UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM10-Q
For the quarterly period ended September 30, 2022
OR
For the transition period from ________ to ________
Commission File Number 0-33203
LANDMARK BANCORP, INC.
(Exact name of registrant as specified in its charter)
701 Poyntz Avenue, Manhattan, Kansas 66502
(Address of principal executive offices) (Zip code)
(785)565-2000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: as of November 09, 2022, the issuer had outstanding 4,966,884 shares of its common stock, $0.01 par value per share.
Form 10-Q Quarterly Report
Table of Contents
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LANDMARK BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Per share amounts for the periods ended September 30, 2021 have been adjusted to give effect to the 5% stock dividend paid during December 2021.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.Interim Financial Statements
The unaudited consolidated financial statements of Landmark Bancorp, Inc. (the “Company”) and its wholly owned subsidiaries, Landmark National Bank (the “Bank”) and Landmark Risk Management Inc., have been prepared in accordance with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements and should be read in conjunction with the Company’s most recent Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 22, 2022, containing the latest audited consolidated financial statements and notes thereto. The consolidated financial statements in this report have not been audited by an independent registered public accounting firm, but in the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of financial statements have been reflected herein. The results of the nine-month interim period ended September 30, 2022 are not necessarily indicative of the results expected for the year ending December 31, 2022 or any other future time period. The Company has evaluated subsequent events for recognition and disclosure up to the date the financial statements were issued.
2.Acquisition
On October 1, 2022, the Company completed its acquisition of Freedom Bancshares, Inc., the holding company of Freedom Bank. Freedom Bank was founded in 2006 and operates out of a single location in Overland Park, Kansas. As of September 30, 2022, Freedom Bank reported total assets of $201.9million, gross loans of $118.0million, and total deposits of $150.4million. The acquisition will be accounted for as a business combination under ASC 805.
3.Investments
A summary of investment securities available-for-sale is as follows:
Schedule of Available-for-sale Securities
The tables above show that some of the securities in the available-for-sale investment portfolio had unrealized losses, or were temporarily impaired, as of September 30, 2022 and December 31, 2021. This temporary impairment represents the estimated amount of loss that would be realized if the securities were sold on the valuation date. Securities which were temporarily impaired are shown below, along with the length of time in a continuous unrealized loss position.
Schedule of Available for Sale Securities Continuous Unrealized Loss Position Fair Value
The Company’s U.S. treasury portfolio consists of securities issued by the United States Department of the Treasury. The receipt of principal and interest on U.S. treasury securities is guaranteed by the full faith and credit of the U.S. government. Based on these factors, along with the Company’s intent to not sell the securities and its belief that it was more likely than not that the Company will not be required to sell the securities before recovery of its cost basis, the Company believed that the U.S. treasury securities identified in the table above were temporarily impaired as of September 30, 2022 and December 31, 2021.
The Company’s U.S. federal agency portfolio consists of securities issued by the government-sponsored agencies of Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Bank (“FHLB”). The receipt of principal and interest on U.S. federal agency obligations is guaranteed by the respective government-sponsored agency guarantor, such that the Company believes that its U.S. federal agency obligations do not expose the Company to credit-related losses. Based on these factors, along with the Company’s intent to not sell the securities and its belief that it was more likely than not that the Company will not be required to sell the securities before recovery of their cost basis, the Company believed that the U.S. federal agency obligations identified in the tables above were temporarily impaired as of September 30, 2022 and December 31, 2021.
The Company’s portfolio of municipal obligations consists of both tax-exempt and taxable general obligations securities issued by various municipalities. As of September 30, 2022, the Company did not intend to sell and it was more likely than not that the Company will not be required to sell its municipal obligations in an unrealized loss position until the recovery of its cost. Due to the issuers’ continued satisfaction of the securities’ obligations in accordance with their contractual terms and the expectation that they will continue to do so, the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believed that the municipal obligations identified in the tables above were temporarily impaired as of September 30, 2022 and December 31, 2021.
The Company’s agency mortgage-backed securities portfolio consists of securities underwritten to the standards of and guaranteed by the government-sponsored agencies of FHLMC, FNMA and the Government National Mortgage Association. The receipt of principal, at par, and interest on agency mortgage-backed securities is guaranteed by the respective government-sponsored agency guarantor, such that the Company believed that its agency mortgage-backed securities did not expose the Company to credit-related losses. Based on these factors, along with the Company’s intent to not sell the securities and the Company’s belief that it was more likely than not that the Company will not be required to sell the securities before recovery of their cost basis, the Company believed that the agency mortgage-backed securities identified in the table above were temporarily impaired as of September 30, 2022 and December 31, 2021.
The table below sets forth amortized cost and fair value of investment securities at September 30, 2022. The table includes scheduled principal payments and estimated prepayments, based on observable market inputs, for agency mortgage-backed securities. Actual maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties.
Schedule of Investments Classified by Contractual Maturity Date
Sales proceeds and gross realized gains and losses on sales of available-for-sale securities were as follows for the periods indicated:
Schedule of Realized Gain (loss)
Securities with carrying values of $329.6 million and $331.7 million were pledged to secure public funds on deposit, repurchase agreements and as collateral for borrowings at September 30, 2022 and December 31, 2021, respectively. Except for U.S. federal agency obligations, no investment in a single issuer exceeded 10% of consolidated stockholders’ equity.
4.Loans and Allowance for Loan Losses
Loans consisted of the following as of the dates indicated below:
Schedule of Loans
The following tables provide information on the Company’s allowance for loan losses by loan class and allowance methodology:
Schedule of Allowance for Credit Losses on Financing Receivables
One-to-fourfamily
residentialreal estateloans
The Company recorded net loan recoveries of $43,000 during the third quarter of 2022 compared to net loan charge-offs of $397,000 during the third quarter of 2021. The Company recorded net loan recoveries of $83,000 during the nine months ended September 30, 2022 compared to net loan charge-offs of $509,000 during the nine months ended September 30, 2021.
The Company’s impaired loans decreased $1.0 million from $6.7 million at December 31, 2021 to $5.7 million at September 30, 2022. The difference between the unpaid contractual principal and the impaired loan balance is a result of charge-offs recorded against impaired loans. The difference in the Company’s non-accrual loan balances and impaired loan balances at September 30, 2022 and December 31, 2021, was related to troubled debt restructurings (“TDR”) that are current and accruing interest, but still classified as impaired. Interest income recognized on a cash basis was immaterial during the three and nine months ended September 30, 2022 and 2021.
The following tables present information on impaired loans:
Schedule of Impaired Financing Receivables
The Company’s key credit quality indicator is a loan’s performance status, defined as accruing or non-accruing. Performing loans are considered to have a lower risk of loss. Non-accrual loans are those which the Company believes have a higher risk of loss. The accrual of interest on non-performing loans is discontinued at the time the loan is 90 days delinquent, unless the credit is well secured and in process of collection. Loans are placed on non-accrual or are charged off at an earlier date if collection of principal or interest is considered doubtful. There were no loans 90 days or more delinquent and accruing interest at September 30, 2022 or December 31, 2021.
The following tables present information on the Company’s past due and non-accrual loans by loan class:
Schedule of Past Due Financing Receivables
Under the original terms of the Company’s non-accrual loans, interest earned on such loans for the nine months ended September 30, 2022 and 2021 would have increased interest income by $155,000 and $635,000, respectively. No interest income related to non-accrual loans was included in interest income for the nine months ended September 30, 2022 and 2021.
The Company also categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. Nonclassified loans generally include those loans that are expected to be repaid in accordance with contractual loan terms. Classified loans are those that are assigned a special mention, substandard or doubtful risk rating using the following definitions:
Special Mention: Loans are currently protected by the current net worth and paying capacity of the obligor or of the collateral pledged but such protection is potentially weak. These loans constitute an undue and unwarranted credit risk, but not to the point of justifying a classification of substandard. The credit risk may be relatively minor, yet constitutes an unwarranted risk in light of the circumstances surrounding a specific asset.
Substandard: Loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged. Loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans classified doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
The following table provides information on the Company’s risk categories by loan class:
Schedule of Troubled Debt Restructurings on Financing Receivables
At September 30, 2022, the Company had seven loan relationships consisting of 11 outstanding loans that were previously classified as TDRs. No loans were classified as TDRs during the three or nine months ending September 30, 2022. During the second quarter of 2022, a $7,000commercial loan paid off after being classified as a TDR in 2018. During the first quarter of 2022, two construction and land loans totaling $599,000 were paid off. These loans were originally classified as TDRs in 2012. A commercial loan totaling $32,000 was paid off in the first quarter of 2022 after being classified as a TDR in the first quarter of 2021. An agriculture loan totaling $250,000 was also paid off in the first quarter of 2022 after being classified as a TDR in the third quarter of 2021. During the three and nine months ended September 30, 2021, an agriculture loan paid off that was previously classified as a TDR in 2016. During the nine months ended September 30, 2021, a commercial loan relationship consisting of five loans was modified after originally being classified as a TDR in 2020. The borrower liquidated some of the collateral securing the loans and refinanced the remaining balance of $479,000 into one loan which retained a TDR classification.
The Company evaluates each TDR individually and returns the loan to accrual status when a payment history is established after the restructuring and future payments are reasonably assured. There were no loans modified as TDRs for which there was a payment default within 12 months of modification as of September 30, 2022 and 2021. The Company did not record any charge-offs against loans classified as TDRs in the first nine months of 2022 or 2021. No provision was recorded against TDRs in the three months ended September 30, 2022 as compared to a credit provision of $2,000 during the same period of 2021. A credit provision for loan losses of $2,000 and $7,000 was recorded against TDRs in the nine months ended September 30, 2022 and 2021, respectively. The Company had no allowance for loan losses recorded against loans classified as TDRs at September 30, 2022 compared to $2,000 at December 31, 2021.
The following table presents information on loans that are classified as TDRs:
5.Goodwill and Other Intangible Assets
The Company tests goodwill for impairment annually or more frequently if circumstances warrant. The Company’s annual impairment test as of December 31, 2021 concluded that its goodwill was not impaired. The Company concluded there were no triggering events during the first nine months of 2022 that required an interim goodwill impairment test.
Core deposit intangible assets are amortized over the estimated useful life of ten years on an accelerated basis. A summary of the other intangible assets that continue to be subject to amortization was as follows:
Schedule of Other Intangible Assets and Goodwill
The following sets forth estimated amortization expense for core deposit and lease intangible assets for the remainder of 2022 and in successive years ending December 31:
Schedule of Finite-lived Intangible Assets, Future Amortization Expense
6.Mortgage Loan Servicing
Mortgage loans serviced for others are not reported as assets. The following table provides information on the principal balances of mortgage loans serviced for others:
Schedule of Participating Mortgage Loans
Custodial escrow balances maintained in connection with serviced loans were $10.2 million and $5.8 million at September 30, 2022 and December 31, 2021, respectively. Gross service fee income related to such loans was $456,000 and $452,000 for the three months ended September 30, 2022 and 2021, respectively, and is included in fees and service charges in the consolidated statements of earnings. Gross service fee income related to such loans was $1.4 and $1.3 million for the nine months ended September 30, 2022 and 2021, respectively.
Activity for mortgage servicing rights was as follows:
Schedule of Servicing Asset at Amortized Cost
The fair value of mortgage servicing rights was $10.4 million and $6.7 million at September 30, 2022 and December 31, 2021, respectively. Fair value at September 30, 2022 was determined using discount rate of 9.50%; prepayment speeds ranging from 6.00% to 13.70%, depending on the stratification of the specific mortgage servicing right; and a weighted average default rate of 1.44%. Fair value at December 31, 2021 was determined using discount rates ranging from 9.00% to 12.00%; prepayment speeds ranging from 6.02% to 23.70%, depending on the stratification of the specific mortgage servicing right; and a weighted average default rate of 1.34%.
The Company had a mortgage repurchase reserve of $225,000 at September 30, 2022 and $226,000 at December 31, 2021, which represents the Company’s best estimate of probable losses that the Company will incur related to the repurchase of one-to-four family residential real estate loans previously sold or to reimburse investors for credit losses incurred on loans previously sold where a breach of the contractual representations and warranties occurred. The Company charged a $1,000 loss against the reserve during the first nine months ended September 30, 2022. The Company charged a $9,000 loss against the reserve during the first nine months ended September 30, 2021. As of September 30, 2022, the Company did not have any outstanding mortgage repurchase requests.
7.Earnings per Share
Basic earnings per share have been computed based upon the weighted average number of common shares outstanding during each period. Diluted earnings per share include the effect of all potential common shares outstanding during each period. The diluted earnings per share computation for the three and nine months ended September 30, 2022 excluded 48,302 of unexercised stock options because their inclusion would have been anti-dilutive during such period. The diluted earnings per share computation for the three and nine months ended September 30, 2021 excluded 33,320 of unexercised stock options because their inclusion would have been anti-dilutive during such period. The Company’s Board of Directors declared a cash dividend of $0.21 per share to be paid November 30, 2022, to common stockholders of record as of the close of business on November 16, 2022. The Board of Directors also declared a 5% stock dividend issuable December 16, 2022 to common stockholders of record on December 2, 2022. The shares used in the calculation of basic and diluted earnings per share are shown below:
Schedule of Earnings Per Share, Basic and Diluted
8. Other Borrowings
On September 29, 2022, the Company borrowed $10.0 million from an unrelated financial institution at a fixed rate of 6.15%. This borrowing matures on September 1, 2027and requires quarterly principal and interest payments. The borrowing is secured with the stock of the Bank and the proceeds were used to fund part of the acquisition of Freedom Bancshares, Inc.
9.Repurchase Agreements
The Company has overnight repurchase agreements with certain deposit customers whereby the Company uses investment securities as collateral for non-insured funds. These balances are accounted for as collateralized financing and included in other borrowings on the balance sheet.
Repurchase agreements are comprised of non-insured customer funds, totaling $6.3 million at September 30, 2022 and $7.4 million at December 31, 2021, which were secured by $10.7 million and $9.2 million of the Company’s investment portfolio at the same dates, respectively.
The following is a summary of the balances and collateral of the Company’s repurchase agreements:
Schedule of Repurchase Agreements
The investment securities are held by a third party financial institution in the customer’s custodial account. The Company is required to maintain adequate collateral for each repurchase agreement. Changes in the fair value of the investment securities impact the amount of collateral required. If the Company were to default, the investment securities would be used to settle the repurchase agreement with the deposit customer.
10.Revenue from Contracts with Customers
All of the Company’s revenue from contracts with customers in the scope of ASC 606 is recognized within non-interest income. Items outside the scope of ASC 606 are noted as such.
Schedule of Revenue from Contracts with Customers Within Non-interest Income
A description of the Company’s revenue streams 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 usage 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 during which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.
Interchange Income
The Company earns interchange fees from debit cardholder transactions conducted through the interchange 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 Real Estate Owned
The Company records a gain or loss from the sale of real estate owned 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 real estate owned to the buyer, the Company assesses 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 real estate owned asset is derecognized and the gain or loss on sale is recorded upon the 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. There were no sales of real estate owned that were financed by the Company during the first nine months of 2022 or 2021.
11.Fair Value of Financial Instruments and Fair Value Measurements
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. 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 the entity has the ability to access as of the measurement date.
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; or other inputs that are observable or can be corroborated by observable market data.
Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Fair value estimates of the Company’s financial instruments as of September 30, 2022 and December 31, 2021, including methods and assumptions utilized, are set forth below:
Schedule of Fair Value, by Balance Sheet Grouping
Transfers
The Company did not transfer any assets or liabilities among levels during the nine months ended September 30, 2022 or during the year ended December 31, 2021.
Valuation Methods for Instruments Measured at Fair Value on a Recurring Basis
The following tables represent the Company’s financial instruments that are measured at fair value on a recurring basis at September 30, 2022 and December 31, 2021, allocated to the appropriate fair value hierarchy:
Schedule of Fair Value, Assets Measured On Recurring Basis
The Company’s investment securities classified as available-for-sale include U.S. treasury securities, U.S. federal agency obligations, municipal obligations, agency mortgage-backed securities and certificates of deposit. Quoted exchange prices are available for the Company’s U.S. treasury securities, which are classified as Level 1. U.S. federal agency securities and agency mortgage-backed securities are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. These measurements are classified as Level 2. Municipal obligations are valued using a type of matrix, or grid, pricing in which securities are benchmarked against U.S. treasury rates based on credit rating. These model and matrix measurements are classified as Level 2 in the fair value hierarchy.
Changes in the fair value of available-for-sale securities are included in other comprehensive income to the extent the changes are not considered other-than-temporary impairments. Other-than-temporary impairment tests are performed on a quarterly basis and any decline in the fair value of an individual security below its cost that is deemed to be other-than-temporary results in a write-down of that security’s cost basis.
Mortgage loans originated and intended for sale in the secondary market are carried at fair value. The mortgage loan valuations are based on quoted secondary market prices for similar loans and are classified as Level 2. Changes in the fair value of mortgage loans originated and intended for sale in the secondary market and derivative financial instruments are included in gains on sales of loans.
The aggregate fair value, contractual balance (including accrued interest), and gain on loans held for sale were as follows:
Schedule of Fair Value Contractual Balance and Gain Loss On Loans Held for Sale
The Company’s derivative financial instruments consist of interest rate lock commitments and corresponding forward sales contracts on mortgage loans held for sale. The fair values of these derivatives are based on quoted prices for similar loans in the secondary market. The market prices are adjusted by a factor, based on the Company’s historical data and its judgment about future economic trends, which considers the likelihood that a commitment will ultimately result in a closed loan. These instruments are classified as Level 2. The amounts are included in other assets or other liabilities on the consolidated balance sheets and gains on sales of loans, net in the consolidated statements of earnings. The total amount of gains from changes in fair value of derivative financial instruments included in earnings were as follows:
Schedule of Gains and Losses from Changes in Fair Value of Loans Held for Sale
Valuation Methods for Instruments Measured at Fair Value on a Nonrecurring Basis
The Company does not record its loan portfolio at fair value. Collateral-dependent impaired loans are generally carried at the lower of cost or fair value of the collateral, less estimated selling costs. Collateral values are determined based on appraisals performed by qualified licensed appraisers hired by the Company and then further adjusted if warranted based on relevant facts and circumstances. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and 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. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated at least quarterly for additional impairment and adjusted accordingly, based on the same factors identified above. The carrying value of the Company’s impaired loans was $5.7 million and $6.7 million at September 30, 2022 and December 31, 2021, respectively. The Company’s impaired loans with an allowance for loan losses was $811,000 and $509,000, with an allocated allowance of $693,000 and $504,000, at September 30, 2022 and December 31, 2021, respectively.
Real estate owned includes assets acquired through, or in lieu of, foreclosure and land previously acquired for expansion. Real estate owned is initially recorded at the fair value of the collateral less estimated selling costs. Subsequent valuations are updated periodically and are based upon independent appraisals, third party price opinions or internal pricing models. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and 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. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Real estate owned is reviewed and evaluated at least annually for additional impairment and adjusted accordingly, based on the same factors identified above.
The following table presents quantitative information about Level 3 fair value measurements measured at fair value on a nonrecurring basis as of September 30, 2022 and December 31, 2021.
Schedule of Fair Value Measurements On Nonrecurring, Valuation Techniques
12.Regulatory Capital Requirements
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 initiate regulatory action. Management believed that as of September 30, 2022, the Company and the Bank met all capital adequacy requirements to which they were subject at that time.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. The Company and the Bank are subject to the Basel III Rule, which is applicable to all U.S. banks that are subject to minimum capital requirements, as well as to bank and savings and loan holding companies other than “small bank holding companies” (generally, non-public bank holding companies with consolidated assets of less than $3.0 billion).
The Basel III Rule includes a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and a minimum Tier 1 leverage ratio of 4.0%. A capital conservation buffer, equal to 2.5% of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements for the common equity Tier 1 capital ratio, and Tier 1 capital and total risk based capital ratios.
As of September 30, 2022 and December 31, 2021, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action then in effect. There are no conditions or events since that notification that management believes have changed the institution’s category.
The following is a comparison of the Company’s regulatory capital to minimum capital requirements at September 30, 2022 and December 31, 2021.
Schedule of Compliance with Regulatory Capital Requirements for Mortgage Companies
The following is a comparison of the Bank’s regulatory capital to minimum capital requirements at September 30, 2022 and December 31, 2021:
Schedule of Compliance with Regulatory Capital Requirements Under Banking Regulations
13. Impact of Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), commonly referred to as “CECL.” The provisions of the update eliminate the probable initial recognition threshold under current GAAP which requires reserves to be based on an incurred loss methodology. Under CECL, reserves required for financial assets measured at amortized cost will reflect an organization’s estimate of all expected credit losses over the expected term of the financial asset and thereby require the use of reasonable and supportable forecasts to estimate future credit losses. Because CECL encompasses all financial assets carried at amortized cost, the requirement that reserves be established based on an organization’s reasonable and supportable estimate of expected credit losses extends to held to maturity debt securities. Under the provisions of the update, credit losses recognized on available for sale debt securities will be presented as an allowance as opposed to a write-down. In addition, CECL will modify the accounting for only purchased credit impaired loans. Under prior GAAP, a purchased loan’s contractual balance was adjusted to fair value through a credit discount, and no reserve was recorded on the purchased loan upon acquisition. Since under CECL reserves will be established for purchased loans at the time of acquisition, the accounting for purchased loans is made more comparable to the accounting for originated loans. Finally, increased disclosure requirements under CECL oblige organizations to present the currently required credit quality disclosures disaggregated by the year of origination or vintage. The FASB expects that the evaluation of underwriting standards and credit quality trends by financial statement users will be enhanced with the additional vintage disclosures. In October 2019, the FASB approved a change in the effective dates for CECL which delayed the effective date to fiscal years beginning after December 15, 2022 for smaller reporting companies. Because the Company is a smaller reporting company, the proposed delay is applicable to the Company, and the Company plans to delay the implementation of CECL until January 1, 2023. Management has initiated an implementation committee that has implemented a process to collect the data and is utilizing a vendor solution for the new standard. Initial calculations estimate the effect will be an increase to the allowance for loan losses upon adoption. However, the size of the overall increase is uncertain at this time. Management is utilizing the delay to continue to refine and back test the CECL calculation. The internal controls over financial reporting specifically related to CECL are in the final design stage.
In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this update simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The amendments require an entity to perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognizing an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The amendments also eliminate the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The amendments in this ASU are effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. In October 2019, the FASB approved a change in the effective dates for ASU 2017-04 which delayed the effective date to fiscal years beginning after December 15, 2022 for smaller reporting companies. Because the Company is a smaller reporting company, the proposed delay is applicable to the Company, and the Company plans to delay the implementation of ASU 2017-04 until January 1, 2023. Early adoption of the amendments of this ASU is permitted. The adoption of ASU 2017-04 is not expected to have a material effect on the Company’s operating results or financial condition.
In May 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. Reference rate reform relates to the effects undertaken to eliminate certain reference rates such as the London Interbank Offered Rate (“LIBOR”) and introduce new reference rates that may be based on larger or more liquid observations and transactions. ASU 2020-04 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other contracts. Generally, ASU 2020-04 would allow entities to consider contract modifications due to reference rate reform to be a continuation of an existing contract; thus, the Company would not have to determine if the modification is considered insignificant. The Company is in the process of reviewing loan documentation, along with the transition procedures it will need in order to implement reference rate reform. While the Company has yet to adopt ASU 2020-04, the standard was effective upon issuance and terminates December 31, 2022 such that changes made to contracts beginning on or after January 1, 2023 would not apply. The adoption of ASU 2020-04 is not expected to have a material effect on the Company’s operating results or financial condition.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview.Landmark Bancorp, Inc. is a financial holding company incorporated under the laws of the State of Delaware and is engaged in the banking business through its wholly owned subsidiary, Landmark National Bank, and in the insurance business through its wholly owned subsidiary, Landmark Risk Management, Inc. References to the “Company,” “we,” “us,” and “our” refer collectively to Landmark Bancorp, Inc., Landmark National Bank and Landmark Risk Management, Inc. The Company is listed on the Nasdaq Global Market under the symbol “LARK.” The Bank is dedicated to providing quality financial and banking services to its local communities. Our strategy includes continuing a tradition of holding and acquiring quality assets while growing our commercial, commercial real estate and agriculture loan portfolios. We are committed to developing relationships with our borrowers and providing a total banking service.
The Bank is principally engaged in the business of attracting deposits from the general public and using such deposits, together with borrowings and other funds, to originate one-to-four family residential real estate, construction and land, commercial real estate, commercial, agriculture, municipal and consumer loans. Although not our primary business function, we invest in certain investment and mortgage-related securities using deposits and other borrowings as funding sources.
Landmark Risk Management, Inc., which was formed and began operations on in 2017, is a Nevada-based captive insurance company which provides property and casualty insurance coverage to the Company and the Bank for which insurance may not be currently available or economically feasible in the current insurance marketplace. Landmark Risk Management, Inc. is subject to the regulations of the State of Nevada and undergoes periodic examinations by the Nevada Division of Insurance.
Our results of operations depend generally on net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. Net interest income is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. In addition, we are subject to interest rate risk to the degree that our interest-earning assets mature or reprice at different times, or at different speeds, than our interest-bearing liabilities. Our results of operations are also affected by non-interest income, such as service charges, loan fees, gains from the sale of newly originated loans, gains or losses on investments and certain other non-interest related items. Our principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy costs, professional fees, data processing expenses and provision for loan losses.
We are significantly impacted by prevailing economic conditions, including federal monetary and fiscal policies, and federal regulations of financial institutions. Deposit balances are influenced by numerous factors such as competing investments, the level of income and the personal rate of savings within our market areas. Factors influencing lending activities include the demand for housing and the interest rate pricing competition from other lending institutions.
Currently, our business consists of ownership of the Bank, with its main office in Manhattan, Kansas and twenty- nine additional branch offices in central, eastern, southeast and southwest Kansas, and our ownership of Landmark Risk Management, Inc. On October 1, 2022, the Company completed its acquisition of Freedom Bancshares, Inc., the holding company of Freedom Bank. Freedom Bank was founded in 2006 and operates out of a single location in Overland Park, Kansas. As of September 30, 2022, Freedom Bank reported total assets of $201.9 million, gross loans of $118.0 million, and total deposits of $150.4 million.
In October 2022, we declared our 85th consecutive quarterly dividend, and we currently have no plans to change our dividend strategy given our current capital and liquidity position. However, while we have achieved a strong capital base and expect to continue operating profitably, this is dependent upon the performance of the economy. In addition, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021, we will not be permitted to make capital distributions (including for dividends and repurchases of stock) or pay discretionary bonuses to executive officers without restriction if we do not maintain 2.5% in Common Equity Tier 1 Capital attributable to a capital conservation buffer, a standard we exceeded at September 30, 2022.
Critical Accounting Policies. Critical accounting policies are those which are both most important to the portrayal of our financial condition and results of operations and require our management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies relate to the allowance for loan losses and the accounting for income taxes, each of which involve significant judgment by our management. There have been no material changes to the critical accounting policies included under Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission on March 22, 2022.
Summary of Results. During the third quarter of 2022, we recorded net earnings of $2.5 million, which was a decrease of $2.0 million, or 44.7%, from the $4.5 million of net earnings in the third quarter of 2021. During the first nine months of 2022, we recorded net earnings of $8.7 million, which was a decrease of $6.2 million, or 41.7%, from the $14.9 million of net earnings in the first nine months of 2021. The decrease in net earnings during 2022 was primarily due to lower interest income on PPP loans and a decrease in gains on sales of mortgage loans. Interest income on PPP loans declined as our balances decreased as a result of the forgiveness of these loans. Gains on sales of mortgage loans decreased as originations of residential real estate loans declined. Decreased loan originations mainly resulted from low housing inventories coupled with increasing mortgage interest rates during 2022, which reduced refinancing activity.
The following table summarizes earnings and key performance measures for the periods presented:
(1) Per share values for the periods ended September 30, 2021 have been adjusted to give effect to the 5% dividend paid during December 2021.
(2) Ratios have been annualized and are not necessarily indicative of the results for the entire year.
(3) Net interest margin is presented on a fully tax equivalent basis, using a 21% federal tax rate.
Interest Income. Interest income of $10.6 million for the quarter ended September 30, 2022 increased $597,000, or 6.0%, as compared to the same period of 2021. Interest income on loans decreased $436,000, or 5.2%, to $8.0 million for the quarter ended September 30, 2022, compared to the same period of 2021 due to lower yields . Our yields decreased from 5.03% in the third quarter of 2021 to 4.63% in the third quarter of 2022. The decrease in yields on loans was driven by a decrease in interest income on PPP loans, which decreased from $1.6 million in the third quarter of 2021 to $13,000 in the third quarter of 2022. The increase in market interest rates has offset some of the decline in PPP loan income as loans reprice or are originated. Partially offsetting the lower yields was an increase in our average loan balances, which increased from $668.0 million in the third quarter of 2021 to $687.7 million in the third quarter of 2022. Our average loan balances included average PPP loans of $491,000 in the third quarter of 2022 and $40.4 million in the third quarter of 2021. Interest income on investment securities increased $1.0 million, or 67.5%, to $2.6 million for the third quarter of 2022, as compared to $1.5 million in the same period of 2021. The increase in interest income on investment securities was primarily the result of an increase in the average balances of investment securities which increased from $351.2 million in the third quarter of 2021 to $494.3 million in the third quarter of 2022. Also contributing to the average balances was increased yields on investment securities, which increased from 1.88% in the third quarter of 2021 to 2.18% in the third quarter of 2022.
Interest income of $29.0 million for the nine months ended September 30, 2022 decreased $1.4 million, or 4.5%, as compared to the same period of 2021. Interest income on loans decreased $3.3 million, or 13.0%, to $22.4 million for the nine months ended September 30, 2022, compared to the same period of 2021 due to a decrease in our average loan balances, which decreased from $702.5 million during the first nine months of 2021 to $659.1 million during the first nine months of 2022. Also contributing to lower interest income were lower yields on loans, which decreased from 4.90% in the nine months ended September 30, 2021 to 4.54% during the nine months ended September 30, 2022. Our average loan balances included average PPP loans of $5.3 million in the nine months ended September 30, 2022 compared to $82.7 million the same period of 2021. Interest income on PPP loans decreased from $4.9 million in the first nine months of 2021 to $671,000 in the first nine months of 2022. The yield on PPP loans increased from 7.85% in the first nine months of 2021 to 16.87% in the first nine months of 2022. The increase in market interest rates has offset some of the decline in PPP loan income as loans reprice or are originated. Interest income on investment securities increased $2.0 million, or 42.4%, to $6.6 million for the first nine months of 2022, as compared to $4.6 million in the same period of 2021. The increase in interest income on investment securities was the result of higher average balances, which increased from $329.4 million in the first nine months of 2021 compared to $464.7 million in the first nine months of 2022. Partially offsetting the higher average balances of investment securities were lower yields, which decreased from 2.08% in the first nine months of 2021 to 2.00% in the first nine months of 2022.
Interest Expense. Interest expense during the quarter ended September 30, 2022 increased $759,000, or 200.8%, to $1.1 million, as compared to the same period of 2021. Interest expense on interest-bearing deposits increased $513,000, or 198.8%, to $771,000 for the quarter ended September 30, 2022 as compared to the same period of 2021. Our total cost of interest-bearing deposits increased from 0.13% in the third quarter of 2021 to 0.39% in the third quarter of 2022 as a result of higher rates paid on money market and checking accounts, primarily due to public fund deposit accounts with rates that are repriced based on market indexes. Also contributing to higher interest expense was an increase in average interest-bearing deposit balances, which increased from $769.7 million in the third quarter of 2021 to $782.6 million in the third quarter of 2022. For the third quarter of 2022, interest expense on borrowings increased $246,000, or 205.0%, to $366,000 as compared to the same period of 2021 due to an increase in our average borrowings, which increased from $21.7 million in the third quarter of 2021 to $37.5 million in the same period of 2022. Also contributing to the increase in interest expense on borrowings were higher rates, which increased from 2.14% in the third quarter of 2021 to 3.58% in the same period of 2022.
Interest expense during the nine months ended September 30, 2022 increased $827,000, or 71.2%, to $2.0 million as compared to the same period of 2021. Interest expense on interest-bearing deposits increased $524,000, or 65.5%, to $1.3 million for the nine months ended September 30, 2022 as compared to the same period of 2021. The increase in interest expense on interest-bearing deposits was the result of higher rates paid on money market and checking accounts, primarily due to public fund deposit accounts with rates that are repriced based on market indexes. The increase in interest expense on deposits was also due to an increase in average interest-bearing deposit balances, which increased from $768.1 million in the first nine months of 2021 to $788.7 million in the same period of 2022. For the first nine months of 2022, interest expense on borrowings increased $303,000, or 83.7%, to $665,000 as compared to the same period of 2021, due to an increase in our average outstanding borrowings, which increased from $21.7 million in the first nine months of 2021 to $27.0 million in the first nine months of 2022. Also contributing to the higher interest expense on borrowings were higher average rates on our borrowings, which increased to 3.10% for the first nine months of 2022 compared to 2.19% for the same period of 2021.
Net Interest Income. Net interest income decreased $162,000, or 1.7%, to $9.5 million for the third quarter of 2022 compared to the same period of 2021. The decrease in net interest income was primarily a result of a decrease in interest on loans, and higher interest expense. Compared to the same period last year, the decrease in loan interest income was primarily due to lower interest and fees earned on PPP loans as most of these loans were forgiven by the SBA. The increase in market interest rates has offset some of the decline in PPP loan income as loans reprice or are originated. Interest and fees on PPP loans in the third quarter of 2022 totaled $13,000 compared to $1.6 million in the same period last year. Higher market interest rates also drove the increase in interest expense as our public fund deposits and borrowings repriced higher. Net interest margin, on a tax-equivalent basis, decreased from 3.36% in the third quarter of 2021 to 3.21% in the same period of 2022.
Net interest income decreased $2.2 million, or 7.5%, to $27.0 million for the first nine months of 2022 compared to the same period of 2021. The decrease was primarily due to lower interest and fees earned on PPP loans, which decreased from $4.9 million in the first nine months of 2021 to $671,000 in the same period of 2022. Net interest margin, on a tax-equivalent basis, decreased from 3.47% in the first nine months of 2021 to 3.08% in the same period of 2022.
The increase in market interest rate should continue to increase our net interest margin as a result of higher yields on loans and investment securities exceeding the increase in our cost of funds. Our net interest margin increased from 2.99% in the first quarter of 2022 to 3.05% in the second quarter of 2022 and 3.21% in the third quarter of 2022 as our assets began to reprice faster than our cost of funds. Our net interest margin has been positively impacted by PPP loans over the past couple of years, however, the impact of these loans on net interest margin going forward is expected to be minimal. While the rise in interest rates should result in increased net interest income and net interest margin, these improvements could be offset by increased competition for loans and deposits. Additionally, the deposit balance increases we have seen over the past two years may reverse resulting in the need for higher cost funding.
Average Assets/Liabilities. The following table reflects the tax-equivalent yields earned on average interest-earning assets and costs of average interest-bearing liabilities for the periods indicated (derived by dividing income or expense by the monthly average balance of assets or liabilities, respectively) as well as “net interest margin” (which reflects the effect of the net earnings balance) for the periods shown:
Rate/Volume Table. The following table describes the extent to which changes in tax-equivalent interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities affected the Company’s interest income and expense for the periods indicated. The table distinguishes between (i) changes attributable to rate (changes in rate multiplied by prior volume), (ii) changes attributable to volume (changes in volume multiplied by prior rate), and (iii) net change (the sum of (i) and (ii)). The net changes attributable to the combined effect of volume and rate that cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.
Provision for Loan Losses. We maintain, and our Board of Directors monitors, an allowance for losses on loans. The allowance is established based upon management’s periodic evaluation of known and inherent risks in the loan portfolio, review of significant individual loans and collateral, review of delinquent loans, past loss experience, adverse situations that may affect the borrowers’ ability to repay, current and expected market conditions, and other factors management deems important. Determining the appropriate level of reserves involves a high degree of management judgment and is based upon historical and projected losses in the loan portfolio and the collateral value or discounted cash flows of specifically identified impaired loans. Additionally, allowance policies are subject to periodic review and revision in response to a number of factors, including current market conditions, actual loss experience and management’s expectations.
During the third quarter of 2022 we recorded a $500,000 provision for loan losses as compared to no provision recorded in the same period of 2021. The $500,000 provision for loan losses recorded in the third quarter of 2022 was primarily related to an increase in loan balances. We recorded net loan recoveries of $43,000 during the third quarter of 2022 compared to net loan charge-offs of $397,000 during the third quarter of 2021.
During the first nine months of 2022, we had no provision for loan losses as the $500,000 provision in the third quarter of 2022 was offset by a credit of $500,000 during the first quarter of 2022. This compared to a provision for loan losses of $500,000 in the first nine months of 2021. We recorded net loan recoveries of $83,000 during the nine months ended September 30, 2022 compared to net loan charge-offs of $509,000 during the nine months ended September 30, 2021.
For further discussion of the allowance for loan losses, refer to the “Asset Quality and Distribution” section below.
Non-interest Income. Total non-interest income was $3.5 million in the third quarter of 2022, a decrease of $1.9 million, or 35.4%, from the same period in 2021. The decrease in non-interest income during the third quarter of 2022 compared to the same period last year was primarily due to a decrease of $1.6 million in gains on sales of one-to-four family residential real estate loans as higher interest rates and low housing inventories reduced originations of these loans, which are typically sold in the secondary market. Higher mortgage rates however did result in increased originations of adjustable-rate loans this quarter which are maintained in our one-to-four family residential loan portfolio. A loss of $353,000 was recorded in the third quarter of 2022 on the sale of investment securities due to the sale of the lowest yielding securities in our portfolio. Partially offsetting this decrease was an increase of $243,000 in fees and services charges primarily due to higher overdraft charges and other fees on deposit accounts.
Total non-interest income was $10.9 million in the first nine months of 2022, a decrease of $6.8 million, or 38.4%, from the first nine months of 2021, primarily as a result of a decrease of $5.6 million in gains on sales of loans. Our gains on sales of loans decreased as our originations of secondary market one-to-four family residential real estate loans slowed due to the increase in mortgage interest rates and decreased inventory in the housing market in our market areas. Also contributing to the decrease in non-interest income was a decrease of $1.5 million gains on sales of investment securities. We recorded a loss of $353,000 on sales of investment securities during the first nine months of 2022 compared to net gains of $1.1 million in the same period of 2021. Partially offsetting the decrease in gains on sales of loans and investment securities was a $625,000 increase in fees and services charges due primarily to higher overdraft charges and other fees on deposit accounts.
Non-interest Expense. Non-interest expense totaled $9.5 million for the third quarter of 2022, a slight increase of $15,000, or 0.2%, over the same quarter of 2021. The increase in non-interest expense in the third quarter of 2022 compared to the same period last year was mainly due to higher occupancy and equipment costs as well as acquisition costs. Partially offsetting those increases were lower data processing fees, reduced mortgage servicing rights amortization and a decline in compensation and benefits and other non-interest expense. The decline in data processing fees was due to a new contract with our main technology vendor in effect this year, while lower mortgage banking activity this quarter resulted in lower costs for compensation, amortization and other non-interest expense.
Non-interest expense totaled $27.3 million for the first nine months of 2022, a decrease of $388,000 or 1.4%, from $27.7 million for the first nine months of 2021. The decrease in non-interest expense in the first nine months of 2022 compared to the same period last year was mainly due to lower data processing fees, reduced mortgage servicing rights amortization and a decline in compensation and benefits and other non-interest expense. The decline in data processing fees was due to a new contract with our main technology vendor in effect this year, while lower mortgage banking activity this quarter resulted in lower costs for compensation, amortization and other non-interest expense. Partially offsetting the decreases in non-interest expense were costs of $355,000 during the first nine months of 2022 related to the recently announced acquisition of Freedom Bancshares, Inc. and its wholly owned subsidiary Freedom Bank.
Income Tax Expense. During the third quarter of 2022, we recorded income tax expense of $522,000, compared to $1.1 million during the same period of 2021. Our effective tax rate decreased from 19.8% in the third quarter of 2021 to 17.3% in the third quarter of 2022. The decrease in the effective tax rate was due to lower earnings before income taxes while tax-exempt income was similar between the periods.
We recorded income tax expense of $1.9 million for the first nine months of 2022 compared to $3.8 million in the same period of 2021. Our effective tax rate was 20.3% in the first nine months of 2021 compared to 18.0% in the first nine months of 2022. The decrease in the effective tax rate was due to lower earnings before income taxes while tax-exempt income was similar between the periods.
Financial Condition. Economic conditions in the United States slowed during the first nine months of 2022 as elevated inflation levels and higher interest rates impacted the economy. The State of Kansas and the geographic markets in which the Company operates was also impacted by these economic headwinds. The supply chain constraints, labor shortages and geopolitical events have all contributed to the rising inflation levels which are impacting all areas of the economy both nationally and locally. The Company’s allowance for loan losses included estimates of the economic impact of these conditions and other qualitative factors on our loan portfolio. However, our loan portfolio is diversified across various types of loans and collateral throughout the markets in which we operate. Aside from a few problem loans that management is working to resolve, our asset quality has remained strong over the past few years. While further increases in problem assets may arise, management believes its efforts to run a high quality financial institution with a sound asset base will continue to create a strong foundation for continued growth and profitability in the future.
Asset Quality and Distribution. Our primary investing activities are the origination of one-to-four family residential real estate, construction and land, commercial real estate, commercial, agriculture, municipal and consumer loans and the purchase of investment securities. Total assets increased $26.3 million, or 2.0%, from December 31, 2021 to $1.4 billion at September 30, 2022.
The allowance for loan losses is established through a provision for loan losses based on our evaluation of the risk inherent in the loan portfolio and changes in the nature and volume of our loan activity. This evaluation, which includes a review of all loans with respect to which full collectability may not be reasonably assured, considers the fair value of the underlying collateral, economic conditions, historical loan loss experience, level of classified loans and other factors that warrant recognition in providing for an appropriate allowance for loan losses. At September 30, 2022, our allowance for loan losses totaled $8.9 million, or 1.25% of gross loans outstanding, compared to $8.8 million, or 1.32% of gross loans outstanding, at December 31, 2021. Our allowance for loan losses as a percentage of gross loans outstanding, excluding PPP loans of $410,000 at September 30, 2022 and $17.2 million at December 31, 2021, was 1.25% at September 30, 2022 compared to 1.36% at December 31, 2021. This reflects a more comparable ratio to periods prior to PPP, as no allowance for loan losses has been allocated to PPP loans since they are guaranteed by the Small Business Administration. The decline in our allowance for loan losses as a percentage of gross loans outstanding was primarily due to improving economic conditions and a decrease in our classified loan totals.
As of September 30, 2022 and December 31, 2021, approximately $16.2 million and $18.0 million, respectively, of loans were considered classified and assigned a risk rating of special mention, substandard or doubtful. These ratings indicate that these loans were identified as potential problem loans having more than normal risk and raised doubts as to the ability of the borrowers to comply with present loan repayment terms. Even though borrowers were experiencing moderate cash flow problems as well as some deterioration in collateral value, management believed the allowance was sufficient to cover the risks and probable incurred losses related to such loans at September 30, 2022 and December 31, 2021, respectively.
Loans past due 30-89 days and still accruing interest totaled $657,000, or 0.09% of gross loans, at September 30, 2022, compared to $2.0 million, or 0.30% of gross loans, at December 31, 2021. At September 30, 2022, $4.8 million in loans were on non-accrual status, or 0.68% of gross loans, compared to $5.2 million, or 0.79% of gross loans, at December 31, 2021. Non-accrual loans consist of loans 90 or more days past due and certain impaired loans. There were no loans 90 days delinquent and accruing interest at September 30, 2022 or December 31, 2021. Our impaired loans totaled $5.7 million at September 30, 2022 compared to $6.7 million at December 31, 2021. The difference in the Company’s non-accrual loan balances and impaired loan balances at September 30, 2022 and December 31, 2021 was related to TDRs that were accruing interest but still classified as impaired.
At September 30, 2022, the Company had seven loan relationships consisting of 11 outstanding loans that were previously classified as TDRs. No loans were classified as TDRs during the three or nine months ending September 30, 2022. During the second quarter of 2022, a $7,000 commercial loan paid off after being classified as a TDR in 2018. During the first quarter of 2022, two construction and land loans totaling $599,000 were paid off. These loans were originally classified as TDRs in 2012. A commercial loan totaling $32,000 was paid off in the first quarter of 2022 after being classified as a TDR in the first quarter of 2021. An agriculture loan totaling $250,000 was also paid off in the first quarter of 2022 after being classified as a TDR in the third quarter of 2021. During the three and nine months ended September 30, 2021, an agriculture loan paid off that was previously classified as a TDR in 2016. During the nine months ended September 30, 2021, a commercial loan relationship consisting of five loans was modified after originally being classified as a TDR in 2020. The borrower liquidated some of the collateral securing the loans and refinanced the remaining balance of $479,000 into one loan which retained a TDR classification.
As part of our credit risk management, we continue to manage the loan portfolio to identify problem loans and have placed additional emphasis on commercial real estate and construction and land relationships. We are working to resolve the remaining problem credits or move the non-performing credits out of the loan portfolio. During the first nine months of 2022, two commercial real estate properties were sold resulting in a gain of $114,000. At September 30, 2022, we had $1.3 million of real estate owned compared to $2.6 million at December 31, 2021. As of September 30, 2022, real estate owned primarily consisted of commercial buildings, undeveloped land and residential real estate properties. The Company is currently marketing all of the remaining properties in real estate owned.
Liability Distribution. Our primary ongoing sources of funds are deposits, FHLB borrowings, proceeds from principal and interest payments on loans and investment securities and proceeds from the sale of mortgage loans and investment securities. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates and economic conditions. We experienced a decrease of $31.3 million in total deposits during the first nine months of 2022, to $1.1 billion at September 30, 2022. The decrease in deposits was primarily due to a seasonal decline in public funds accounts.
Non-interest-bearing deposits at September 30, 2022, were $347.9 million, or 31.1% of deposits, compared to $350.0 million, or 30.5% of deposits, at December 31, 2021. Money market and checking deposit accounts were 45.2% of our deposit portfolio and totaled $505.0 million at September 30, 2022, compared to $536.9 million, or 46.8% of deposits, at December 31, 2021. Savings accounts increased to $171.0 million, or 15.3% of deposits, at September 30, 2022, from $155.5 million, or 13.5% of deposits, at December 31, 2021. Certificates of deposit totaled $93.2 million, or 8.4% of deposits, at September 30, 2022, compared to $106.1 million, or 9.2% of deposits, at December 31, 2021.
Certificates of deposit at September 30, 2022, scheduled to mature in one year or less totaled $77.6 million. Historically, maturing deposits have generally remained with the Bank, and we believe that a significant portion of the deposits maturing in one year or less will remain with us upon maturity in some type of deposit account.
Total borrowings increased $83.8 million to $112.9 million at September 30, 2022, from $29.1 million at December 31, 2021. The increase in total borrowings was due to an increase in Federal Home Loan Bank borrowings and other borrowings. The increase in borrowings was due to funding the acquisition of Freedom Bancshares, Inc. and to offset the decline in deposits.
Cash Flows. During the nine months ended September 30, 2022, our cash and cash equivalents decreased by $140.0 million. Our operating activities provided net cash of $14.5 million during the first nine months of 2022 primarily as a result of net earnings. Our investing activities used net cash of $202.8 million during the first nine months of 2022, primarily due to loan growth and the purchase of investment securities. Financing activities provided net cash of $48.3 million during the first nine months of 2022, primarily as a result of an increase in borrowings.
Liquidity.Our most liquid assets are cash and cash equivalents and investment securities available-for-sale. The levels of these assets are dependent on the operating, financing, lending and investing activities during any given year. These liquid assets totaled $542.2 million at September 30, 2022 and $577.3 million at December 31, 2021. During periods in which we are not able to originate a sufficient amount of loans and/or periods of high principal prepayments, we generally increase our liquid assets by investing in short-term, high-grade investments or holding higher balances of cash and cash equivalents. The higher balances of cash and cash equivalents are primarily held in our Federal Reserve account.
Liquidity management is both a daily and long-term function of our strategy. Excess funds are generally invested in short-term investments. Excess funds are typically generated as a result of increased deposit balances, while uses of excess funds are generally deposit withdrawals and loan advances. In the event we require funds beyond our ability to generate them internally, additional funds are generally available through the use of FHLB advances, a line of credit with the FHLB, other borrowings or through sales of investment securities. At September 30, 2022, we had $74.9 million against our line of credit with the FHLB. At September 30, 2022, we had collateral pledged to the FHLB that would allow us to borrow $45.9 million, subject to FHLB credit requirements and policies. At September 30, 2022, we had no borrowings through the Federal Reserve discount window, while our borrowing capacity with the Federal Reserve was $64.6 million. We also have various other federal funds agreements, both secured and unsecured, with correspondent banks totaling approximately $30.0 million in available credit under which we had no outstanding borrowings at September 30, 2022. At September 30, 2022, we had subordinated debentures totaling $21.7 million and $6.3 million of repurchase agreements. At September 30, 2022, the Company had no borrowings against a $5.0 million line of credit from an unrelated financial institution maturing on November 1, 2023, with an interest rate that adjusts daily based on the prime rate less 0.50%. This line of credit has covenants specific to capital and other financial ratios, which the Company was in compliance with at September 30, 2022. The Company also borrowed $10.0 million from the same unrelated financial institution at a fixed rate of 6.15%. This borrowing matures on September 1, 2027 and requires quarterly principal and interest payments. The $10.0 million borrowings was used to fund part of the acquisition of Freedom Bancshares, Inc.
Off Balance Sheet Arrangements. As a provider of financial services, we routinely issue financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by us generally to guarantee the payment or performance obligation of a customer to a third party. While these standby letters of credit represent a potential outlay by us, a significant amount of the commitments may expire without being drawn upon. We have recourse against the customer for any amount the customer is required to pay to a third party under a standby letter of credit. The letters of credit are subject to the same credit policies, underwriting standards and approval process as loans made by us. Most of the standby letters of credit are secured, and in the event of nonperformance by the customers, we have the right to the underlying collateral, which could include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities. The contract amount of these standby letters of credit, which represents the maximum potential future payments guaranteed by us, was $2.2 million at September 30, 2022.
At September 30, 2022, we had outstanding loan commitments, excluding standby letters of credit, of $142.0 million. We anticipate that sufficient funds will be available to meet current loan commitments. These commitments consist of unfunded lines of credit and commitments to finance real estate loans.
Capital.Current regulatory capital regulations require financial institutions (including banks and bank holding companies) to meet certain regulatory capital requirements. The Company and the Bank are subject to the Basel III Rules that implemented the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Basel III Rules are applicable to all U.S. banks that are subject to minimum capital requirements, as well as to bank and savings and loan holding companies other than “small bank holding companies” (generally, non-public bank holding companies with consolidated assets of less than $3.0 billion).
The Basel III Rules require a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, a Tier 1 capital to risk-weighted assets minimum ratio of 6.0%, a Total Capital to risk-weighted assets minimum ratio of 8.0%, and a Tier 1 leverage minimum ratio of 4.0%. A capital conservation buffer, equal to 2.5% common equity Tier 1 capital, is also established above the regulatory minimum capital requirements (other than the Tier 1 leverage ratio). As of September 30, 2022 and December 31, 2021, the Bank met the requirements to be “well capitalized,” which is the highest rating available under the regulatory capital regulations framework for prompt corrective action. Management believed that as of September 30, 2022, the Company and the Bank met all capital adequacy requirements to which we are subject.
Dividends. During the quarter ended September 30, 2022, we paid a quarterly cash dividend of $0.21 per share to our stockholders.
The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations. In addition, under the Basel III Rules, financial institutions have to maintain 2.5% in common equity Tier 1 capital attributable to the capital conservation buffer in order to pay dividends and make other capital distributions. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of September 30, 2022. The National Bank Act imposes limitations on the amount of dividends that a national bank may pay without prior regulatory approval. Generally, the amount is limited to the bank’s current year’s net earnings plus the adjusted retained earnings for the two preceding years. As of September 30, 2022, approximately $8.5 million was available to be paid as dividends to the Company by the Bank without prior regulatory approval.
Additionally, our ability to pay dividends is limited by the subordinated debentures that are held by three business trusts that we control. Interest payments on the debentures must be paid before we pay dividends on our capital stock, including our common stock. We have the right to defer interest payments on the debentures for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we may pay dividends on our capital stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our assets and liabilities are principally financial in nature, and the resulting net interest income thereon is subject to changes in market interest rates and the mix of various assets and liabilities. Interest rates in the financial markets affect our decisions relating to pricing our assets and liabilities, which impact net interest income, a significant cash flow source for us. As a result, a substantial portion of our risk management activities relates to managing interest rate risk.
Our Asset/Liability Management Committee monitors the interest rate sensitivity of our balance sheet using earnings simulation models. We have set policy limits of interest rate risk to be assumed in the normal course of business and monitor such limits through our simulation process.
We have been successful in meeting the interest rate sensitivity objectives set forth in our policy. Simulation models are prepared to determine the impact on net interest income for the coming twelve months, including one using interest rates as of the forecast date, and forecasting volumes for the twelve-month projection. This position is then subjected to a shift in interest rates of 100, 200 and 300 basis points with an impact to our net interest income on a one-year horizon as follows:
The 200 basis point falling scenario was considered to be not meaningful (“NM”) as of December 31, 2021.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Forward-Looking Statements
This document (including information incorporated by reference) contains, and future oral and written statements by us and our management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to our financial condition, results of operations, plans, objectives, future performance and business. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of our management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and we undertake no obligation to update any statement in light of new information or future events.
Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on operations and future prospects of us and our subsidiaries include, but are not limited to, the following:
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning us and our business, including other factors that could materially affect our financial results, is included in our filings with the Securities and Exchange Commission, including the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2021 filed on March 22, 2022.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2022. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2022 to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2022 that materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company or its subsidiaries is a party or which any of their property is subject, other than ordinary routine litigation incidental to their respective businesses.
ITEM 1A. RISK FACTORS
There have been no material changes in the risk factors set forth under Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information about purchases by the Company during the quarter ended September 30, 2022, of the Company’s equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:
(1) In March 2020, our Board of Directors approved a stock repurchase plan, permitting us to repurchase up to 225,890 shares. Unless terminated earlier by resolution of the Board of Directors, the stock repurchase plan will expire when we have repurchased all shares authorized for repurchase thereunder. As of September 30, 2022, there were 186,196 shares remaining to repurchase under the March 2020 Repurchase Program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.