ 15.34
Unrecognized stock based compensation expense related to unvested shares for 2022 and beyond is estimated as follows (in thousands):
$ 375
Thereafter
NOTE 18 - EARNINGS PER SHARE
The factors used in the basic and diluted earnings per share computation follow:
(in thousands, except share and per share data)
Net income
$ 14,909 $ 9,005 $ 10,518
Less:
Earnings allocated to unvested shares
219 68 106
Net income attributable to common shareholders, basic and diluted
$ 14,690 $ 8,937 $ 10,412
Basic
Weighted average common shares including unvested common shares and participating preferred shares outstanding
7,593,176 7,492,190 7,468,215
Less:
Weighted average unvested common shares
111,740 56,809 75,084
Weighted average common shares outstanding
7,481,436 7,435,381 7,393,131
Basic income per common share
$ 1.96 $ 1.20 $ 1.41
Diluted
Add: Dilutive effects of assumed exercises of common stock warrants
- - -
Weighted average common shares and potential common shares
7,481,436 7,435,381 7,393,131
Diluted income per common share
$ 1.96 $ 1.20 $ 1.41
The Company had no outstanding stock options at December 31, 2021, 2020 or 2019.
NOTE 19 - REVENUE FROM CONTRACTS WITH CUSTOMERS
All of the Company’s revenue from customers in the scope of ASC 606 is recognized within non-interest income. A description of the Company’s revenue streams accounted for under ASC 606 follows:
Service Charges on Deposit Accounts: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges are withdrawn from the customer’s account balance.
Bank Card Interchange Income: The Company earns interchange fees from bank cardholder transactions conducted through a third party payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.
Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assess whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. Gains and losses on sales of OREO are reported in non-interest income.
Other Non-interest Income: Other non-interest income includes revenue from several sources that are within the scope of ASC 606, including title insurance commissions, income from secondary market loan sales, gains on sales of premises and equipment, and other transaction-based revenue that is individually immaterial. Other non-interest income included approximately $623,000, $558,000, and $501,000 of revenue for the years ended December 31, 2021, 2020, and 2019, respectively, within the scope of ASC 606. The remaining other non-interest income for the year is excluded from the scope of ASC 606.
NOTE 20 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of Limestone Bancorp Inc. is presented as follows:
CONDENSED BALANCE SHEETS
December 31,
(in thousands)
ASSETS
Cash and cash equivalents
$ 4,759 $ 5,037
Investment in banking subsidiary
165,481 150,560
Investment in and advances to other subsidiaries
776 776
Deferred taxes, net
6,532 5,953
Other assets
1,282 1,180
Total assets
$ 178,830 $ 163,506
LIABILITIES AND SHAREHOLDERS’ EQUITY
Debt
$ 46,775 $ 46,775
Accrued expenses and other liabilities
1,096 707
Shareholders’ equity
130,959 116,024
Total liabilities and shareholders’ equity
$ 178,830 $ 163,506
CONDENSED STATEMENTS OF OPERATIONS
Years ended December 31,
(in thousands)
Interest income
$ 18 $ 37 $ 83
Dividends from subsidiaries
2,019 23 36
Other income
20 20 19
Interest expense
(2,040 )
(2,008 )
(1,803 )
Other expense
(1,501 )
(1,357 )
(1,179 )
Loss before income tax and undistributed subsidiary income
(1,484 )
(3,285 )
(2,844 )
Income tax benefit
(885 )
(815 )
(1,997 )
Equity in undistributed subsidiary income
15,508 11,475 11,365
Net income
$ 14,909 $ 9,005 $ 10,518
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31,
(in thousands)
Cash flows from operating activities
Net income
$ 14,909 $ 9,005 $ 10,518
Adjustments:
Equity in undistributed subsidiary income
(15,508 )
(11,475 )
(11,365 )
Deferred taxes, net
(579 )
(815 )
(1,996 )
Stock-based compensation expense
699 580 535
Net change in other assets
(102 )
(97 )
(401 )
Net change in other liabilities
390 145 423
Net cash from operating activities
(191 )
(2,657 )
(2,286 )
Cash flows from investing activities
Investments in subsidiaries
- - (10,000 )
Net cash from investing activities
- - (10,000 )
Cash flows from financing activities
Proceeds from issuance of subordinated capital notes
- 8,000 17,000
Repayment of senior debt
- (5,000 )
(5,000 )
Common shares withheld for taxes
(87 )
(75 )
(314 )
Net cash from by financing activities
(87 )
2,925 11,686
Net change in cash and cash equivalents
(278 )
268 (600 )
Beginning cash and cash equivalents
5,037 4,769 5,369
Ending cash and cash equivalents
$ 4,759 $ 5,037 $ 4,769
NOTE 21 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Presented below is a summary of the consolidated quarterly financial data for the years ended December 31, 2021 and 2020.
Fourth
Third
Second
First
Quarter
Quarter
Quarter
Quarter
Interest income (1)
$ 12,314 $ 12,975 $ 12,376 $ 12,250
Interest expense
1,307 1,354 1,462 1,570
Net interest income
11,007 11,621 10,914 10,680
Provision for loan losses
500 300 - 350
Net interest income after provision
10,507 11,321 10,914 10,330
Non-interest income
1,984 2,436 2,135 1,884
Non-interest expense
7,983 8,050 7,954 7,984
Income before income taxes
4,508 5,707 5,095 4,230
Income tax expense (2)
1,063 1,366 1,194 1,008
Net income
$ 3,445 $ 4,341 $ 3,901 $ 3,222
Basic and diluted earnings per common share (3)
$ 0.45 $ 0.57 $ 0.51 $ 0.43
Cash dividends declared per common share
$ 0.00 $ 0.00 $ 0.00 $ 0.00
Fourth
Third
Second
First
Quarter
Quarter
Quarter
Quarter
Interest income (1)
$ 12,606 $ 12,094 $ 12,786 $ 13,267
Interest expense
1,820 2,151 2,676 3,505
Net interest income
10,786 9,943 10,110 9,762
Provision for loan losses
900 1,350 1,100 1,050
Net interest income after provision
9,886 8,593 9,010 8,712
Non-interest income
1,777 1,742 1,601 1,724
Non-interest expense
7,866 8,079 8,236 8,235
Income before income taxes
3,797 2,256 2,375 2,201
Income tax expense (2)
680 190 393 361
Net income
$ 3,117 $ 2,066 $ 1,982 $ 1,840
Basic and diluted earnings per common share (3)
$ 0.42 $ 0.28 $ 0.26 $ 0.25
Cash dividends declared per common share
$ 0.00 $ 0.00 $ 0.00 $ 0.00
(1)
Interest income includes PPP loan origination fees as detailed below:
First quarter
$ 436,000 $ -
Second quarter
692,000 179,000
Third quarter
1,368,000 195,000
Fourth quarter
261,000 767,000
(2)
See Footnote 12 for more information on the Company’s income taxes for 2021 and 2020.
(3)
The sum of the quarterly net income per share (basic and diluted) differs from the annual net income per share (basic and diluted) because of the differences in the weighted average number of common shares outstanding and the common shares used in the quarterly and annual computations as well as differences in rounding.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. The Company’s management, under the supervision and with the participation of its Chief Executive Officer and its Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2021. Based on that evaluation, management believes that the Company’s disclosure controls and procedures were effective to collect, process, and disclose the information required to be disclosed in the reports filed or submitted under the Securities Exchange Act of 1934 within the required time periods as of the end of the period covered by this report.
There was no change in the internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The management of Limestone Bancorp, Inc. (the “Company”) is responsible for the preparation, integrity, and fair presentation of the Company’s annual consolidated financial statements. All information has been prepared in accordance with U.S. generally accepted accounting principles and, as such, includes certain amounts that are based on management’s best estimates and judgments.
Management is responsible for establishing and maintaining adequate internal control over financial reporting presented in conformity with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Two of the objectives of internal control are to provide reasonable assurance to management and the Board of Directors that transactions are properly authorized and recorded in the Company’s financial records, and that the preparation of the Company’s financial statements and other financial reporting is done in accordance with U.S. generally accepted accounting principles. There are inherent limitations in the effectiveness of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to reliability of financial statements. Furthermore, internal control can vary with changes in circumstances.
Management has made its own assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2021, in relation to the criteria described in the report, Internal Control - Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
Based on its assessment, management believes that as of December 31, 2021, the Company’s internal control over financial reporting was effective in achieving the objectives stated above.
This annual report does not include an attestation report of our registered public accounting firm regarding internal controls over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

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ITEM 9B. OTHER INFORMATION
Item 9B. Other Information
None
PART III

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors, Executive Officers and Corporate Governance.
The Company has adopted a code of ethics applicable to the Chief Executive Officer and the senior financial officers, which is posted on the Bank’s website at http://www.limestonebank.com under the Investors Relations section of the ‘About Us’ tab. If the Company amends or waives any of the provisions of the Code of Ethics applicable to its Chief Executive Officer or senior financial officers, management intends to disclose the amendment or waiver on its website. The Company will provide to any person without charge, upon request, a copy of this Code of Ethics. You can request a copy by contacting Limestone Bancorp, Inc., Chief Financial Officer, 2500 Eastpoint Parkway, Louisville, Kentucky, 40223, (telephone) 502-499-4800.
Additional information required by this Item 10 is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2022, which includes the required information. The required information contained in the Company’s proxy statement under the headings “Proposal 1: Election of Directors,” “Corporate Governance,” and “Certain Relationships and Related Transactions - Delinquent Section 16(a) Reports” is incorporated herein by reference.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation.
The information required by this Item 11 is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2022, which includes the required information. The required information contained in the Company’s proxy statement under the headings “Corporate Governance,” “Compensation Discussion and Analysis,” “Executive Compensation,” and “Compensation Committee Report” is incorporated herein by reference.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain information required by this Item 12 is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2022, which includes the required information. The required information contained in the Company’s proxy statement under the heading “Stock Ownership of Directors, Officers, and Principal Shareholders” is incorporated herein by reference.
Certain information required by this Item 12 appears under the heading “Equity Compensation Plan Information” in Item 5 of this report and is incorporated herein by reference.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item 13 is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2022, which includes the required information. The required information contained in the Company’s proxy statement under the headings “Corporate Governance” and “Certain Relationships and Related Transactions” is incorporated herein by reference.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accounting Fees and Services.
The information required by this Item 14 is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2022, which includes the required information. The required information contained in the Company’s proxy statement under the heading “Principal Accountant Fees and Services” is incorporated herein by reference.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits and Financial Statement Schedules
(a) 1.
The following financial statements are included in this Form 10-K:
Consolidated Balance Sheets as of December 31, 2021 and 2020
Consolidated Statements of Operations for the Years Ended December 31, 2021, 2020, and 2019
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2021, 2020, and 2019
Consolidated Statements of Change in Stockholders’ Equity for the Years Ended December 31, 2021, 2020, and 2019
Consolidated Statements of Cash Flows for the Years Ended December 31, 2021, 2020, and 2019
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
(a) 2.
List of Financial Statement Schedules
Financial statement schedules are omitted because the information is not applicable.
(a) 3.
List of Exhibits
The Exhibit Index appearing before the required signatures in this report is incorporated by reference. The compensatory plans or arrangement required to be filed as exhibits to this Form 10-K pursuant to Item 15(c) are noted with an asterisk in the Exhibit Index as noted therein.