# LANDMARK BANCORP INC (LARK) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from LANDMARK BANCORP INC's 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1141688/000149315223009718/form10-k.htm
Accession: 0001493152-23-009718
Filing date: 2023-03-30
Report date: 2022-12-31
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/fy2021/ (FY 2021)
Next year: /company/LARK/mda/fy2023/ (FY 2023)

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.

38

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."],["","\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 economic impact of past and any future terrorist attacks, acts of war, including the current conflict in 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, such as the implementation of CECL."],["","\u25cf","Our ability to effectively manage our credit risk."],["","\u25cf","Our ability to forecast probable loan losses and maintain an adequate allowance for loan 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.”

39

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.

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 loan 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 additional branch offices in
central, eastern, southeast and southwest Kansas, 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 loan losses
and business combinations, both of which involve significant judgment by our management.

We
perform periodic and systematic detailed reviews of our lending portfolio to assess overall collectability. The level of the allowance
for loan losses reflects our estimate of the incurred losses in our loan portfolio. While these estimates are based on substantive methods
for determining allowance requirements, actual outcomes may differ significantly from estimated results. Additional explanation of the
methodologies used in establishing this allowance is provided in the “Asset Quality and Distribution” section.

Accounting for business combinations
requires us to make estimates and assumptions to record the net assets acquired and liabilities assumed at fair value. Goodwill is recognized
for the excess purchase price over the estimated fair value of acquired net assets.

40

COMPARISON
OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2022 AND DECEMBER 31, 2021

SUMMARY
OF PERFORMANCE. Net earnings for 2022 decreased $8.1 million, or 45.2%, to $9.9 million as compared to $18.0 million for 2021. The
decrease in net earnings was primarily driven by lower gains on sales of loans, costs associated with the acquisition of Freedom and
losses on sales of investment securities. Gains on sales of one-to-four family residential real estate loans declined as a result of
higher interest rates and low housing inventories. During 2022, a loss of $1.1 million was recorded on the sales of investment securities
as the lowest yielding investment securities were strategically sold to reinvest into higher yielding assets.

Net
interest income for 2022 increased $560,000 to $38.9 million, or 1.5% higher than the $38.3 million recorded for 2021. The increase in
net interest income was primarily due higher income on our investment securities which increased as a result of higher yields and average
balances.

We
distributed a 5% stock dividend for the 22nd consecutive year in December 2022. All per share and average share data in this section
reflect the 2022 and 2021 stock dividends.

Interest
Income. Interest income for 2022 increased $3.4
million to $43.2 million, an increase of 8.5% as compared to 2021. Interest income on loans decreased $139,000, or 0.4%, to $33.5
million for 2022 as compared to $33.6 million in 2021, due primarily to a decline of $4.8 million in income on PPP loans. The yield
on PPP loans increased from 8.16% in 2021 to 16.86% in 2022, however, the higher yields were offset by lower average balances which
declined from $67.6 million in 2021 to $4.0 million in 2022. As of December 31, 2022, all but one PPP loan had been forgiven by the
SBA. Our average loan balances increased from $689.9 million in 2021 to $702.2 million in 2022 as growth in other loan types offset
the decline in PPP loans. Additionally, the accretion of purchase accounting on loans , which adjusted acquired loans to market
rates, increased by $435,000 in 2022, as compared to 2021, due to the acquisition of Freedom. Interest income on investment
securities increased $3.4 million, or 56.5%, to $9.4 million during 2022, as compared to $6.0 million in 2021. The increase in
interest income on investment securities was the result of higher yields on investment securities, which increased from 1.99% in
2021 to 2.15% in 2022. Higher market interest rates have positively impacted the yield on our investment securities portfolio as our
purchases yield more than maturities. Also contributing to the increased income was higher average balances, which increased from
$343.1 million in 2021 to $474.7 million in 2022.

Interest
Expense. Interest expense during 2022 increased
$2.8 million, or 188.6%, to $4.3 million as compared to 2021. Interest expense on interest-bearing deposits increased $1.8 million, or
171.4%, to $2.8 million for 2022 as compared to $1.0 million in 2021. Our total cost of interest-bearing deposits increased from 0.13%
during 2021 to 0.35% during 2022 primarily as a result of higher rates paid on money market and checking accounts. Most of the increases
in rates was related to accounts that have rates that reprice based on market indexes. Also contributing to the increase in interest
expense was an increase in average interest-bearing deposit balances, which increased from $765.5 million in 2021 to $804.1 million in
2022. Interest expense on borrowings increased $1.1 million, or 225.0%, to $1.6 million during 2022 as compared to $483,000 in 2021.
Contributing to higher interest expense on borrowings were higher average outstanding borrowings, which increased from $27.6 million
in 2021 to $50.0 million during 2022 and higher rates on those 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
2022, net interest income increased $560,000, or 1.5%, to $38.9 million compared to $38.3 million in 2021. Our net interest margin, on
a tax-equivalent basis, decreased to 3.21% during 2022 from 3.39% during 2021. Our net interest margin increased from 2.99% in the first
quarter of 2022 to 3.05% in the second quarter of 2022, 3.21% in the third quarter of 2022, and 3.53% in the fourth quarter of 2022
as our assets began to reprice faster than our cost of funds. Our net interest margin has been positively impacted by PPP loans over
the past three years, however, the impact of these loans on net interest margin going forward will be minimal. While the rise in interest
rates should result in higher yields on our assets, these improvements could be offset by increased competition for loans and deposits.
Additionally, the deposit balance increases we have seen over the past three years may reverse resulting in the need for higher cost
funding.

41

Provision
for Loan Losses. We maintain, and our Board of Directors
monitors, an allowance for losses on loans. The allowance is established based upon management’s periodic evaluation of known and
inherent risks in the loan portfolio, review of significant individual loans and collateral, review of delinquent loans, past loss experience,
adverse situations that may affect the borrowers’ ability to repay, current and expected market conditions, and other factors management
deems important. Determining the appropriate level of reserves involves a high degree of management judgment and is based upon historical
and projected losses in the loan portfolio and the collateral value or discounted cash flows of specifically identified impaired loans.
Additionally, allowance policies are subject to periodic review and revision in response to a number of factors, including current market
conditions, actual loss experience and management’s expectations.

During
2022, we did not recorded a provision for loan losses compared to a provision of $500,000 in 2021. We recorded net loan recoveries of
$16,000 during 2022 compared to net loan charge-offs of $500,000 during 2021.

Non-interest
Income. Total non-interest income was $13.7 million
in 2022, a decrease of $8.6 million, or 38.5%, compared to 2021. The decrease in non-interest income was primarily the result of decreases
of $7.0 million in gains on sales of loans, as originations of one-to-four family residential real estate loans declined due to lower
housing inventories and higher mortgage rates, which reduced refinancing activity. Also contributing to the decrease in non-interest
income was lower gains on sales of investment securities, which decreased to a loss of $1.1 million in 2022 from a gain of $1.1 million
in 2021. Partially offsetting those decreases was an increase of $794,000 in fees and service charges. The increase in fees and service
charges was primarily due to growth in deposit and loan servicing fees.

Non-interest
Expense. Non-interest expense increased $4.0 million,
or 10.8%, to $41.3 million in 2022 compared to $37.3 million in 2021. The increase was primarily due to $3.4 million in acquisition costs
related to the Freedom acquisition. Also contributing to the increase in non-interest expense were increases of $636,000 in occupancy
and equipment, an increase of $248,000 in compensation and benefits and $262,000 in other non-interest expense. These increases were
primarily due to the costs associated with operating a new branch facility acquired in the Freedom acquisition during the fourth quarter
of 2022. Offsetting those increases was a decrease of $436,000 in data processing expenses which was due to a new contract with our main
technology provider during 2022.

INCOME
TAXES. We recorded income tax expense of $1.4 million in 2022 compared to $4.8 million in 2021. The effective tax rate decreased
from 21.1% in 2021 to 12.7% in 2022, primarily due to lower earnings before income taxes. Also contributing to a decline in our effective
tax rate was the recognition of $465,000 of previously unrecognized tax benefits during 2022, which compared to an expense of $162,000
in 2021 related to an increase in accrued interest and penalties on unrecognized tax benefits.

FINANCIAL
CONDITION. Economic conditions in the United States slowed during 2022 as elevated inflation levels and higher interest rates impacted
the economy. The State of Kansas and the geographic markets in which the Company operates were also impacted by these economic headwinds.
Supply chain constraints, labor shortages and geopolitical events have contributed to the rising inflation levels which are impacting
all areas of the economy both nationally and locally. The Company’s allowance for loan losses included estimates of the economic
impact of these conditions and other qualitative factors on our loan portfolio. However, our loan portfolio is diversified across various
types of loans and collateral throughout the markets in which we operate. Aside from a few problem loans that management is working to
resolve, our asset quality has remained strong over the past few years. While further increases in problem assets may arise, management
believes its efforts to run a high quality financial institution with a sound asset base will continue to create a strong foundation
for continued growth and profitability in the future.

Asset
Quality and Distribution. Our primary investing activities
are the origination of one-to-four family residential real estate, construction and land, commercial real estate, commercial, agriculture,
municipal and consumer loans and the purchase of investment securities. Total assets increased $173.9 million or 13.1%, to $1.5 billion
at December 31, 2022, compared to $1.3 billion at December 31, 2021. The increase in our total assets was primarily the result of the
acquisition of Freedom. Investment securities available-for-sale increased $108.6 million, or 28.5%, from $380.7 million at December
31, 2021 to $489.3 million at December 31, 2022. Net loans, excluding loans held for sale, increased $187.9 million, or 28.8%, to $841.1
million at December 31, 2022, compared to $653.2 million at December 31, 2021. Partially offsetting those increases was a decrease of
$166.1 million, or 87.8%, in cash and cash equivalents, which decreased to $23.2 million at December 31, 2022 from $189.2 million at
December 31, 2021.

42

The
allowance for loan losses is established through a provision for loan losses based on our evaluation of the incurred losses in the loan
portfolio and changes in the nature and volume of our loan activity. This evaluation, which includes a review of all loans with respect
to which full collectability may not be reasonably assured, considers the fair value of the underlying collateral, economic conditions,
historical loan loss experience, level of classified loans and other factors that warrant recognition in providing for an appropriate
allowance for loan losses. At December 31, 2022, our allowance for loan losses totaled $8.8 million, or 1.03% of gross loans outstanding,
compared to $8.8 million, or 1.25% of gross loans outstanding, at December 31, 2021. The decline in our allowance for loan losses as
a percentage of gross loans outstanding was primarily due to a decline in non-accrual and classified loans, as well as acquired loans
which were recorded at fair value on the acquisition date of October 1, 2022.

As
of December 31, 2022 and 2021, approximately $13.0 million and $18.0 million, respectively, of loans were considered classified and assigned
a risk rating of special mention, substandard or doubtful. The decrease in classified loans was primarily due to improvements in the
agriculture industry. 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
the risks and probable incurred losses related to such loans at December 31, 2022 and 2021, respectively.

Loans
past due 30-89 days and still accruing interest totaled $738,000, or 0.09% of gross loans, at December 31, 2022, compared to $2.0 million,
or 0.30% of gross loans, at December 31, 2021. At December 31, 2022, $3.3 million of loans were on non-accrual status, or 0.39% of gross
loans, compared to $5.2 million, or 0.79% of gross loans, at December 31, 2021. Non-accrual loans consist of loans 90 or more days past
due and certain impaired loans. There were no loans 90 days delinquent and accruing interest at December 31, 2022 and 2021. Our impaired
loans totaled $4.1 million December 31, 2022 compared to $6.7 million at December 31, 2021. The difference in the Company’s non-accrual
loan balances and impaired loan balances at December 31, 2022 and December 31, 2021 was related to TDRs that were accruing interest but
still classified as impaired.

At
December 31, 2022, the Company had 8 loan relationships consisting of 12 outstanding loans totaling $2.5 million that were classified
as TDRs compared to 11 loan relationships consisting of 16 outstanding loans totaling $3.4 million that were classified as TDRs at December
31, 2021.

During
2022, a $231,000 commercial loan was classified as a TDR after the loan was renewed with payments restructured to match the borrower’s
cash flows. During 2022, commercial loans totaling $479,000, $32,000 and $7,000 paid off after being classified as TDRs in 2022, 2021
and 2020, respectively. Also during 2022, two construction and land loans totaling $599,000 were paid off. These loans were originally
classified as TDRs in 2012. Additionally, the Company advanced funds on a construction and land loan which was originally classified
as a TDR in 2012. The customer had paid off the balances on the construction loan during 2021, before borrowing again in 2022. The loan
is still classified as a TDR with $431,000 of charged off principal remaining from the original amount of $708,000. An agriculture loan
totaling $250,000 was also paid off in 2022 after being classified as a TDR in 2021.

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, 2022, we had $934,000 of real estate owned compared to
$2.6 million at December 31, 2021. The decrease in real estate owned as of December 31, 2022 compared to December 31, 2021 was
primarily due to sale of commercial real estate and a valuation allowance recorded against another commercial real estate property.
As of December 31, 2022, 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 $152.2 million, or 13.2% in total deposits during 2022, to $1.3 billion at December 31, 2022, from $1.1 billion at December 31, 2021.
The increase in deposits was primarily due to the Freedom acquisition.

43

Total
borrowings increased $39.2 million, or 134.9%, to $68.3 million at December 31, 2022, from $29.1 million at December 31, 2021. The increase
in borrowings was primarily due to $22.2 million of repurchase agreements assumed in the Freedom acquisition and borrowings used to finance
the purchase.

Non-interest-bearing
deposits at December 31, 2022, were $410.1 million, or 31.5% of deposits, compared to $350.0 million, or 30.5% of deposits, at December
31, 2021. Money market and checking accounts were 48.2% of our deposit portfolio and totaled $626.7 million at December 31, 2022, compared
to $536.9 million, or 46.8% of deposits, at December 31, 2021. Savings accounts increased to $170.6 million, or 13.1% of deposits, at
December 31, 2022, from $155.5 million, or 13.5% of deposits, at December 31, 2021. Certificates of deposit totaled $93.3 million, or
7.2% of deposits, at December 31, 2022, compared to $106.1 million, or 9.2% of deposits, at December 31, 2021. 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, 2022, scheduled to mature in one year or less totaled $78.4 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 2022, our cash and cash equivalents decreased by $166.1 million. Our operating activities provided net cash of $24.8
million in 2022, 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 $197.2 million during 2022, primarily for the purchase of investment securities. Our financing activities
provided net cash of $6.3 million during 2022, primarily as a result of an increase in borrowings.

Liquidity.
Our most liquid assets are cash and cash equivalents
and investment securities available-for-sale. The levels of these assets are dependent on the operating, financing, lending and investing
activities during any given year. These liquid assets totaled $521.5 million at December 31, 2022 and $577.3 million at December 31,
2021. During periods in which we are not able to originate a sufficient amount of loans and/or periods of high principal prepayments,
we generally increase our liquid assets by investing in short-term, high-grade investments.

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, 2022, we had an outstanding balance of $8.2 million against our line of credit with the FHLB. At December
31, 2022, we had collateral pledged to the FHLB that would allow us to borrow $101.8 million, subject to FHLB credit requirements and
policies. At December 31, 2022, we had no borrowings through the Federal Reserve discount window, while our borrowing capacity with the
Federal Reserve was $65.4 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, 2022. At
December 31, 2022, we had subordinated debentures totaling $21.7 million and $29.4 million of repurchase agreements. At December 31,
2022, the Company had no borrowings against a $5.0 million line of credit from an unrelated financial institution maturing on November
1, 2023, with an interest rate that adjusts daily based on the prime rate less 0.50%. This line of credit has covenants specific to capital
and other financial ratios, which the Company was in compliance with at December 31, 2022. The Company also borrowed $9.0 million from
the same unrelated financial institution at a fixed rate of 6.15%. This borrowing matures on September 1, 2027 and requires quarterly
principal and interest payments. The original 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 $2.7 million at December 31, 2022.

44

At
December 31, 2022, we had outstanding loan commitments, excluding standby letters of credit, of $183.5 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, 2022, the Bank maintained a leverage ratio of 8.14% and a total risk-based capital
ratio of 13.44%. As shown by the following table, the Bank’s capital exceeded the minimum capital requirements in effect at December
31, 2022, including the capital conservation buffers.

[[GREPCENT_TABLE]]
[["","","Actual","","","Actual","","","Minimum","","","Minimum"],["(dollars in thousands)","","amount","","","percent","","","amount","","","percent(1)"],["Leverage","","$","122,275","","","","8.14","%","","$","60,100","","","","4.00","%"],["Common Equity Tier 1 Capital","","","101,275","","","","10.37","%","","","68,352","","","","7.00","%"],["Tier 1 Capital","","","122,275","","","","12.52","%","","","82,999","","","","8.50","%"],["Total risk-based Capital","","","131,236","","","","13.44","%","","","102,528","","","","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, 2022 and 2021, 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, 2022. 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, 2022, 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 22nd consecutive year in December 2022. The 2021 quarterly cash dividends were $0.18
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, 2022. The National Bank Act imposes limitations on the amount of dividends that a national
bank may pay without prior regulatory approval. Generally, the amount is limited to the bank’s current year’s net earnings
plus the adjusted retained earnings for the two preceding years. As of December 31, 2022, $7.7 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.

45

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.