Attached files

file filename
EX-21 - SUBSIDIARIES OF REGISTRANT - SB FINANCIAL GROUP, INC.f10k2015ex21_sbfinancial.htm
EX-23 - CONSENT OF BKD, LLP - SB FINANCIAL GROUP, INC.f10k2015ex23_sbfinancial.htm
EX-31.1 - CERTIFICATION - SB FINANCIAL GROUP, INC.f10k2015ex31i_sbfinancial.htm
EX-32.1 - CERTIFICATION - SB FINANCIAL GROUP, INC.f10k2015ex32i_sbfinancial.htm
EX-4.7 - AGREEMENT TO FURNISH INSTRUMENTS AND AGREEMENTS DEFINING RIGHTS OF HOLDERS OF LONG-TERM DEBT - SB FINANCIAL GROUP, INC.f10k2015ex4vii_sbfinancial.htm
EX-31.2 - CERTIFICATION - SB FINANCIAL GROUP, INC.f10k2015ex31ii_sbfinancial.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)  

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

For the fiscal year ended December 31, 2015 

OR

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

For the transition period from ___________ to ____________

   

Commission File Number 001-36785

 

SB FINANCIAL GROUP, INC.

(Exact name of Registrant as specified in its charter)

 

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

 

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

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

Title of each class   Name of each exchange on which registered
Common Shares, No Par Value   The NASDAQ Stock Market, LLC
    (NASDAQ Capital Market)
     
Depository Shares, each representing   The NASDAQ Stock Market, LLC
1/100th of a 6.50% Noncumulative Convertible   (NASDAQ Capital Market)
Perpetual Preferred Share, Series A, No Par Value    

 

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

Not Applicable

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes ☒     No ☐ 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.☐ 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Smaller Reporting Company ☒ 

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

The aggregate market value of the common shares of the registrant held by non-affiliates computed by reference to the price at which the common shares were last sold as of the last business day of the registrant’s most recently completed second fiscal quarter was $51.7 million.

The number of common shares of the registrant outstanding at February 29, 2016 was 4,899,019.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Shareholders to be held on April 20, 2016 are incorporated by reference into Part III of this Annual Report on Form 10-K. 

 

 

 

 

 

SB FINANCIAL GROUP, INC.

 

2015 ANNUAL REPORT ON FORM 10-K

 

TABLE OF CONTENTS

 

PART I    
     
Item 1. Business 3
Item 1A. Risk Factors 19
Item 1B. Unresolved Staff Comments 25
Item 2. Properties 26
Item 3. Legal Proceedings 27
Item 4. Mine Safety Disclosures 27
Supplemental Item: Executive Officers of the Registrant 27
     
PART II    
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 28
Item 6. Selected Financial Data 30
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 39
Item 8. Financial Statements and Supplementary Data 42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 43
Item 9A. Controls and Procedures 43
Item 9B. Other Information 44
     
PART III    
     
Item 10. Directors, Executive Officers and Corporate Governance 44
Item 11. Executive Compensation 45
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 45
Item 13. Certain Relationships and Related Transactions, and Director Independence 46
Item 14. Principal Accountant Fees and Services 46
     
PART IV    
     
Item 15. Exhibits and Financial Statement Schedules 46
     

Signatures and Certifications

51

 

 2 

 

 

PART I

 

Item 1. Business.

 

Certain statements contained in this Annual Report on Form 10-K which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. See “Cautionary Statement Regarding Forward-Looking Information” under Item 1A. Risk Factors on page 21 of this Annual Report on Form 10-K.

 

General

 

SB Financial Group, Inc., an Ohio corporation (the “Company”), is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Company was organized in 1983. The executive offices of the Company are located at 401 Clinton Street, Defiance, Ohio 43512. The name of the Company was changed to SB Financial Group, Inc. from Rurban Financial Corp. effective April 18, 2013.

 

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

 

State Bank

 

The State Bank and Trust Company (“State Bank”) is an Ohio state-chartered bank and wholly owned subsidiary of the Company. State Bank offers a full range of commercial banking services, including checking accounts, savings accounts, money market accounts and time certificates of deposit; automatic teller machines; commercial, consumer, agricultural and residential mortgage loans; personal and corporate trust services; commercial leasing; bank credit card services; safe deposit box rentals; Internet and telephone banking; and other personalized banking services. The trust and financial services division of State Bank offers various trust and financial services, including asset management services for individuals and corporate employee benefit plans, as well as brokerage services through Cetera Investment Services, an unaffiliated company. State Bank presently operates eighteen banking centers, all located within the Ohio counties of Allen, Defiance, Franklin, Fulton, Hancock, Lucas, Paulding, Wood and Williams, and one banking center located in Allen County, Indiana. State Bank also presently operates four loan production offices, in Franklin and Seneca Counties, Ohio, Steuben County, Indiana and Monroe County, Michigan. At December 31, 2015, State Bank had 206 full-time equivalent employees.

 

RFCBC

 

RFCBC, Inc. (“RFCBC”) is an Ohio corporation and wholly owned subsidiary of the Company that was incorporated in August 2004. RFCBC operates as a loan subsidiary in servicing and working out problem loans. At December 31, 2015, RFCBC had no employees.

 

RDSI

 

Rurbanc Data Services, Inc. dba RDSI Banking Systems (“RDSI”) has been in operation since 1964 and became an Ohio corporation in June 1976. In September 2006, RDSI acquired Diverse Computer Marketers, Inc. (“DCM”), which was merged into RDSI effective December 31, 2007, and now operates as a division of RDSI doing business as “DCM”. DCM has one operating location in Lansing, Michigan. RDSI/DCM provides item processing and related services to community banks located primarily in the Midwest. At December 31, 2015, RDSI/DCM had 8 full-time equivalent employees.

 

 3 

 

 

RMC

 

Rurban Mortgage Company (“RMC”) is an Ohio corporation and wholly owned subsidiary of State Bank. RMC is a mortgage company; however, it is presently inactive. At December 31, 2015, RMC had no employees.

 

SBI

 

SBT Insurance, LLC (“SBI”) is an Ohio corporation and wholly owned subsidiary of State Bank. SBI is an insurance company that engages in the sale of insurance products to retail and commercial customers of State Bank. At December 31, 2015, SBI had no employees.

 

RST II

 

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

 

Competition

 

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

 

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

 

RDSI operates in the check and statement processing service business, which consists primarily of data processing providers and commercial printers. The primary factors in competition are price and printing capability.

 

Supervision and Regulation

 

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

 

Regulation of Bank Holding Companies and Their Subsidiaries in General

 

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

 

 4 

 

 

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

 

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

 

The Federal Home Loan Banks (“FHLBs”) provide credit to their members in the form of advances. As a member of the FHLB of Cincinnati, State Bank must maintain certain minimum investments in the capital stock of the FHLB of Cincinnati. State Bank was in compliance with these requirements at December 31, 2015.

 

Restrictions on Dividends

 

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

 

The ability of the Company to obtain funds for the payment of dividends and for other cash requirements is largely dependent on the amount of dividends that may be declared by its subsidiaries. State Bank may not pay dividends to the Company if, after paying such dividends, it would fail to meet the required minimum levels under the risk-based capital guidelines and the minimum leverage ratio requirements. State Bank must obtain the approval of the FRB and the Ohio Division of Financial Institutions (ODFI) if a dividend in any year would cause the total dividends for that year to exceed the sum of the current year’s net profits and the retained net profits for the preceding two years, less required transfers to surplus. At December 31, 2015, State Bank had $12.4 million of excess earnings over the preceding three years.

 

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

 

Affiliate Transactions

 

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

 

 5 

 

 

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

 

Regulatory Capital

 

The FRB has adopted risk-based capital guidelines for bank holding companies and for state member banks, such as State Bank. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk weighted assets by assigning assets and off-balance-sheet items to broad risk categories. Prior to January 1, 2015, the minimum ratio of total capital to risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) was 8%. Of that 8%, at least 4% was required to be comprised of common shareholders’ equity (including retained earnings but excluding treasury stock), non-cumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets (“Tier 1 capital”). The remainder of total risk-based capital (“Tier 2 capital”) may consist, among other things, of certain amounts of mandatory convertible debt securities, subordinated debt, preferred stock not qualifying as Tier 1 capital, allowance for loan and lease losses and net unrealized gains, after applicable taxes, on available-for-sale equity securities with readily determinable fair values, all subject to limitations established by the guidelines. Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, one of four risk weights (0%, 20%, 50% and 100%) is applied to different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of the counterparty. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

In July 2013, the FRB and the federal banking agencies published final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and State Bank. These rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to various documents released by the Basel Committee on Banking Supervision.

 

Effective January 1, 2015, State Bank and the Company became subject to new capital regulations under BASEL III (with some provisions transitioned into full effectiveness over two to four years). The new requirements create a new required ratio for common equity Tier 1 (“CET1”) capital, increases the leverage and Tier 1 capital ratios, changes the risk-weights of certain assets for purposes of the risk-based capital ratios, creates an additional capital conservation buffer over the required capital ratios and changes what qualifies as capital for purposes of meeting these various capital requirements. These new capital requirements are as follows: leverage ratio of 4% of adjusted total assets, total capital ratio of 8% of risk-weighted assets and the Tier 1 capital ratio of 6.5% of risk-weighted assets. In addition, the Company will have to meet the new minimum CET1 capital ratio of 4.5% of risk-weighted assets. CET1 consists generally of common stock, retained earnings and accumulated other comprehensive income (AOCI), subject to certain adjustments. Beginning in 2016, failure to maintain the required capital conservation buffer will limit the ability of the Company to pay dividends, repurchase shares or pay discretionary bonuses.

 

Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be deducted from capital, subject to a two-year transition period. In addition, Tier 1 capital will include AOCI, which includes all unrealized gains and losses on available for sale debt and equity securities, subject to a two-year transition period. State Bank decided in the first quarter of 2015 to permanently opt-out of the inclusion of AOCI in its capital calculations to reduce the impact of market volatility on its regulatory capital levels.

 

 6 

 

 

The new requirements under BASEL III also include changes in the risk-weights of certain assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential mortgage loans that are 90 days past due or otherwise in nonaccrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less; a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital; and increased risk-weights (0% to 600%) for equity exposures.

 

In addition to the minimum CET1, Tier 1 and total capital ratios, State Bank will have to maintain a capital conservation buffer consisting of additional CET1 capital equal to 2.5% of risk-weighted assets above each of the required minimum capital levels in order to avoid limitations on paying dividends, engaging in share repurchases and paying certain discretionary bonuses. This new capital conservation buffer requirement is phased in beginning in January 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented in January 2019.

 

The FRB’s prompt corrective action standards will change when these new capital ratios become effective. Under the new standards, in order to be considered well-capitalized, State Bank will be required to have at least a CET1 ratio of 6.5% (new), a Tier 1 ratio of 8% (increased from 6%), a total capital ratio of 10% (unchanged) and a leverage ratio of 5% (unchanged) and not be subject to specified requirements to meet and maintain a specific capital ratio for a capital measure.

 

State Bank conducted a proforma analysis of the application of these new capital requirements as of December 31, 2015. Based on that analysis, State Bank determined that it meets all these new requirements, including the full 2.5% capital conservation buffer, and would remain well capitalized if these new requirements had been in effect on that date. (see Note 13) In addition, as noted above, beginning in 2016, if State Bank does not have the required capital conservation buffer, its ability to pay dividends to the Company would be limited.

 

In April 2015, the Federal Reserve Board issued a final rule which increased the size limitation for qualifying bank holding companies under the Federal Reserve Board’s Small Bank Holding Company Policy Statement from $500 million to $1 billion of total consolidated assets. As a result, the Company now qualifies under the Small Bank Holding Company Policy Statement for exemption from the Federal Reserve Board’s consolidated risk-based capital and leverage rules at the holding company level.

Federal Deposit Insurance Corporation (“FDIC”)

 

The FDIC is an independent federal agency which insures the deposits of federally-insured banks and savings associations up to certain prescribed limits and safeguards the safety and soundness of financial institutions. State Bank’s deposits are subject to the deposit insurance assessments of the FDIC. Under the FDIC’s deposit insurance assessment system, the assessment rate for any insured institution may vary according to regulatory capital levels of the institution and other factors such as supervisory evaluations.

 

In addition, the FDIC has proposed changing the deposit insurance premium assessment method for banks with less than $10 billion in assets that have been insured by the FDIC for at least five years. The proposed changes would revise the financial ratios method so that it would be based on a statistical model estimating the probability of failure of a bank over three years; update the financial measures used in the financial ratios method consistent with the statistical model; and eliminate risk categories for established small banks and use the financial ratios method to determine assessment rates for all such banks (subject to minimum or maximum initial assessment rates based upon a bank’s composite examination rating).

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

 

 

 7 

 

 

SEC and NASDAQ Regulation

 

The Company is subject to the jurisdiction of the Securities and Exchange Commission (the “SEC”) and certain state securities authorities relating to the offering and sale of its securities. The Company is subject to the registration, reporting and other regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the rules adopted by the SEC under those acts. The Company’s common shares are listed on The NASDAQ Capital Market under the symbol “SBFG”. The Company’s depository shares, each representing a 1/100th interest in the preferred shares, Series A are listed on the NASDAQ Capital Market under the symbol “SBFGP”. The Company is subject to the rules and regulations of The NASDAQ Stock Market, Inc. (“NASDAQ”) applicable to listed companies.

 

Sarbanes-Oxley Act of 2002 and Related Rules Affecting Corporate Governance

 

As mandated by the Sarbanes-Oxley Act of 2002 (“SOX”), the SEC has adopted rules and regulations governing, among other matters, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. The SEC has also approved corporate governance rules promulgated by NASDAQ. The Board of Directors of the Company has taken a series of actions to comply with the NASDAQ and SEC rules and to further strengthen its corporate governance practices. The Company has adopted and implemented a Code of Conduct and Ethics and a copy of that policy can be found on the Company’s website at www.yoursbfinancial.com by first clicking “Corporate Governance” and then “Code of Conduct”. The Company has also adopted charters of the Audit Committee, the Compensation Committee and the Governance and Nominating Committee, which charters are available on the Company’s website at www.yoursbfinancial.com by first clicking “Corporate Governance” and then “Supplementary Info”.

 

USA Patriot Act

 

The Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) gives the United States Government greater powers over financial institutions to combat money laundering and terrorist access to the financial system in our country. The Patriot Act requires regulated financial institutions to establish programs for obtaining identifying information from customers seeking to open new accounts and establish enhanced due diligence policies, procedures and controls designed to detect and report suspicious activity.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

 

The Dodd-Frank Act was enacted into law on July 21, 2010. The Dodd-Frank Act is significantly changing the regulation of financial institutions and the financial services industry. Because the Dodd-Frank Act requires various federal agencies to adopt a broad range of regulations with significant discretion, many of the details of the new law and the effects they will have on the Company will not be known for months and even years.

 

Among the provisions already implemented pursuant to the Dodd-Frank Act, the following provisions have or may have an effect on the business of the Company and its subsidiaries:

 

the CFPB has been formed with broad powers to adopt and enforce consumer protection regulations;
   
the federal law prohibiting the payment of interest on commercial demand deposit accounts was eliminated effective July 21, 2011;
   
the standard maximum amount of deposit insurance per customer was permanently increased to $250,000;
   
the assessment base for determining deposit insurance premiums has been expanded from domestic deposits to average assets minus average tangible equity;
   
public companies in all industries are or will be required to provide shareholders the opportunity to cast a non-binding advisory vote on executive compensation;
    

 8 

 

 

new capital regulations for bank holding companies have been adopted, which will impose stricter requirements, and any new trust preferred securities issued after May 19, 2010, will no longer constitute Tier I capital; and
   
new corporate governance requirements applicable generally to all public companies in all industries require new compensation practices and disclosure requirements, including requiring companies to “claw back” incentive compensation under certain circumstances, to consider the independence of compensation advisors and to make additional disclosures in proxy statements with respect to compensation matters.

 

Many provisions of the Dodd-Frank Act have not yet been implemented and will require interpretation and rule making by federal regulators. As a result, the full effect of the Dodd-Frank Act on the Company cannot yet be determined. However, it is likely that the implementation of these provisions will increase compliance costs and fees paid to regulators, along with possibly restricting the operations of the Company and its subsidiaries.

 

The Volcker Rule

 

In December 2013, five federal agencies adopted a final regulation implementing the Volcker Rule provision of the Dodd-Frank Act (the “Volcker Rule”). The Volcker Rule places limits on the trading activity of insured depository institutions and entities affiliated with a depository institution, subject to certain exceptions. The trading activity includes a purchase or sale as principal of a security, derivative, commodity future or option on any such instrument in order to benefit from short-term price movements or to realize short-term profits. The Volcker Rule exempts specified U.S. Government, agency and/or municipal obligations, and it excepts trading conducted in certain capacities, including as a broker or other agent, through a deferred compensation or pension plan, as a fiduciary on behalf of customers, to satisfy a debt previously contracted, repurchase and securities lending agreements and risk-mitigating hedging activities.

 

The Volcker Rule also prohibits a banking entity from having an ownership interest in, or certain relationships with, a hedge fund or private equity fund, with a number of exceptions. The Company does not engage in any of the trading activities or have any ownership interest in or relationship with any of the types of funds regulated by the Volcker Rule.

 

Executive and Incentive Compensation

 

In June 2010, the Federal Reserve Board, the OCC and the FDIC issued joint interagency guidance on incentive compensation policies (the “Joint Guidance”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. This principles-based guidance, which covers all employees that 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 (a) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (b) be compatible with effective internal controls and risk management and (c) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

 

Pursuant to the Joint Guidance, the Federal Reserve Board will review as part of a regular, risk-focused examination process, the incentive compensation arrangements of financial institutions such as the Company. Such 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 and deficiencies will be incorporated into the institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against an institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and prompt and effective measures are not being taken to correct the deficiencies.

 

 9 

 

 

On February 7, 2011, federal banking regulatory agencies jointly issued proposed rules on incentive-based compensation arrangements under applicable provisions of the Dodd-Frank Act (the “Proposed Rules”). The Proposed Rules generally apply to financial institutions with $1.0 billion or more in assets that maintain incentive-based compensation arrangements for certain covered employees. The Proposed Rules (i) prohibit covered financial institutions from maintaining incentive-based compensation arrangements that encourage covered persons to expose the institution to inappropriate risk by providing the covered person with “excessive” compensation; (ii) prohibit covered financial institutions from establishing or maintaining incentive-based compensation arrangements for covered persons that encourage inappropriate risks that could lead to a material financial loss, (iii) require covered financial institutions to maintain policies and procedures appropriate to their size, complexity and use of incentive-based compensation to help ensure compliance with the Proposed Rules and (iv) require covered financial institutions to provide enhanced disclosure to regulators regarding their incentive-based compensation arrangements for covered person within 90 days following the end of the fiscal year.

 

Pursuant to rules adopted by the stock exchanges and approved by the SEC in January 2013 under the Dodd-Frank Act, public companies are required to implement “clawback” procedures for incentive compensation payments and to disclose the details of the procedures which allow recovery of incentive compensation that was paid on the basis of erroneous financial information necessitating a restatement due to material noncompliance with financial reporting requirements. This clawback policy is intended to apply to compensation paid within a three-year look-back window of the restatement and would cover all executives who received incentive awards. Public company compensation committee members are also required to meet heightened independence requirements and to consider the independence of compensation consultants, legal counsel and other advisors to the compensation committee. The compensation committees must have the authority to hire advisors and to have the company fund reasonable compensation of such advisors.

 

Effect of Environmental Regulation

 

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

 

 10 

 

 

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

 

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

 

   2015   2014   2013 
($ in thousands)  Average       Average   Average       Average   Average       Average 
   Balance   Interest   Rate   Balance   Interest   Rate   Balance   Interest   Rate 
Assets:                                    
Taxable securities  $78,840   $1,506    1.91%  $69,795   $1,198    1.72%  $78,520   $1,244    1.58%
Non-taxable securities (1)   17,593    1,052    5.98%   18,051    1,074    5.95%   17,267    1,065    6.17%
Loans, net (2)(3)   531,614    23,745    4.47%   501,486    22,524    4.49%   469,603    22,936    4.88%
Total earning assets   628,047    26,303    4.19%   589,332    24,796    4.21%   565,390    25,245    4.47%
Cash and due from banks   38,895              24,665              20,827           
Allowance for loan losses   (6,979)             (6,785)             (6,962)          
Premises and equipment   16,427              13,725              14,635           
Other assets   43,196              51,340              46,030           
                                              
Total assets  $719,586             $672,277             $639,920           
                                              
Liabilities                                             
Savings and interest-bearing demand deposits  $309,169   $346    0.11%  $275,188   $105    0.04%  $262,954   $136    0.05%
Time deposits   162,245    1,633    1.01%   171,399    1,879    1.10%   180,154    2,095    1.16%
Repurchase agreements & Other   15,749    17    0.11%   18,764    91    0.48%   13,085    58    0.44%
Advances from FHLB   29,996    375    1.25%   24,294    334    1.37%   18,551    339    1.83%
Trust preferred securities   10,310    213    2.07%   17,448    1,071    6.14%   20,620    1,407    6.82%
Total interest-bearing liabilities   527,469    2,584    0.49%   507,093    3,480    0.69%   495,364    4,035    0.81%
                                              
Demand deposits   104,426              88,973              78,540           
Other liabilities   9,073              16,025              11,316           
Total liabilities   640,968              612,091              585,220           
Shareholders' equity   78,618              60,186              54,700           
                                              
Total liabilities and shareholders' equity  $719,586             $672,277             $639,920           
                                              
Net interest income (tax equivalent basis)       $23,719             $21,316             $21,210      
                                              
Net interest income as a percent of average interest-earning assets             3.78%             3.62%             3.75%

  

(1) Security interest is computed on a tax equivalent basis using a 34 percent statutory tax rate.  The tax equivalent adjustment was $0.36 million, $0.37 million and $0.36 million in 2015, 2014 and 2013, respectively.
(2) Nonaccruing loans and loans held for sale are included in the average balances.
(3) Loan interest is computed on a tax equivalent basis using a 34 percent statutory tax rate.  The tax equivalent adjustment was $0.02 million, $0.02 million and $0.04 million in 2015, 2014 and 2013, respectively.

 

 11 

 

 

I.DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL (Continued)

 

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

 

Volume Variance - change in volume multiplied by the previous year's rate.
Rate Variance - change in rate multiplied by the previous year's volume.
Rate/Volume Variance - change in volume multiplied by the change in rate. This variance was allocated to volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each.
Interest on non-taxable securities has been adjusted to a fully tax equivalent basis using a statutory tax rate of 34 percent in 2015 and 2014.

 

   Total         
   Variance   Variance Attributable To 
($ in thousands)  2015/2014   Volume   Rate 
Interest income    
Taxable securities  $308   $155   $153 
Non-taxable securities   (22)   (27)   5 
Federal funds sold   -    -    - 
Loans, net of unearned income and deferred fees *   1,221    1,353    (132)
    1,507    1,481    26 
                
Interest expense               
Savings and interest-bearing demand deposits  $241   $13    228 
Time deposits   (246)   (100)   (146)
Repurchase agreements & Other   (74)   (1)   (73)
Advances from FHLB   41    78    (37)
Trust preferred securities   (858)   (438)   (420)
    (896)   (448)   (447)
                
Net interest income  $2,403   $1,929   $473 

 

* Interest on non-taxable loans has been adjusted to fully tax equivalent.

 

 12 

 

 

II.INVESTMENT PORTFOLIO

 

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

 

  ($ in thousands)  2015   2014   2013 
               
  U.S. Treasury and government agencies  $10,905   $15,307   $11,300 
  Mortgage-backed securities   61,343    50,740    57,223 
  State and political subdivisions   17,518    19,170    18,155 
  Money Market Mutual Fund   -    -    3,092 
  Marketable equity securities   23    23    23 
                  
  Total  $89,789   $85,240   $89,793 

 

  B. The maturity distribution and weighted average interest rates of securities available for sale at December 31, 2015, are set forth in the table below. The weighted average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount:

 

     Maturing 
         After One Year   After Five Years     
     Within   but within   but within   After 
  ($ in thousands)  One Year   Five Years   Ten Years   Ten Years 
                   
  U.S. Treasury and government agencies  $100   $683   $1,032   $9,090 
  Mortgage-backed securities   744    8,765    8,556    43,278 
  State and political subdivisions   330    1,443    5,367    10,378 
                       
  Total Securities with maturity  $1,174   $10,891   $14,955   $62,746 
                       
  Weighted average yield by maturity (1)   2.62%   2.50%   3.18%   2.59%
                       
                       
  Marketable equity securities with no maturity   23    -    -    - 
                       
  Total Securities with no stated maturity  $23   $-   $-   $- 
                       
  Weighted average yield no maturity (1)    <0.01%   -    -    - 

 

(1) Yields are presented on a tax-equivalent basis.

 

  C. Excluding those holdings of the investment portfolio in U.S. Treasury securities and other agencies of the U.S. Government, there were no other securities of any one issuer which exceeded 10 percent of the shareholders' equity of the Company at December 31, 2015.

 

 13 

 

 

III.LOAN PORTFOLIO

 

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

 

Loans Held for Investment (HFI)  2015   2014   2013   2012   2011 
($ in thousands)                    
Commercial business and agricultural  $130,421   $134,546   $124,578   $123,767   $116,172 
Commercial real estate   242,208    217,030    205,301    201,392    187,829 
Residential real estate   130,806    113,214    99,620    87,859    87,656 
Consumer & other loans   54,224    51,546    47,804    50,371    50,897 
                          
Total loans, (HFI) net of unearned income   557,659    516,336    477,303    463,389    442,554 
                          
Residential Loans held for sale   7,516    5,168    3,366    6,147    5,238 
Total Loans, net of unearned income  $565,175   $521,504   $480,669   $469,536   $447,792 

 

Concentrations of Credit Risk: The Company grants commercial, real estate and installment loans to customers mainly in Northwest Ohio. Commercial loans include loans collateralized by commercial real estate, business assets and, in the case of agricultural loans, crops and farm equipment and the loans are expected to be repaid from cash flow from operations of businesses. As of December 31, 2015, commercial business and agricultural loans made up approximately 23.4 percent of the loan portfolio while commercial real estate loans accounted for approximately 43.4 percent of the loan portfolio. As of December 31, 2015, residential first mortgage loans made up approximately 23.5 percent of the loan portfolio and are secured by first mortgages on residential real estate, with consumer loans to individuals approximately 9.7 percent of the loan portfolio and are primarily secured by consumer assets.

 

Maturities and Sensitivities of Loans to Changes in Interest Rates: The following table shows the amounts of commercial and agricultural loans outstanding as of December 31, 2015, which, based on remaining scheduled repayments of principal, are due in the periods indicated. Also, the amounts have been classified according to sensitivity to changes in interest rates for commercial and agricultural loans due after one year. (Variable-rate loans are those loans with floating or adjustable interest rates.)

 

Maturing  Commercial   Commercial     
($ in thousands)  Business & Ag.   Real Estate   Total 
Within one year  $17,783   $18,324   $36,107 
After one year but within five years   45,368    82,917    128,285 
After five years   67,270    140,967    208,237 
                
Total Commercial, Commercial RE & Ag.  $130,421   $242,208   $372,629 

 

   Interest Sensitivity     
   Fixed   Variable     
($ in thousands)  Rate   Rate   Total 
Commercial Business and Agricultural            
Due after one year but within five years  $19,407   $25,961   $45,368 
Due after five years   10,074    57,196    67,270 
Total  $29,481   $83,157   $112,638 
                
Commercial Real Estate               
Due after one year but within five years   37,879    45,038    82,917 
Due after five years   44,454    96,513    140,967 
Total  $82,333   $141,551   $223,884 
                
Total Commercial, Commercial RE & Ag.               
Due after one year but within five years   57,286    70,999    128,285 
Due after five years   54,528    153,709    208,237 
Total  $111,814   $224,708   $336,522 

 

 14 

 

 

III.LOAN PORTFOLIO (Continued)

 

Risk Elements: Non-accrual, Past Due, Restructured and Impaired Loans – The following schedule summarizes non-accrual, past due, and restructured loans at December 31 for the years indicated:

 

($ in thousands)  2015   2014   2013   2012   2011 
                     
Loans accounted for on a non-accrual basis  $6,646   $4,609   $4,844   $5,305   $6,900 
Accruing loans 90 days past due   -    -    -    -    - 
Accruing Troubled Debt Restructurings   1,500    1,384    1,739    1,258    1,334 
Total non-performing loans and TDRs  $8,146   $5,993   $6,583   $6,563   $8,234 

 

Listed below is the interest income on impaired and non-accrual loans at December 31 for the years indicated:

 

   2015   2014 
($ in thousands)   
Cash basis interest income recognized on impaired loans outstanding  $239   $200 
Interest income actually recorded on impaired loans and included in net income for the period   245    206 
Unrecorded interest income on non-accrual loans   86    88 

 

Management believes the allowance for loan losses at December 31, 2015 was adequate to absorb any losses on non-performing loans, as the allowance balance is maintained by management at a level considered adequate to cover losses that are probable based on past loss experience, general economic conditions, information about specific borrower situations, including their financial position and collateral values, and other factors and estimates which are subject to change over time.

 

 1.Non-accrual Policy
   
The accrual of interest income is discontinued when the collection of a loan or interest, in whole or in part, is doubtful. When interest accruals are discontinued, interest income accrued in the current period is reversed. Loans which are past due 90 days or more as to interest or principal payments are considered for non-accrual status.
   
 2.Potential Problem Loans
   
As of December 31, 2015, in addition to the $6.6 million of non-performing loans reported under Item III.C.1. above (which amount includes all loans classified by management as doubtful or loss), there were approximately $1.8 million in other outstanding loans where known information about possible credit problems of the borrowers caused management to have concerns as to the ability of such borrowers to comply with the present loan repayment terms (loans classified as substandard by management) and which may result in disclosure of such loans pursuant to Item III.C.1. at some future date. In regard to loans classified as substandard, management believes that such potential problem loans have been adequately evaluated in the allowance of loan losses.
   
3.Foreign Outstandings
   
  None
   
 4.Loan Concentrations
   
  At December 31, 2015, loans outstanding related to agricultural operations or collateralized by agricultural real estate and equipment aggregated approximately $43.8 million, or 7.9 percent of total loans.

 

  D. Other Interest-Bearing Assets

 

There were no other interest-bearing assets as of December 31, 2015 which would be required to be disclosed under Item III.C.1 or Item III.C.2. if such assets were loans.

 

 15 

 

 

IV. SUMMARY OF LOAN LOSS EXPERIENCE

 

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

 

  ($ in thousands)  2015   2014   2013   2012   2011 
  Loans                    
  Loans outstanding at end of period  $557,659   $516,336   $477,303   $463,389   $442,554 
                            
  Average loans outstanding during period  $531,614   $501,486   $469,603   $455,516   $438,883 
                            
  Allowance for loan losses                         
  Balance at beginning of period  $6,771   $6,964   $6,811   $6,529   $6,715 
  Loans charged-off:                         
  Commercial business and agricultural loans   (497)   (607)   (1)   (400)   (642)
  Commercial real estate   (303)   (13)   (111)   (287)   (2,057)
  Residential real estate mortgage   (56)   (92)   (264)   (129)   (248)
  Consumer loans and other   (96)   (135)   (443)   (512)   (460)
      (952)   (847)   (819)   (1,328)   (3,407)
  Recoveries of loans previously charged-off                         
  Commercial business and agricultural loans   29    22    22    48    468 
  Commercial real estate   3    125    17    50    32 
  Residential real estate mortgage   29    32    21    86    700 
  Consumer loans and other   10    25    12    76    27 
      71    204    72    260    1,227 
  Net loans charged-off   (881)   (643)   (747)   (1,068)   (2,180)
  Provision for loan losses   1,100    450    900    1,350    1,994 
  Balance at end of period  $6,990   $6,771   $6,964   $6,811   $6,529 
                            
  Ratio of net charge-offs to average loans   0.17%   0.13%   0.16%   0.23%   0.50%

 

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

 

 16 

 

 

IV. SUMMARY OF LOAN LOSS EXPERIENCE (Continued)

 

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

 

       Percentage       Percentage       Percentage       Percentage       Percentage 
       of Loans In       of Loans In       of Loans In       of Loans In       of Loans In 
       Each       Each       Each       Each       Each 
       Category to       Category to       Category to       Category to       Category to 
   Allowance   Total   Allowance   Total   Allowance   Total   Allowance   Total   Allowance   Total 
   Amount   Loans   Amount   Loans   Amount   Loans   Amount   Loans   Amount   Loans 
($ in thousands)  2015   2014   2013   2012   2011 
                                         
Commercial and agricultural  $1,118    23.4%  $1,838    26.1%  $2,334    26.1%  $1,747    26.7%  $1,965    26.3%
Commercial real estate   3,886    43.4%   2,857    42.0%   2,708    43.0%   3,034    43.5%   2,880    42.4%
Residential real estate   1,312    23.5%   1,308    21.9%   1,067    20.9%   1,088    19.0%   956    19.8%
Consumer & other loans   674    9.7%   768    10.0%   855    10.0%   942    10.9%   728    11.5%
   $6,990    100.0%  $6,771    100.0%  $6,964    100.0%  $6,811    100.0%  $6,529    100.0%

 

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

 

V. DEPOSITS

 

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

 

   2015   2014   2013 
   Average   Average   Average   Average   Average   Average 
($ in thousands)  Amount   Rate   Amount   Rate   Amount   Rate 
     
Savings and interest-bearing demand                        
deposits  $309,169    0.11%  $275,188    0.04%  $262,954    0.05%
Time deposits   162,245    1.01%   171,399    1.10%   180,154    1.16%
Demand deposits (non-interest-bearing)   104,426    -    88,973    -    78,540    - 
   $575,840        $535,560        $521,648      

 

Maturities of time certificates of deposit and other time deposits of $100,000 or more outstanding at December 31, 2015, are summarized as follows:

 

   Amount 
   ($ in thousands) 
Three months or less  $13,471 
Over three months and through six months   8,073 
Over six months and through twelve months   14,612 
Over twelve months   35,432 
      
Total  $71,588 

 

 17 

 

 

VI. RETURN ON EQUITY AND ASSETS

 

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

 

($ in thousands)  2015   2014   2013 
     
Average total assets  $719,586   $672,277   $639,920 
Average shareholders’ equity  $78,618   $60,186   $54,700 
Net income  $7,619   $5,263   $5,205 
Net income available to common shareholders  $6,663   $5,263   $5,205 
Cash dividends declared  $0.20   $0.16   $0.12 
Return on average total assets   1.06%   0.78%   0.81%
Return on average shareholders' equity   9.69%   8.74%   9.52%
Dividend payout ratio  (1)   14.71%   14.88%   11.26%
Average shareholders' equity to average assets   10.93%   8.95%   8.55%

 

(1) Cash dividends declared on common shares divided by net income availbel to common.

 

VII. SHORT-TERM BORROWINGS

 

The following information is reported for short-term borrowings for the periods noted:

 

($ in thousands)  2015   2014   2013 
     
Amount outstanding at end of year  $12,406   $12,740   $14,696 
Weighted average interest rate at end of year   0.10%   0.10%   0.11%
Maximum amount outstanding at any month end  $20,306   $20,607   $15,025 
Average amount outstanding during the year  $15,749   $17,057   $12,011 
Weighted average interest rate during the year   0.11%   0.11%   0.09%

 

 18 

 

 

Item 1A. Risk Factors

 

Cautionary Statement Regarding Forward-Looking Information

 

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

 

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

 

Forward-looking statements involve risks and uncertainties. Actual results may differ materially from those predicted by the forward-looking statements because of various factors and possible events, including those risk factors identified below. These risks and uncertainties include, but are not limited to, risks and uncertainties inherent in the national and regional banking industry, changes in economic and political conditions in the market areas in which the Company and its subsidiaries operate, changes in laws, regulations or policies by regulatory agencies, changes in accounting standards and policies, changes in tax laws, fluctuations in interest rates, demand for loans in the market areas in which the Company and its subsidiaries operate, increases in FDIC insurance premiums, changes in the competitive environment, losses of significant customers, geopolitical events, unanticipated litigation, the loss of key personnel and other factors. There is also the risk that the Company’s management or Board of Directors incorrectly analyzes these risks and forces, or that the strategies the Company develops to address them are unsuccessful.

 

Forward-looking statements speak only as of that date on which they are made. Except as may be required by law, the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made.

 

All forward-looking statements attributable to the Company or any person acting on our behalf are qualified in their entirety by the following cautionary statements.

 

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

 

Our success depends to a large extent upon local and national economic conditions, as well as governmental fiscal and monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond our control can adversely affect our asset quality, deposit levels and loan demand and, therefore, our earnings and our capital. Economic turmoil in Europe and Asia and changes in oil production in the Middle East affect the economy and stock prices in the United States, which can affect our earnings and capital and the ability of our customers to repay loans. Because we have a significant amount of real estate loans, additional decreases in real estate values could adversely affect the value of property used as collateral and our ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings and cash flows. In addition, our lending and deposit gathering activities are concentrated primarily in Northwest Ohio. As a result, our success depends in large part on the general economic conditions of these areas, particularly given that a significant portion of our lending relates to real estate located in this region. Therefore, adverse changes in the economic conditions in these areas could adversely impact our earnings and cash flows.

 

 19 

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 20 

 

 

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

 

The FDIC insures deposits at FDIC insured financial institutions, including State Bank. The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level. During 2008 and 2009, there were higher levels of bank failures which dramatically increased resolution costs of the FDIC and depleted the deposit insurance fund. The FDIC collected a special assessment in 2009 to replenish the Deposit Insurance Fund and also required a prepayment of an estimated amount of future deposit insurance premiums. If the costs of future bank failures increase, deposit insurance premiums may also increase. In addition, the FDIC has proposed changes to its assessment system for banks with less than $10 billion in assets that have been insured by the FDIC for at least five years. It is unclear how a final new assessment system might impact Civista’s deposit insurance premiums in the future.

 

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

 

The financial services industry is extensively regulated. We are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our operations. These laws and regulations are primarily intended for the protection of consumers, depositors, borrowers and the deposit insurance fund, not to benefit our shareholders. Changes to laws and regulations or other actions by regulatory agencies may negatively impact us, possibly limiting the services we provide, increasing the ability of non-banks to compete with us or requiring us to change the way we operate. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on the operation of an institution and the ability to determine the adequacy of an institution’s allowance for loan losses. Failure to comply with applicable laws, regulations and policies could result in sanctions being imposed by the regulatory agencies, including the imposition of civil money penalties, which could have a material adverse effect on our operations and financial condition.

 

In light of current conditions in the global financial markets and the global economy, regulators have increased their focus on the regulation of the financial services industry. In the last several years, Congress and the federal bank regulators have acted on an unprecedented scale in responding to the stresses experienced in the global financial markets. Some of the laws enacted by Congress and regulations promulgated by federal bank regulators subject us and other financial institutions to additional restrictions, oversight and costs that may have an adverse impact on our business and results of operations.

 

The Dodd-Frank Act was signed into law on July 21, 2010, and, although it became generally effective in July 2010, many of its provisions have extended implementation periods and delayed effective dates and have and will continue to require extensive rulemaking by regulatory authorities. In addition, we may be subjected to higher deposit insurance premiums to the FDIC. We may also be subject to additional regulations under the newly established Consumer Financial Protection Bureau, which was given broad authority to implement new consumer protection regulations. These and other provisions of the Dodd-Frank Act, including future rules implementing its provisions and the interpretation of those rules, may place significant additional costs on us, impede our growth opportunities and place us at a competitive disadvantage. In addition, we cannot predict whether there will be additional new laws or regulations that might affect the Company and result in material adverse effects on our financial condition and results of operations.

 

 21 

 

 

Changes in tax laws could adversely affect our performance.

 

We are subject to extensive federal, state and local taxes, including income, exise, sales/use, payroll, franchise, withholding and ad valorem taxes. Changes to our taxes could have a material adverse effect on our results of operations. In addition, our customers are subject to a wide variety of federal, state and local taxes. Changes in taxes paid by our customers may adversely affect their ability to purchase homes or consumer products, which could adversely affect their demand for our loans and deposit products. In addition, such negative effects on our customers could result in defaults on the loans we have made.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Your ability to sell or purchase our common and depository shares depends upon the existence of an active trading market for our common shares. While our common and depository shares are quoted on the NASDAQ Capital Market, they trade infrequently. As a result, you may be unable to sell or purchase our shares at the volume, price and time you desire. The limited trading market for our shares may cause fluctuations in the market value of our shares to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market.

 

 22 

 

 

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

 

The market price of our common and depository shares may fluctuate significantly due to, among other things, changes in market sentiment regarding our operations, financial results or business prospects, the banking industry generally or the macroeconomic outlook. Factors that could impact trading prices include:

 

our operating and financial results, including how those results vary from the expectations of management, securities analysts and investors;
   
developments in our business or operations or in the financial sector generally;
   
any future offerings by us of debt or preferred shares, which would be senior to our common shares upon liquidation and for purposes of dividend distributions;
   
legislative or regulatory changes affecting our industry generally or our business and operations specifically;
   
the operating and stock price performance of companies that investors consider to be comparable to us;
   
announcements of strategic developments, acquisitions and other material events by us or our competitors;
   
expectations of (or actual) equity dilution, including the actual or expected dilution to various financial measures, including earnings per share, that may be caused by any future offering and/or sale of additional securities of the Company;
   
actions by our current shareholders, including future sales of common shares by existing shareholders, including our directors and executive officers; and
   
other changes in U.S. or global financial markets, global economies and general market conditions, such as interest or foreign exchange rates, stock, commodity, credit or asset valuations or volatility.

 

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

 

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

 

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

 

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

 

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

 

 23 

 

 

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

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make significant estimates that affect the financial statements. Two of our most critical estimates are the level of the allowance for loan losses and the accounting for goodwill and other intangibles. Because of the inherent nature of these estimates, we cannot provide complete assurance that we will not be required to adjust earnings for significant unexpected loan losses, nor that we will not recognize a material provision for impairment of our goodwill. For additional information regarding these critical estimates, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on page 34 of this Annual Report on Form 10-K.

 

Changes in accounting standards could impact our results of operations.

 

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

 

Our information systems may experience an interruption or security breach.

 

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

 

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

 

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

 

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

 

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

 

 24 

 

 

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

 

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

 

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

 

New regulations applicable to residential mortgage origination could adversely impact our business.

 

In the past several years, the CFPB has issued significant new mortgage rules and additional guidance and initiatives aimed at the mortgage lending industry. These new rules, guidance and initiatives impact a key business line for the Company, and may have an impact on our mortgage loan origination practices going forward. The Company has been closely monitoring these regulatory developments, and the Company continues to evaluate the applicable requirements of the new mortgage rules that have been issued, including the TILA-RESPA Integrated Disclosure (TRID) rules (which were originally to be effective on August 1, 2015, but were subsequently postponed until October 3, 2015). The new TRID rules contain new requirements and new disclosure forms that are required to be provided to borrowers during the origination process for mortgage loans, and the implementation of these new requirements and forms have necessitated operational and technological changes for our residential mortgage loan business. The Company has been working closely with its vendors and partners and has diligently strived to achieve compliance as of the new effective date and to maintain compliance with these complex new rules as additional guidance and clarification is provided by the regulators. These new rules, as well as additional rules, guidance and initiatives established by the CFPB or other regulators in the future, may continue to increase regulatory compliance costs, impede the growth of our mortgage lending business and otherwise adversely impact our business.

 

Item 1B. Unresolved Staff Comments

 

None.

 

 25 

 

 

Item 2. Properties.

 

The Company’s principal executive offices are located at 401 Clinton Street, Defiance, Ohio. This facility is owned by State Bank, and a portion of the facility is used as a retail banking center. In addition, State Bank owns the land and buildings occupied by 19 of its banking centers and leases one other property used as a banking center. The Company also occupies office space from various parties for multiple business purposes on varying lease terms. There is no outstanding mortgage debt on any of the properties which the Company owns. The Dublin and Findlay banking centers were opened during 2015, and the Bowling Green banking center was purchased in 2015 and will open in the fourth quarter of 2016.

 

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

 

Description/Address  Leased/ Owned  Deposits 12/31/15 
            
Main Banking Center & Corporate Office       
 401   Clinton Street, Defiance, OH  Owned  $159,767 
              
Banking Centers/Drive-Thru's        
 1419   West High Street, Bryan, OH  Owned   32,911 
 1232   Main Street, Bowling Green, OH  Owned   N/A  
 510   Third Street, Defiance, OH (Drive-thru)  Owned   N/A  
 1600   North Clinton Street, Defiance, OH  Leased   32,622 
 312   Main Street, Delta, OH  Owned   12,766 
 4080   West Dublin Granville Road, Dublin, OH  Owned   13,530 
 211   East Lincoln Street, Findlay, OH  Owned   2,355 
 12832   Coldwater Road, Fort Wayne, IN  Owned   16,382 
 235   Main Street, Luckey, OH  Owned   41,651 
 133   East Morenci Street, Lyons, OH  Owned   20,185 
 930   West Market Street, Lima, OH  Owned   34,200 
 1201   East Main Street, Montpelier, OH  Owned   38,944 
 218   North First Street, Oakwood, OH  Owned   20,432 
 220   North Main Street, Paulding, OH  Owned   38,548 
 610   East South Boundary Street, Perrysburg, OH  Owned   12,372 
 119   South State Street, Pioneer, OH  Owned   28,761 
 6401   Monroe Street, Sylvania, OH  Owned   29,613 
 311   Main Street, Walbridge, OH  Owned   26,525 
 515   Parkview, Wauseon, OH  Owned   24,889 
              
Loan Production Offices        
 908   North Wayne Street, Suite A, Angola, IN  Leased   - 
 68   North High Street, Bldg. E, Ste. 105, New Albany, OH  Leased   - 
 206   South Washington Street, Tiffin, OH  Leased   - 
 8194   Secor Road, Lambertville, MI  Leased   - 
              
 Service Facilities (RDSI/DCM/SBT)        
 112   East Jackson Street, West Unity, OH  Owned    N/A  
 104   Depot Street, Archbold, OH  Leased    N/A  
 105   East Holland Street, Archbold, OH  Leased    N/A  
 3125   Pine Tree Road, Suite 3D, Lansing, MI  Leased    N/A  
              
    Total Deposits     $586,453 

 

 26 

 

 

The Company’s subsidiaries have several noncancellable leases for business use that expire over the next ten years. Aggregate rental expense for these leases was $0.14 and $0.31 million for the years ended December 31, 2015, and 2014, respectively. Future minimum lease payments under operating leases are:

 

($ in thousands)    
2016  $135 
2017   111 
2018   102 
2019   103 
2020   103 
Thereafter   104 
      
Total Lease Payments  $658 

 

Item 3. Legal Proceedings.

 

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

 

Item 4. Mine Safety Disclosures.

 

Not Applicable

 

Supplemental Item: Executive Officers of the Registrant

 

The following table lists the names and ages of the executive officers of the Company as of February 29, 2015, the positions presently held by each executive officer and the business experience of each executive officer during the past five years. Unless otherwise indicated, each person has held his principal occupation(s) for more than five years.

 

Name  Age  Position(s) Held with the Company and
its Subsidiaries and Principal Occupation(s)
Mark A. Klein   61  Chairman of the Company since April 2015; Director of the Company since February 2010; President and Chief Executive Officer of the Company since January 2010 and of The State Bank since January 2006; Director of State Bank since 2006; President of RDSI since October 2011; Member of State Bank Investment Committee since March 2007.
Anthony V. Cosentino   54  Executive Vice President and Chief Financial Officer of the Company and State Bank since March 2010; Chief Financial Officer of RDSI since October 2011; Member of State Bank Investment Committee since June 2010.
Jonathan R. Gathman   42  Executive Vice President and Senior Lending Officer of the Company since October 2005; Senior Vice President and Commercial Lending Manager from June 2005 through October 2005; Vice President and Commercial Lender from February 2003 through June 2005. Began working for State Bank in May 1996.

 

 27 

 

 

PART II

 

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

 

Market Information

 

Our common shares are traded on the NASDAQ Capital Market under the symbol “SBFG” and there were 4,890,886 shares outstanding as of December 31, 2015. These common shares were held by approximately 1,400 record holders. Our depository shares representing a 1/100th interest in our preferred shares, Series A, are traded on the NASDAQ Capital Market under the symbol ”SBFGP” and there were 1,500,000 depository shares outstanding as of December 31, 2015. On or after the fifth anniversary of the issue date of the Series A Preferred Shares (December 23, 2019), the Company may require all holders of Series A Preferred Shares (and, therefore, depository shares) to convert their shares into common shares of the Company provided the Company’s common share price exceeds 120 percent of $10.34. At December 31, 2015, the aggregate number of common shares issuable upon the conversion of outstanding Series A Preferred Shares was 1,451,377.

 

The following table presents quarterly market price information and cash dividends paid per share for our common shares for 2015 and 2014:

 

   Year Ending 
   December 31, 2015   December 31, 2014 
Quarter ended:  High   Low   Dividend   High   Low   Dividend 
March 31  $11.25   $9.18   $0.045   $9.00   $7.75   $0.035 
June 30   11.87    10.40    0.050    8.75    7.71    0.040 
September 30   11.45    9.51    0.050    9.20    8.06    0.040 
December 31   11.75    9.95    0.055    9.70    8.50    0.045 

 

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

 

 28 

 

 

  

   Period Ending 
Index  12/31/10   12/31/11   12/31/12   12/31/13   12/31/14   12/31/15 
SB Financial Group, Inc.   100.00    66.25    163.98    201.33    244.73    295.54 
NASDAQ Composite   100.00    99.21    116.82    163.75    188.03    201.40 
NASDAQ Bank   100.00    89.50    106.23    150.55    157.95    171.92 

 

Source : SNL Financial LC, Charlottesville, VA
© 2016
www.snl.com

 

The following table provides information regarding SB Financial’s purchases of its common shares during the period ended 2015:

 

   Total
Number of
   Average 
   Shares   Price Paid 
Period  Purchased   per Share 
           
May 2015   186   $10.90 

 

There were no common shares repurchased by the Company in 2014.

 

 29 

 

 

Item 6. Selected Financial Data

 

Financial Highlights

Year Ended December 31

 

($ in thousands except per share data)

EARNINGS  2015   2014   2013   2012   2011 
Interest income  $25,927   $24,408   $24,848   $26,122   $27,509 
Interest expense   2,584    3,480    4,035    5,390    6,798 
Net interest income   23,343    20,928    20,813    20,732    20,711 
Provision for loan losses   1,100    450    900    1,350    1,994 
Noninterest income   15,707    12,827    14,046    14,845    13,857 
Noninterest expense   26,927    25,957    26,511    27,484    30,253 
Provision for income taxes   3,404    2,085    2,243    1,929    658 
Net income   7,619    5,263    5,205    4,814    1,664 
Preferred stock dividends   956    -    -    -    - 
Net income available to common   6,663    5,263    5,205    4,814    1,664 
                          
PER SHARE DATA                         
Basic earnings  $1.36   $1.08   $1.07   $0.99   $0.34 
Diluted earnings   1.19    1.07    1.07    0.99    0.34 
Cash dividends declared   0.20    0.16    0.12    -    - 
Total equity per share   12.81    11.96    11.55    10.96    9.86 
                          
AVERAGE BALANCES                         
Average total assets  $719,586   $672,277   $639,920   $638,035   $643,528 
Average equity   78,618    60,186    54,700    50,300    47,035 
                          
RATIOS                         
Return on average total assets   1.06%   0.78%   0.81%   0.75%   0.26%
Return on average equity   9.69    8.74    9.52    9.57    3.54 
Cash dividend payout ratio*   14.75    14.81    11.21    -    - 
Average equity to average assets   10.93    8.95    8.55    7.88    7.31 
                          
PERIOD END TOTALS                         
Total assets  $733,071   $684,228   $631,754   $638,234   $628,664 
Total investments; fed funds sold   89,789    85,240    89,793    98,702    111,978 
Total loans and leases   557,659    516,336    477,303    463,389    442,554 
Loans held for sale   7,516    5,168    3,366    6,147    5,238 
Allowance for loan losses   6,990    6,771    6,964    6,811    6,529 
Total deposits   586,453    550,906    518,234    527,001    518,765 
Notes payable   -    -    589    1,702    2,788 
Advances from FHLB   35,000    30,000    16,000    21,000    12,776 
Trust preferred securities   10,310    10,310    20,620    20,620    20,620 
Total equity   81,241    75,683    56,269    53,284    47,932 

 

*Cash dividends divided by net income

  

 30 

 

 

Quarterly Financial Information (unaudited)

Year ended December 31

 

($ in thousands except per share data)

2015  December   September   June   March 
                 
Interest income  $6,622   $6,717   $6,414   $6,174 
Interest expense   646    644    651    643 
Net interest income   5,976    6,073    5,763    5,531 
Provision for loan losses   150    100    500    350 
Non-interest income   3,716    3,952    4,443    3,596 
Non-interest expense   6,839    6,626    6,818    6,644 
Income tax expense   835    1,035    897    637 
Net income  $1,868   $2,264   $1,991   $1,496 
Preferred share dividend   244    244    244    225 
Net income available to common  $1,624   $2,020   $1,747   $1,271 
                     
Basic earnings per share  $0.33   $0.41   $0.36   $0.26 
Diluted earnings per share   0.29    0.35    0.31    0.23 
Dividends per share   0.055    0.05    0.05    0.045 

 

2014  December   September   June   March 
                 
Interest income  $6,190   $6,321   $6,156   $5,741 
Interest expense   685    971    908    916 
Net interest income   5,505    5,350    5,248    4,825 
Provision for loan losses   150    150    150    - 
Non-interest income   3,163    3,809    3,295    2,560 
Non-interest expense   6,363    6,888    6,627    6,079 
Income tax expense   630    608    521    326 
Net income  $1,525   $1,513   $1,245   $980 
                     
Basic earnings per share  $0.31   $0.31   $0.26   $0.20 
Diluted earnings per share   0.30    0.31    0.25    0.20 
Dividends per share   0.045    0.04    0.04    0.035 

  

 31 

 

 

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

 

SB Financial Group, Inc. (“SB Financial” or the “Company”), is a bank holding company registered with the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. Through its direct and indirect subsidiaries, SB Financial is engaged in commercial banking, computerized item processing, and trust and financial services.

 

The following discussion provides a review of the consolidated financial condition and results of operations of SB Financial and its subsidiaries (collectively, the “Company”). This discussion should be read in conjunction with the Company’s consolidated financial statements and related footnotes as of and for the years ended December 31, 2015 and 2014.

 

Strategic Discussion

 

The focus and strategic goal of the Company is to grow into a top decile (>90th percentile) independent financial services company. We intend to achieve that goal by succeeding at the five key initiatives we have adopted.

 

Increase profitability through ongoing diversification of revenue streams: For the twelve months ended December 31, 2015, the Company generated $15.7 million in revenue from “fee based” products, or 40.2 percent of total operating revenue. These revenue sources include fees generated from saleable residential mortgage loans, retail deposit products, wealth management division, saleable business-based loans (small business and farm service) and fees generated by our wholly-owned item processing subsidiary (RDSI).

 

Strengthen our penetration in all markets served: Over our 113 year history of continuous operation in Northwest Ohio, we have established a significant presence in our traditional markets in Defiance, Fulton, Paulding and Williams counties in Ohio. In our newer markets of Columbus, Findlay, Toledo (Ohio) and Ft. Wayne (Indiana), our current market penetration is minimal but we believe our potential for growth is significant. During 2015, we expanded our presence into Columbus (Dublin), Ohio and Findlay, Ohio with new banking center openings.

 

Expand product utilization by new and existing customers: As of December 31, 2015, we served 26,076 households and provided 57,118 products to these households. Our strategy is to continue to expand the scope of our relationship with each household via our dynamic “on-boarding” process. Proactively identifying client needs is a key ingredient of our value proposition.

 

Deliver gains in operational excellence: Our management team believes that becoming and remaining a high-performance financial services company will depend upon seamlessly and consistently delivering operational excellence. This excellence is demonstrated by the Company’s leadership in the origination and servicing of residential mortgage loans. As of December 31, 2015, the Company serviced 5,632 loans with a principal balance of $772.5 million.

 

Sustain asset quality: As of December 31, 2015, the Company was near the top quartile of our peer group in asset quality metrics. Specifically, total non-performing assets were $8.4 million, or 1.15 percent of total assets. Total delinquent loans at December 31, 2015 were 1.09 percent of total loans.

 

Critical Accounting Policies

 

The accounting and reporting policies of SB Financial are in accordance with generally accepted accounting principles in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the Company’s consolidated financial statements for the years ended December 31, 2015 and 2014. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The Company’s financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective or complex.

 

 32 

 

 

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

 

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

 

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

 

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

 

Earnings Summary

 

Net income for 2015 was $7.62 million, and net income available to common shareholders was $6.66 million or $1.19 per diluted share, compared with net income and net income available to common of $5.26 million, or $1.07 per diluted share for 2014. State Bank reported net income for 2015 of $8.37 million, which was up from the $6.95 million in net income in 2014. RDSI reported a net loss for 2015 of $3 thousand, compared to a net loss of $180 thousand reported for 2014.

 

Positive results for 2015 included loan growth of $41.3 million, and deposit growth of $35.5 million. Both of these factors contributed to a net interest margin of 3.78 percent, which was up 16 basis points from 2014. The mortgage banking business line continues to grow, with residential real estate loan production of $323 million for the year, resulting in $6.3 million of revenue from gains on sale. The level of mortgage origination was up from the $220 million in 2014. The Company’s loans serviced for others ended the year at $773 million.

 

 33 

 

 

Operating revenue was up compared to the prior year by $5.2 million, or 15.7 percent, due to higher mortgage volume, SBA gains and $41.3 million in balance sheet loan growth. Net interest margin for 2015 was 3.78 percent, up 16 basis point from 2014.

 

Operating expense was up compared to the prior year by $0.97 million, or 3.7 percent, due to higher mortgage volumes, fringe benefit cost increases and higher staffing levels. Net charge-offs for 2015 of $0.88 million resulted in a loan loss provision of $1.1 million, which was up from the $0.64 and $0.45 million respectively in 2014.

 

Changes in Financial Condition

 

Total assets at December 31, 2015, were $733.1 million, compared to $684.2 million at December 31, 2014. Loans (excluding loans held for sale) were $557.7 million at December 31, 2015, compared to $516.3 million at December 31, 2014. Total deposits were $586.4 million at December 31, 2015, compared to $550.9 million at December 31, 2014.

 

Total equity was $81.2 million at December 31, 2015, up from $75.7 million at December 31, 2014. The $5.5 million increase in equity, which reflected a 7.3 percent increase over 2014 was due to net income less shareholder dividends of $1.0 million.

 

Results of Operations

 

   Year Ended December 31, 
($ in thousands except per share data)  2015   2014   % Change 
Total assets  $733,071   $684,228    7.1%
Total investments   89,789    85,240    5.3%
Loans held for sale   7,516    5,168    45.4%
Loans, net of unearned income   557,659    516,336    8.0%
Allowance for loan losses   6,990    6,771    3.2%
Total deposits   586,453    550,906    6.5%
                
Total operating revenue  $39,050   $33,755    15.7%
Net interest income   23,343    20,928    11.5%
Loan loss provision   1,100    450    144.4%
Non-interest income   15,707    12,827    22.5%
Non-interest expense   26,927    25,957    3.7%
Net income   7,619    5,263    44.8%
Net income available to common shareholders   6,663    5,263    26.6%
Diluted earnings per share   1.19    1.07    11.3%

 

Net Interest Income  Year Ended December 31, 
($ in thousands)  2015   2014   % Change 
Net interest income  $23,343   $20,928    11.5%

 

Net interest income was $23.3 million for 2015 compared to $20.9 million for 2014, an increase of $2.4 million or 11.5 percent. Average earning assets increased to $628.0 million in 2015, compared to $589.3 million in 2014, an increase of $38.7 million or 6.6 percent due to loan volume. The consolidated 2015 full-year net interest margin increased 16 basis points to 3.78 percent compared to 3.62 percent for the full year of 2014. In the third quarter of 2014, the Company redeemed its fixed rate trust preferred securities prior to maturity, which impacted the full year improvement in net interest margin by 14 basis points.

 

 34 

 

 

Provision for Loan Losses of $1.1 million was taken in 2015 compared to $0.45 million taken for 2014. The $0.65 million increase was due to the higher level of charge-offs and the deterioration in the Company’s non-performing asset levels. For 2015, net charge-offs totaled $0.88 million, or 0.17 percent of average loans. This charge-off level was higher than 2014, in which net charge-offs were $0.64 million or 0.13 percent of average loans.

 

Non-interest Income  Year Ended December 31, 
($ in thousands)  2015   2014   % Change 
Total non-interest income  $15,707   $12,827    22.5%
                
Data service fees   1,190    1,289    -7.7%
Wealth management fees   2,606    2,630    -0.9%
Customer service fees   2,779    2,691    3.3%
Gains on sale of residential loans   6,264    4,228    48.2%
Gains on sale of other loans   947    321    195.0%
Mortgage loan servicing fees, net   1,025    731    40.2%
Gains on sale of securities   -    160    -100.0%
Other   896    777    15.3%

 

Total non-interest income was $15.7 million for 2015 compared to $12.8 million for 2014, representing a $2.9 million, or 22.5 percent increase year-over-year. This increase was driven by a 38 percent increase in gains on sale of residential real estate loans and a 195 percent increase in other loan sale gains. The Company sold $271 million of originated mortgages into the secondary market, which allowed for our serviced loan portfolio to grow to $773 million at December 31, 2015 from $666 million at December 31, 2014.

 

Data servicing fees from RDSI continued to decline, and were down 8 percent in 2015, due to lower check processing volume and client losses. Customer service fees increased during 2015 due to changes in the Company’s deposit products.

 

Other income increased due to gains on sales of assets and swap income.

 

Non-interest Expense  Year Ended December 31, 
($ in thousands)  2015   2014   % Change 
Total non-interest expense  $26,927   $25,957    3.7%
                
Salaries & employee benefits   14,917    13,185    13.1%
Professional fees   1,663    1,703    -2.3%
Occupancy & equipment expense   4,166    4,612    -9.7%
Marketing expense   594    564    5.3%
All other   5,587    5,893    -5.2%

 

Total non-interest expense was $26.9 million for 2015 compared to $26.0 million for 2014, representing a $0.97 million, or 3.7 percent year-over-year. Included in the 2014 expense totals was $0.33 million related to the trust preferred prepayment penalty. Total full-time equivalent headcount (FTE) ended 2015 at 214, which was up 24 from year end 2014.

 

Salaries and benefits were driven by higher personnel and incentive costs due to mortgage and SBA loan sales. Occupancy costs were down as computer equipment purchased in 2010 has been fully expenses and is still operational.

 

 35 

 

 

Balance Sheet            
($ in thousands)  Year Ended December 31, 
Total Loans  2015   2014   % Change 
Commercial  $86,586   $88,329    -2.0%
Commercial real estate   242,208    217,030    11.6%
Agricultural   43,835    46,217    -5.2%
Residential real estate   130,806    113,214    15.5%
Consumer & Other   54,224    51,546    5.2%
                
Total loans, net of unearned income  $557,659   $516,336    8.0%
                
Total loans, held for sale  $7,516   $5,168    45.4%
                
Total Deposits  2015   2014   % Change 
Non interest bearing demand  $113,113   $97,853    15.6%
Interest bearing demand   126,443    121,043    4.5%
Savings & money market   187,859    168,709    11.4%
Time deposits   159,038    163,301    -2.6%
                
Total deposits  $586,453   $550,906    6.5%

 

Loans increased $41.3 million, or 8.0 percent, to $557.7 million at December 31, 2015. The largest component of this increase was in commercial real estate loans which rose $25.2 million followed by residential real estate and consumer which rose $17.6 million and $2.7 million, respectively.

 

Deposits increased $35.5 million, or 6.5 percent, to $586.4 million at December 31, 2015. Deposit growth for the year included $15.3 million in non-interest demand deposits and $19.3 million in savings deposits.

 

Asset Quality  Year Ended December 31, 
($ in thousands)  2015   2014   % Change 
Non-accruing loans  $6,646   $4,608    44.2%
Accruing restructured loans (TDR's)   1,500    1,385    8.3%
OREO & Repossessed assets   286    285    0.4%
Non-performing assets   8,432    6,278    34.3%
Net charge-offs   881    643    37.0%
Loan loss provision   1,100    450    144.4%
Allowance for loan losses   6,990    6,771    3.2%
                
Non-performing assets/total assets   1.15%   0.92%   25.4%
Net charge-offs/average loans   0.13%   0.13%   0.0%
Allowance/loans   1.25%   1.31%   -4.4%
Allowance/non-performing loans   85.81%   112.98%   -24.1%

 

Non-performing assets consisting of loans and OREO (Other Real Estate Owned) and accruing TDRs totaled $8.4 million, or 1.15 percent of total assets at December 31, 2015, an increase of $2.2 million or 34.3 percent from 2014. Net charge-offs were also up during 2015 at $0.88 million, which was a $0.24 million increase compared to 2014. The Company’s loan loss allowance at December 31, 2015, now covers non-performing loans at 86 percent, down from 113 percent at December 31, 2014.

 

 36 

 

 

Stockholders’ equity at December 31, 2015, was $81.2 million or 11.08 percent of total assets compared to $75.7 million or 11.06 percent of total asssets at December 31, 2014. The equity balances for 2014 included the net impact of the Company’s capital raise, which closed in December 2014 and added $14.0 million to total equity through the public offering of depository shares representing 1/100th interest in our 6.50 percent Noncumulative Convertible Preferred Shares, Series A.

 

Regulatory capital reporting is required for State Bank only, as the Company is now exempt from quarterly regulatory capital level measurement. As of December 31, 2015, State Bank met all requirements for well capitalized (See Note 13).

 

Goodwill and Intangibles: The Company completed its most recent annual goodwill impairment test as of December 31, 2015. The first step impairment test compares the fair value of the reporting unit with the carrying value, including goodwill. The reporting unit is State Bank. RDSI has no remaining goodwill. At December 31, 2015, State Bank passed step one, which indicated no impairment.

 

The fair value testing of Goodwill and Intangibles was conducted pursuant to ASC Topic 350 and utilized Company-prepared projections of cash flows, historical financial results and market based comparisons. These inputs were used to evaluate the expected future cash flows of the business and those results determined the fair value of the Goodwill and Intangibles.

 

Management plans to purchase additional premises and equipment to meet the current and future needs of the Company’s customers. These purchases, including buildings and improvements and furniture and equipment (which includes computer hardware, software, office furniture and license agreements), are currently expected to total approximately $2.5 million for the Company during 2016. These capital expenditures and purchases are expected to be funded by cash on hand and from cash generated from current operations.

 

Liquidity

 

Liquidity relates primarily to the Company’s ability to fund loan demand, meet deposit customers’ withdrawal requirements and provide for operating expenses. Sources used to satisfy these needs consist of cash and due from banks, interest bearing deposits in other financial institutions, securities available for sale, loans held for sale, and borrowings from various sources. The assets, excluding the borrowings, are commonly referred to as liquid assets. Liquid assets were $117.8 million at December 31, 2015, compared to $118.6 million at December 31, 2014.

 

The Company’s commercial real estate, first mortgage residential, agricultural and multi-family mortgage portfolio of $416.8 million at December 31, 2015, can and has been readily used to collateralize borrowings, which is an additional source of liquidity. Management believes the Company’s current liquidity level, without these borrowings, is sufficient to meet its current and anticipated liquidity needs. At December 31, 2015, all eligible commercial real estate, residential first, multi-family mortgage and agricultural loans were pledged under an Federal Home Loan Bank (FHLB) blanket lien.

 

Significant additional off-balance-sheet liquidity is available in the form of FHLB advances, unused federal funds lines from correspondent banks and the national certificate of deposit market. Management expects the risk of changes in off-balance-sheet arrangements to be immaterial to earnings. Based on the current collateralization requirements of the FHLB, approximately $31.1 million of additional borrowing capacity existed at December 31, 2015.

 

At December 31, 2015 and 2014, the Company had $15.0 and $14.0 million in federal funds lines available, respectively. The Company also had $27.7 million in unpledged securities at December 31, 2015, that may be used to pledge for additional borrowings.

 

The cash flow statements for the periods presented provide an indication of the Company’s sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. A discussion of the cash flow statements for 2015 and 2014 follows:

 

The Company experienced positive cash flows from operating activities in 2015 and 2014. Net cash from operating activities was $8.6 million and $5.0 million for the years ended December 31, 2015 and 2014, respectively. Significant operating items for 2015 included gain on sale of loans ($7.2 million) and net income ($7.6 million). Net proceeds from sales of loans held for sale and loans originated and held for sale were a positive $16.2 million.

 

 37 

 

 

The Company experienced negative cash flows from investing activities in 2015 and 2014. Net cash used in investing activities was $54.7 million and $36.6 million for the years ended December 31, 2015 and 2014, respectively. The changes for 2015 include the purchase of available-for-sale securities of $26.3 million, and net increase in loans of $42.3 million. The changes for 2014 include the purchase of available-for-sale securities of $26.1 million and net increase in loans of $40.0 million. The Company had proceeds from repayments, maturities, sales and calls of securities of $20.3 million and $31.0 million in 2015 and 2014, respectively. The Company had proceeds from sales of premises and foreclosed assets of $0.8 million and $0.3 million in 2015 and 2014, respectively.

 

The Company experienced positive cash flows from financing activities in 2015 and 2014. Net cash in financing activities was $38.3 million in 2015 and $46.7 million in 2014. Positive $35.5 million $32.6 million is attributable to the change in deposits for 2015 and 2014, respectively. In 2014, the Company provided cash of $14.0 million from a preferred capital raise, and repaid trust preferred securities in the amount of $10.6 million.

 

The Company uses an economic value of equity (“EVE”) analysis to measure risk in the balance sheet incorporating all cash flows over the estimated remaining life of all balance sheet positions. The EVE analysis calculates the net present value of the Company’s assets and liabilities in rate shock environments that range from -400 basis points to +400 basis points. The likelihood of a decrease in rates was considered to be remote given the current interest rate environment and therefore, only the minus 100 basis point rate change was included for 2015 and 2014. The results of this analysis are reflected in the following tables.

 

December 31, 2015

Economic Value of Equity

($’s in thousands)

 
Change in Rates  $ Amount   $ Change   % Change 
+400 basis points  $137,575   $16,287    13.43%
+300 basis points   135,269    13,981    11.53%
+200 basis points   131,535    10,247    8.45%
+100 basis points   127,022    5,734    4.73%
Base Case   121,288    -    - 
-100 basis points   114,630    (6,657)   (5.49%)

 

December 31, 2014

Economic Value of Equity

($’s in thousands)

 
Change in Rates  $ Amount   $ Change   % Change 
+400 basis points  $128,975   $18,443    16.69%
+300 basis points   126,167    15,635    14.14%
+200 basis points   122,675    12,142    10.99%
+100 basis points   117,985    7,453    6.74%
Base Case   110,532    -    - 
-100 basis points   105,296    (5,236)   (4.74%)

 

 38 

 

 

Tabular Disclosure of Contractual Obligations

 

The following table details the Company’s contractual obligations as of December 31, 2015, which were comprised of long-term debt obligations, other debt obligations, operating lease obligations and other long-term liabilities. Long-term debt obligations are comprised of FHLB Advances of $35.0 million. Other debt obligations are comprised of Trust Preferred securities of $10.3 million. The Other long-term liabilities include time deposits of $159.0 million.

 

  Payment due by period 
($ in thousands)
Contractual Obligations
  Total   Less than
1 year
   1 - 3 years   3 - 5 years   More than
5 years
 
                     
Long-Term Debt Obligations  $35,000   $14,000   $14,500   $6,500   $- 
                          
Other Debt Obligations   10,310    -    -    -    10,310 
                          
Operating Lease Obligations   658    135    213    206    104 
                          
Other Long-Term Liabilities Reflected on the Registrant's Balance Sheet under GAAP   156,038    75,593    59,520    23,394    531 
                          
Total  $205,006   $89,728   $74,233   $30,100   $10,945 

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

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

 

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

 

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

 

 39 

 

 

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

 

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

 

There are several ways an institution can manage interest rate risk including: 1) matching repricing periods for new assets and liabilities, for example, by shortening or lengthening terms of new loans, investments, or liabilities; 2) selling existing assets or repaying certain liabilities; and 3) hedging existing assets, liabilities, or anticipated transactions. An institution might also invest in more complex financial instruments intended to hedge or otherwise change interest rate risk. Interest rate swaps, futures contracts, options on futures contracts, and other such derivative financial instruments can be used for this purpose. Because these instruments are sensitive to interest rate changes, they require management’s expertise to be effective. The Company has not purchased derivative financial instruments in the past, but during 2015 and 2014 the Company entered into interest rate swap agreements as an accommodation to certain loan customers. See Note 6 to the financial statements. The Company may purchase such instruments in the future if market conditions are favorable.

 

The following table details quantitative disclosures of market risk and provides information about the Company’s financial instruments used for purposes other than trading that are sensitive to changes in interest rates as of December 31, 2015. The table does not present when these items may actually reprice. For loans receivable, securities, and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities as well as the historical impact of interest rate fluctuations on the prepayment of loans and mortgage backed securities. For core deposits (demand deposits, interest-bearing checking, savings, and money market deposits) that have no contractual maturity, the table presents principal cash flows and applicable related weighted-average interest rates based upon the Company’s historical experience, management’s judgment and statistical analysis, as applicable, concerning their most likely withdrawal behaviors. The current historical interest rates for core deposits have been assumed to apply for future periods in this table as the actual interest rates that will need to be paid to maintain these deposits are not currently known. Weighted average variable rates are based upon contractual rates existing at the reporting date.

 

 40 

 

 

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

 

($ in thousands)  2016   2017   2018   2019   2020   Thereafter   Total 
Rate Sensitive Assets                            
Variable Rate Loans  $60,821   $16,519   $12,388   $10,827   $6,458   $28,030   $135,043 
Average interest rate   3.98%   3.95%   3.45%   3.29%   3.58%   3.59%   3.77%
Adjustable Rate Loans  $25,304   $20,701   $17,380   $16,976   $16,131   $154,222   $250,714 
Average interest rate   4.10%   4.30%   4.18%   4.20%   4.22%   4.15%   4.17%
Fixed Rate Loans  $34,507   $19,400   $18,410   $16,558   $19,442   $71,101   $179,419 
Average interest rate   4.01%   4.30%   4.22%   4.35%   4.22%   4.04%   4.13%
Total Loans  $120,632   $56,620   $48,178   $44,361   $42,031   $253,353   $565,175 
Average interest rate   4.01%   4.20%   4.01%   4.03%   4.12%   4.06%   4.06%
Fixed rate investment securities  $14,223   $9,082   $8,942   $11,287   $10,735   $32,476   $86,745 
Average interest rate   1.39%   1.81%   1.86%   2.14%   1.89%   2.54%   2.07%
Variable rate investment securities  $880   $894   $907   $695   $442   $2,974   $6,792 
Average interest rate   1.10%   1.11%   1.13%   1.50%   1.66%   1.83%   1.50%
Fed Funds Sold & Other  $-   $-   $-   $-   $-   $-   $- 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Total Rate Sensitive Assets  $135,735   $66,596   $58,027   $56,343   $53,208   $288,803   $658,712 
Average interest rate   3.72%   3.83%   3.63%   3.62%   3.65%   3.86%   3.77%
                                    
Rate Sensitive Liabilities                                   
Demand - Non Interest Bearing  $15,967   $13,711   $11,778   $10,114   $8,686   $52,857   $113,113 
Demand-Interest Bearing  $15,043   $13,253   $11,677   $10,286   $9,064   $67,120   $126,443 
Average interest rate   0.05%   0.05%   0.05%   0.05%   0.05%   0.05%   0.05%
Money Market Accounts  $13,089   $11,448   $10,013   $8,757   $7,659   $53,446   $104,412 
Average interest rate   0.23%   0.23%   0.23%   0.23%   0.23%   0.23%   0.23%
Savings  $24,118   $7,688   $6,692   $5,824   $5,070   $34,055   $83,447 
Average interest rate   0.10%   0.10%   0.10%   0.10%   0.10%   0.10%   0.10%
Certificates of Deposit  $74,882   $41,865   $18,356   $12,801   $10,607   $528   $159,039 
Average interest rate   0.76%   0.92%   1.35%   1.52%   1.30%   3.49%   0.98%
Fixed rate FHLB Advances  $16,000   $7,500   $5,000   $6,500   $-   $-   $35,000 
Average interest rate   0.76%   1.12%   1.48%   1.85%   0.00%   0.00%   1.14%
Variable rate FHLB Advances  $-   $-   $-   $-   $-   $-   $- 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Fixed rate Notes Payable  $-   $-   $-   $-   $-   $-   $- 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00%
Variable rate Notes Payable  $-   $-   $-   $-   $-   $10,310   $10,310 
Average interest rate   0.00%   0.00%   0.00%   0.00%   0.00%   2.31%   2.31%
Fed Funds Purchased, Repos & Other  $12,406   $-   $-   $-   $-   $-   $12,406 
Average interest rate   0.11%   0.00%   0.00%   0.00%   0.00%   0.00%   0.11%
Total Rate Sensitive Liabilities  $171,505   $95,465   $63,516   $54,282   $41,086   $218,316   $644,170 
Average interest rate   0.44%   0.53%   0.56%   0.64%   0.40%   0.20%   0.40%

  

 41 

 

 

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

 

Comparison of 2015 to 2014  First   Years         
($ in thousands)  Year   2 - 5   Thereafter   Total 
Total Rate Sensitive Assets:                
December 31, 2015  $135,735   $234,174   $288,803   $658,712 
December 31, 2014   141,131    202,744    266,617    610,492 
Increase (decrease)  $(5,396)  $31,430   $22,186   $48,220 
                     
Total Rate Sensitive Liabilities:                    
December 31, 2015  $171,505   $254,349   $218,316   $644,170 
December 31, 2014   133,803    263,424    206,729    603,956 
Increase (decrease)  $37,702   $(9,075)  $11,587   $40,214 

 

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

 

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

 

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

 

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

 

Item 8. Financial Statements and Supplementary Data

 

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

 

 42 

 

 

SB Financial Group, Inc.

Consolidated Balance Sheets
December 31

 

($ in thousands)  2015   2014 
         
ASSETS        
         
Cash and due from banks  $20,459   $28,197 
Available-for-sale securities   89,789    85,240 
Loans held for sale   7,516    5,168 
Loans, net of unearned income   557,659    516,336 
Allowance for loan losses   (6,990)   (6,771)
Premises and equipment, net   19,010    13,604 
Federal Reserve and Federal Home Loan Bank Stock, at cost   3,748    3,748 
Foreclosed assets held for sale, net   286    285 
Interest receivable   1,260    1,346 
Goodwill   16,353    16,353 
Core deposits and other intangibles   82    283 
Cash value of life insurance   13,437    13,148 
Mortgage servicing rights   7,152    5,704 
Other assets   3,310    1,587 
Total assets  $733,071   $684,228 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
           
Liabilities          
Deposits          
Non interest bearing demand  $113,113   $97,853 
Interest bearing demand   126,443    121,043 
Savings   83,447    64,107 
Money market   104,412    104,602 
Time deposits   159,038    163,301 
Total deposits   586,453    550,906 
           
Repurchase agreements   12,406    12,740 
Federal Home Loan Bank advances   35,000    30,000 
Trust preferred securities   10,310    10,310 
Interest payable   264    264 
Other liabilities   7,397    4,325 
Total liabilities   651,830    608,545 
           
Commitments & Contingent Liabilities   -    - 
           
Stockholders' Equity          
Preferred stock 6.5% non-cumulative, Series A, no par value; authorized 200,000 shares; 15,000 shares issued   13,983    13,983 
Common stock, no par value; authorized 10,000,000 shares; 5,027,433 shares issued   12,569    12,569 
Additional paid-in capital   15,438    15,461 
Retained earnings   40,059    34,379 
Accumulated other comprehensive income   650    918 
Treasury stock, at cost - (2015 - 136,547, 2014 - 152,302 shares)   (1,458)   (1,627)
Total stockholders' equity   81,241    75,683 
Total liabilities and stockholders' equity  $733,071   $684,228 

 

See Notes to Consolidated Financial Statements

 

 F-1 

 

 

SB Financial Group, Inc.

Consolidated Statements of Income

Years Ended December 31

 

($ in thousands - except per share data)  2015   2014 
Interest Income        
Loans        
Taxable  $23,692   $22,457 
Tax-exempt   35    44 
Securities          
Taxable   1,506    1,198 
Tax-exempt   694    709 
Total interest income   25,927    24,408 
           
Interest Expense          
Deposits   1,979    1,984 
Repurchase agreements & Other   17    91 
Federal Home Loan Bank advances   375    334 
Trust preferred securities   213    1,071 
Total interest expense   2,584    3,480 
           
Net Interest Income   23,343    20,928 
Provision for loan losses   1,100    450 
Net interest income after provision for loan losses   22,243    20,478 
           
Non-interest Income          
Wealth management fees   2,606    2,630 
Customer service fees   2,779    2,691 
Gain on sale of mortgage loans & OMSR's   6,264    4,228 
Mortgage loan servicing fees, net   1,025    731 
Gain on sale of non-mortgage loans   947    321 
Data service fees   1,190    1,289 
Net gain on sales of securities