# LANDMARK BANCORP INC (LARK) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from LANDMARK BANCORP INC's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1141688/000149315224011513/form10-k.htm
Accession: 0001493152-24-011513
Filing date: 2024-03-27
Report date: 2023-12-31
Extracted from Item 7 to the first post-MD&A boundary after HTML sanitization.
Confidence: high

Company profile: /company/LARK/
All MD&A years: /company/LARK/mda/
Previous year: /company/LARK/mda/fy2022/ (FY 2022)
Next year: /company/LARK/mda/fy2024/ (FY 2024)

ITEM
7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Forward-Looking
Statements

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

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

[[GREPCENT_TABLE]]
[["","\u25cf","The effects of changes in interest rates (including the effects of changes in the rate of prepayments of our assets) and the policies of the Federal Reserve including on our net interest income and the value of our security portfolio."]]
[[/GREPCENT_TABLE]]

40

[[GREPCENT_TABLE]]
[["","\u25cf","The strength of the United States economy in general and the strength of the local economies in which we conduct our operations, including the effects of inflationary pressures and supply chain constraints on such economies, which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of our assets."],["","\u25cf","The effects of recent developments and events in the financial services industry, including the large-scale deposit withdrawals over a short period of time at Silicon Valley Bank, Signature Bank and First Republic Bank that resulted in the failure of those institutions;"],["","\u25cf","The economic impact of past and any future terrorist attacks, acts of war, including Israeli-Palestinian conflict and the Russian invasion of Ukraine, or threats thereof, and the response of the United States to any such threats and attacks."],["","\u25cf","The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, consumer protection, insurance, tax, trade and monetary and financial matters."],["","\u25cf","Our ability to compete with other financial institutions due to increases in competitive pressures in the financial services sector."],["","\u25cf","Our inability to obtain new customers and to retain existing customers."],["","\u25cf","The timely development and acceptance of products and services."],["","\u25cf","Technological changes implemented by us and by other parties, including third-party vendors, which may be more difficult to implement or more expensive than anticipated or which may have unforeseen consequences to us and our customers."],["","\u25cf","Our ability to develop and maintain secure and reliable electronic systems."],["","\u25cf","The effectiveness of our risk management framework."],["","\u25cf","The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents and our ability to identify and address such incidents."],["","\u25cf","Interruptions involving our information technology and telecommunications systems or third-party servicers."],["","\u25cf","Changes in and uncertainty related to the availability of benchmark interest rates used to price our loans and deposits, including the expected elimination of LIBOR and the development of a substitute."],["","\u25cf","The effects of severe weather, natural disasters, widespread disease or pandemics (including the COVID-19 pandemic), and other external events."],["","\u25cf","Our ability to retain key executives and employees and the difficulty that we may experience in replacing key executives and employees in an effective manner."],["","\u25cf","Consumer spending and saving habits which may change in a manner that affects our business adversely."],["","\u25cf","Our ability to successfully integrate acquired businesses and future growth."],["","\u25cf","The costs, effects and outcomes of existing or future litigation."],["","\u25cf","Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the FASB."],["","\u25cf","Our ability to effectively manage our credit risk."],["","\u25cf","Our ability to forecast probable credit losses and maintain an adequate allowance for credit losses."],["","\u25cf","The effects of declines in the value of our investment portfolio."],["","\u25cf","Our ability to raise additional capital if needed."],["","\u25cf","The effects of declines in real estate markets."],["","\u25cf","The effects of fraudulent activity on the part of our employees, customers, vendors, or counterparties."]]
[[/GREPCENT_TABLE]]

These
risks and uncertainties should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such
statements. Additional information concerning us and our business, including other factors that could materially affect our financial
results, is included in “Item 1A. Risk Factors.”

CORPORATE
PROFILE AND OVERVIEW

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

41

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

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

We
are significantly impacted by prevailing economic conditions including federal monetary and fiscal policies and federal regulations of
financial institutions. The Bank’s markets have been impacted by the COVID-19 pandemic, which has had and continues to have a complex
and significant impact on the economy. Deposit balances are influenced by numerous factors such as competing investments, the level of
income and the personal rate of savings within our market areas. Factors influencing lending activities include the demand for housing
and the interest rate pricing competition from other lending institutions.

Currently,
our business consists of ownership of the Bank, with its main office in Manhattan, Kansas and thirty one additional offices in
central, eastern, southeast and southwest Kansas and Missouri, and our ownership of Landmark Risk Management, Inc. Landmark Risk Management,
Inc. is a Nevada-based captive insurance company.

CRITICAL
ACCOUNTING POLICIES

Critical
accounting policies are those that are both most important to the portrayal of our financial condition and results of operations, and
require our management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about
the effect of matters that are inherently uncertain. Our critical accounting policies relate to the allowance for credit losses and business
combinations, both of which involve significant judgment by our management.

On
January 1, 2023, we adopted CECL, which changed our allowance for credit losses from an incurred loss methodology to an expected
loss methodology. The CECL model is subject to changes in our economic forecast, which can impact the calculation of our allowance
for credit losses substantially. Our most significant critical accounting estimates relate to the allowance for credit losses on
loans, which involve significant judgment by our management. The analysis is updated on a quarterly basis based on historical loss
information adjusted for current conditions and reasonable and supportable forecasts. Additionally, the Company considers changes in
economic and business conditions, changes in policies, procedures and underwriting, changes in management or staff and their related
experience, changes in nature and volume of the portfolio, changes in loan review, changes in collateral values, changes in past due
and nonaccrual loans, changes in competition, legal and regulatory issues, changes in concentrations and other qualitative factors,
which impacts the estimate of future credit losses. These qualitative factors comprise a significant portion of the Company’s
allowance for credit losses. Based on a sensitivity analysis of all collectively evaluated loan pools, a five basis point change in
the qualitative risk factors across all loan categories would result in an increase or decrease of $474,000 or 4.5% in the allowance
for credit losses as of December 31,2023. See Note 1 Summary of Significant Accounting Policies for a more detailed description
methodology and impact of adoption.

We
have completed several business and asset acquisitions since 2002, which have generated significant amounts of goodwill. The initial
value assigned to goodwill is the residual of the purchase price over the fair value of all identifiable tangible and intangible assets
acquired and liabilities assumed. Goodwill is not amortized; however, it is tested for impairment at each calendar year end or more frequently
when events or circumstances dictate. The Company performed a qualitative assessment of factors to determine if it is more likely than
not that the fair value of a reporting unit is less than its carrying amount as of December 31, 2023. This assessment included a review
of macroeconomic conditions, industry and market specific considerations and other relevant factors including the Company’s market
capitalization, with control premiums and valuation multiples, compared to recent financial industry acquisition multiples for similar
institutions to estimate the fair value of the Company’s single reporting unit. The Company’s qualitative impairment test
indicated that its goodwill was not impaired. The Company can make no assurances that future impairment tests will not result in goodwill
impairments.

42

COMPARISON
OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2023 AND DECEMBER 31, 2022

SUMMARY
OF PERFORMANCE. Net earnings for 2023 increased $2.4 million, or 23.9%, to $12.2 million as compared to $9.9 million for 2022. The
increase in net earnings during 2023 was primarily related to an increase in interest income due to an increase in average interest earning
assets and higher yields on those assets. The increase in assets was due primarily to our acquisition of Freedom Bank on October 1, 2022
and organic growth. Higher interest rates and average balances of interest bearing liabilities also increased our interest expense. The
acquisition of Freedom Bank also contributed to an increase in non-interest expense in 2023.

We
distributed a 5% stock dividend for the 23rd consecutive year in December 2023. All per share and average share data in this section
reflect the 2023 and 2022 stock dividends.

Interest
Income. Interest income for 2023 increased $21.5
million to $64.7 million, an increase of 49.6% as compared to 2022. Interest income on loans increased $18.3 million, or 54.6%, to $51.8
million for 2023, as compared to 2022 due to higher yields and average balances. Our yields increased from 4.77% in 2022 to 5.81% in
2023. The increase in interest income on loans was also driven by an increase in average loan balances, which increased from $702.2 million
in 2022 to $891.5 million in 2023. Interest income on investment securities increased $3.3 million, or 34.5%, to $12.7 million during
2023, as compared to 2022. The increase in interest income on investment securities was primarily the result of increased yields on investment
securities, which increased from 2.15% in 2022 to 2.76% in 2023. Also contributing to the increase in interest income on investment securities
was an increase in the average balances of investment securities, which increased from $474.7 million in 2022 to $486.3 million in 2023.
Higher market interest rates have positively impacted the yield on our loans and investment securities.

Interest
Expense. Interest expense during 2023 increased
$17.0 million, or 392.2%, to $21.4 million as compared to 2022. Interest expense on interest-bearing deposits increased $12.5 million
to $15.3 million for 2023 as compared to $2.8 million in 2022. Our total cost of interest-bearing deposits increased from 0.35% during
2022 to 1.71% during 2023 as a result of higher rates and increased competition for deposits. Also contributing to the increase in interest
expense was an increase in average interest-bearing deposit balances, which increased from $804.1 million in 2022 to $892.4 million in
2023, largely resulting from the acquisition of Freedom Bank. Interest expense on borrowings increased $4.6 million to $6.1 million during
2023, as compared to 2022, due to an increase in our average borrowings, which increased from $50.0 million in 2022 to $114.2 million
in 2023. Also contributing to the increase in interest expense on borrowings were higher rates, which increased from 3.14% in 2022 to
5.37% in 2023. Higher market interest rates have negatively impacted our cost of interest-bearing deposits and borrowings.

Net
Interest Income. Net interest income represents
the difference between income derived from interest-earning assets and the expense incurred on interest-bearing liabilities. Net interest
income is affected by both the difference between the rates of interest earned on interest-earnings assets and the rates paid on interest-bearing
liabilities (“interest rate spread”) as well as the relative amounts of interest-earning assets and interest-bearing liabilities.

During
2023, net interest income increased $4.4 million, or 11.3%, to $43.3 million compared to $38.9 million in 2022. The increase in net interest
income was primarily a result of an increase in interest income on loans and investments, partially offset by higher interest expense.
The accretion of purchase accounting adjustments increased net interest income by $993,000 in 2023 compared to $460,000 in 2022. The
increase was primarily related to fair value adjustments on loans acquired in the Freedom Bank transaction. Compared to the same period
last year, the increase in interest rates raised the yields on our interest-earning assets and the cost of our interest-bearing liabilities.
Our net interest margin, on a tax-equivalent basis, decreased to 3.17% during 2023 from 3.21% during 2022. Continued increases in interest
rates may not result in a higher net interest margin as a result of increased competition for loans and deposits and the impact of a
negative sloping yield curve. Additionally, deposit balances may decline resulting in the need for higher cost funding.

Provision
for credit Losses. On January 1, 2023, we adopted
CECL and established an allowance for credit losses (“ACL”) based on this framework. The ACL is based on the historical loss
rates and the weighted average remaining maturity for financial assets measured at amortized costs including loans, investment securities
and unfunded loan commitments. The historical loss rates are adjusted to reflect reasonable and supportable forecasts to estimate expected
credit losses over the life of the financial asset.

43

During
2023, we recorded a $349,000 provision for credit losses compared to no provision for credit losses in 2022. The $349,000 provision for
credit losses during 2023 consisted of a $250,000 provision to the allowance for credit losses on loans, $80,000 to unfunded loan commitments
and $19,000 to the allowance for credit losses on held-to-maturity investment securities. We recorded net loan recoveries of $44,000
during 2023 compared to net loan recoveries of $16,000 during 2022.

Non-interest
Income. Total non-interest income was $13.2 million
in 2023, a decrease of $470,000, or 3.4%, compared to 2022. The decrease in non-interest income was primarily the result of a decrease
of $1.2 million in gains on sales of one-to-four family residential real estate loans as higher interest rates and low housing inventories
reduced originations of these loans, which are typically sold in the secondary market. However, higher mortgage rates did result in increased
originations of adjustable-rate loans in 2023, which are maintained in our one-to-four family residential loan portfolio. Also contributing
to the decrease in non-interest income was an increase in losses on sales of investment securities, which increased to $1.2 million in
2023 compared $1.1 million in 2022. Partially offsetting those decreases were increases of $569,000 in fees and service charges and $133,000
in bank owned life insurance. These increases were primarily related to the Freedom Bank acquisition. Additionally, other non-interest
income increased by $146,000 from 2022 to 2023, primarily due to an increase in lease income associated with part of a branch facility
that was vacant in the 2022.

Non-interest
Expense. Non-interest expense increased $713,000,
or 1.7%, to $42.0 million in 2023 compared to $41.3 million in 2022. The increase in non-interest expense in 2023 compared to 2022 was
mainly due to higher compensation and benefits, occupancy and equipment and data processing due to the acquisition of Freedom Bank. Also
contributing to the increases were higher amortization costs associated with the purchase accounting entries related to the acquisition.
Professional fees increased due higher consulting costs and audit fees. Offsetting those increases was a $3.4 million decrease in acquisition
costs associated with the acquisition of Freedom Bank.

INCOME
TAXES. We recorded income tax expense of $2.0 million in 2023 compared to $1.4 million in 2022. The effective tax rate increased
from 12.7% in 2022 to 13.8% in 2023, primarily due to higher earnings before income taxes. During 2023, we recognized $517,000 of previously
unrecognized tax benefits compared to $465,000 during 2022, which reduced the effective tax rates in both years.

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

Asset
Quality and Distribution. Our primary investing activities
are the origination of one-to-four family residential real estate, construction and land, commercial real estate, commercial, agriculture,
municipal and consumer loans and the purchase of investment securities. Total assets increased $58.8 million, or 3.9%, to $1.6 billion
at December 31, 2023, compared to $1.5 billion at December 31, 2022. Net loans, excluding loans held for sale, increased $96.5 million,
or 11.5%, to $937.6 million at December 31, 2023, compared to $841.1 million at December 31, 2022. Investment securities available-for-sale
decreased $36.5 million, or 7.5%, from $489.3 million at December 31, 2022 to $452.8 million at December 31, 2023.

44

The
allowance for credit losses is established through a provision for credit losses based on our economic projections. At December 31, 2023,
our allowance for credit losses on loans totaled $10.6 million, or 1.12% of gross loans outstanding, compared to $8.8 million, or 1.03%
of gross loans outstanding, at December 31, 2022. The increase in our allowance for credit losses on loans as a percentage of gross loans
outstanding was primarily due to the adoption of CECL on January 1, 2023.

As
of December 31, 2023 and 2022, approximately $7.5 million and $13.0 million, respectively, of loans were considered classified and assigned
a risk rating of special mention, substandard or doubtful. These ratings indicate that the loans identified as potential problem loans
have more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. Even though
these borrowers were experiencing moderate cash flow problems as well as some deterioration in collateral value, management believed
the general allowance was sufficient to cover all expected future losses expected in the loan portfolio at the balance sheet date.

Loans
past due 30-89 days and still accruing interest totaled $1.6 million, or 0.17% of gross loans, at December 31, 2023, compared to $738,000,
or 0.09% of gross loans, at December 31, 2022. At December 31, 2023, $2.4 million of loans were on non-accrual status, or 0.25% of gross
loans, compared to $3.3 million, or 0.39% of gross loans, at December 31, 2022. Non-accrual loans consist of loans 90 or more days past
due and certain impaired loans. There were no loans 90 days delinquent and accruing interest at December 31, 2023 and 2022.

As
part of our credit risk management, we continue to manage the loan portfolio to identify problem loans and have placed additional emphasis
on commercial real estate and construction and land relationships. We are working to resolve the remaining problem credits or move the
non-performing credits out of the loan portfolio. At December 31, 2023, we had $928,000 of real estate owned compared to $934,000 at
December 31, 2022. The decrease in real estate owned as of December 31, 2023 compared to December 31, 2022 was primarily due to a valuation
allowance recorded against a residential real estate property. As of December 31, 2023, real estate owned consisted of a commercial building,
undeveloped land and three residential real estate properties. The Company is currently marketing all of the remaining properties in
real estate owned.

Liability
Distribution. Our primary ongoing sources of funds
are deposits, FHLB borrowings, proceeds from principal and interest payments on loans and investment securities and proceeds from the
sale of mortgage loans and investment securities. While maturities and scheduled amortization of loans are a predictable source of funds,
deposit flows and mortgage prepayments are greatly influenced by general interest rates and economic conditions. We experienced an increase
of $15.6 million, or 1.2% in total deposits during 2023, to $1.3 billion at December 31, 2023, from $1.1 billion at December 31, 2022.
The increase in deposits was primarily due to higher balances of brokered deposits.

Total
borrowings increased $30.8 million, or 45.1%, to $99.0 million at December 31, 2023, from $68.3 million at December 31, 2022. The increase
in borrowings was primarily due to funding loan growth.

Non-interest-bearing
deposits at December 31, 2023, were $367.1 million, or 27.9% of deposits, compared to $410.1 million, or 31.5% of deposits, at December
31, 2022. Money market and checking accounts were 46.6% of our deposit portfolio and totaled $613.6 million at December 31, 2023, compared
to $626.7 million, or 48.2% of deposits, at December 31, 2022. Savings accounts decreased to $152.4 million, or 11.6% of deposits, at
December 31, 2023, from $170.6 million, or 13.1% of deposits, at December 31, 2022. Certificates of deposit totaled $183.2 million, or
13.9% of deposits, at December 31, 2023, compared to $93.3 million, or 7.2% of deposits, at December 31, 2022. Competition for deposits
may affect our ability to continue to increase deposit balances and could result in a decrease in our deposit balances in future periods.

Certificates
of deposit at December 31, 2023, scheduled to mature in one year or less totaled $163.4 million. Historically, maturing deposits have
generally remained with the Bank, and we believe that a significant portion of the deposits maturing in one year or less will remain
with us upon maturity in some type of deposit account.

CASH
FLOWS. During 2023, our cash and cash equivalents increased by $3.9 million. Our operating activities provided net cash of $12.6
million in 2023, which is primarily the result of net earnings and sales of one-to-four family residential mortgage loans. Our investing
activities used net cash of $50.6 million during 2023, primarily to fund loan growth. Our financing activities provided net cash of $42.0
million during 2023, primarily as a result of an increase in borrowings.

45

Liquidity.
Our most liquid assets are cash and cash equivalents
and investment securities available-for-sale. The levels of these assets are dependent on the operating, financing, lending and investing
activities during any given year. These liquid assets totaled $484.8 million at December 31, 2023 and $521.5 million at December 31,
2022. During periods in which we are not able to originate a sufficient amount of loans and/or periods of high principal prepayments,
we generally increase our liquid assets by investing in short-term, high-grade investments.

Liquidity
management is both a daily and long-term function of our strategy. Excess funds are generally invested in short-term investments. Excess
funds are typically generated as a result of increased deposit balances, while uses of excess funds are generally deposit withdrawals
and loan advances. In the event we require funds beyond our ability to generate them internally, additional funds are generally available
through the use of brokered deposits, FHLB advances, a line of credit with the FHLB, other borrowings or through sales of investment
securities. At December 31, 2023, we had an outstanding balance of $58.0 million against our line of credit with the FHLB. At December
31, 2023, we had collateral pledged to the FHLB that would allow us to borrow $153.1 million, subject to FHLB credit requirements and
policies. At December 31, 2023, we had no borrowings through the Federal Reserve discount window, while our borrowing capacity with the
Federal Reserve was $60.7 million. We also have various other federal funds agreements, both secured and unsecured, with correspondent
banks totaling approximately $30.0 million in available credit under which we had no outstanding borrowings at December 31, 2023. At
December 31, 2023, we had subordinated debentures totaling $21.7 million and $12.7 million of repurchase agreements. At December 31,
2023, the Company had no borrowings against a $5.0 million line of credit from an unrelated financial institution maturing on November
1, 2024, with an interest rate that adjusts daily based on the prime rate less 0.50%. This line of credit has covenants specific to capital
and other financial ratios, which the Company was in compliance with at December 31, 2023. The Company also borrowed $6.6 million from
the same unrelated financial institution at a fixed rate of 6.15%. This borrowing matures on September 1, 2027 and requires quarterly
principal and interest payments. The original balance of this borrowing was $10.0 million and was used to fund part of the acquisition
of Freedom.

OFF-BALANCE
SHEET ARRANGEMENTS. As a provider of financial services, we routinely issue financial guarantees in the form of financial and performance
standby letters of credit. Standby letters of credit are contingent commitments issued by us generally to guarantee the payment or performance
obligation of a customer to a third party. While these standby letters of credit represent a potential outlay by us, a significant amount
of the commitments may expire without being drawn upon. We have recourse against the customer for any amount the customer is required
to pay to a third party under a standby letter of credit. The letters of credit are subject to the same credit policies, underwriting
standards and approval process as loans made by us. Most of the standby letters of credit are secured, and in the event of nonperformance
by the customers, we have the right to the underlying collateral, which could include commercial real estate, physical plant and property,
inventory, receivables, cash and marketable securities. The contract amount of these standby letters of credit, which represents the
maximum potential future payments guaranteed by us, was $1.6 million at December 31, 2023.

At
December 31, 2023, we had outstanding loan commitments, excluding standby letters of credit, of $211.8 million. We anticipate that sufficient
funds will be available to meet current loan commitments. These commitments consist of unfunded lines of credit and commitments to finance
real estate loans.

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

The
Basel III Rule requires a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, a Tier 1 capital to risk-weighted
assets minimum ratio of 6.0%, a Total Capital to risk-weighted assets minimum ratio of 8.0%, and a Tier 1 leverage minimum ratio of 4.0%.
A capital conservation buffer, equal to 2.5% common equity Tier 1 capital, is also established above the regulatory minimum capital requirements
(other than the Tier 1 leverage ratio). At December 31, 2023, the Bank maintained a leverage ratio of 8.7% and a total risk-based capital
ratio of 13.7%. As shown by the following table, the Bank’s capital exceeded the minimum capital requirements in effect at December
31, 2023, including the capital conservation buffers.

46

[[GREPCENT_TABLE]]
[["","","Actual","","","Actual","","","Minimum","","","Minimum"],["(dollars in thousands)","","amount","","","percent","","","amount","","","percent(1)"],["Leverage","","$","134,422","","","","8.68","%","","$","61,951","","","","4.00","%"],["Common Equity Tier 1 Capital","","","134,422","","","","12.74","%","","","73,833","","","","7.00","%"],["Tier 1 Capital","","","134,422","","","","12.74","%","","","89,655","","","","8.50","%"],["Total risk-based Capital","","","144,468","","","","13.70","%","","","110,750","","","","10.50","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","The minimum required percent includes a capital conservation buffer of 2.5%."]]
[[/GREPCENT_TABLE]]

Banks
and bank holding companies are generally expected to operate at or above the minimum capital requirements. The Company’s and the
Bank’s ratios above are well in excess of regulatory minimums. As of December 31, 2023 and 2022, the Company and the Bank also
exceeded the “well capitalized” thresholds, which is the highest rating available. There are no conditions or events that
management believes have changed the Company’s and the Bank’s category as of the date of this report. We have $21.7 million
in trust preferred securities which, in accordance with current capital guidelines, have been included in total risk-based capital as
of December 31, 2023. Cash distributions on the securities are payable quarterly, are deductible for income tax purposes and are included
in interest expense in the consolidated financial statements.

DIVIDENDS

During
the year ended December 31, 2023, we paid quarterly cash dividends of $0.20 per share to our stockholders, as adjusted to give effect
to 5% stock dividends, which we distributed for the 23th consecutive year in December 2023. The 2022 quarterly cash dividends were $0.19
per share as adjusted to give effect to 5% stock dividends.

The
payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital
pursuant to applicable capital adequacy guidelines and regulations. As described above, the Bank exceeded its minimum capital requirements
under applicable guidelines as of December 31, 2023. The National Bank Act imposes limitations on the amount of dividends that a national
bank may pay without prior regulatory approval. Generally, the amount is limited to the bank’s current year’s net earnings
plus the adjusted retained earnings for the three preceding years. As of December 31, 2023, $12.9 million was available to be paid as
dividends to the Company by the Bank without prior regulatory approval.

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

EFFECTS
OF INFLATION

Our
consolidated financial statements and accompanying footnotes have been prepared in accordance with U.S. generally accepted accounting
principles (“GAAP”), which generally require the measurement of financial position and operating results in terms of historical
dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation
can be found in the increased cost of our operations because our assets and liabilities are primarily monetary, and interest rates have
a greater impact on our performance than do the effects of inflation.