LANDMARK BANCORP INC annual report, FY2016

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Landmark Bancorp, Inc. — 2016 Form 10-K

Reporting period: Fiscal year ended December 31, 2016. Landmark is a Kansas bank holding company whose sole banking subsidiary is Landmark National Bank, operating 29 branches in Kansas. Financial statements are audited; the auditor gave an unqualified opinion.

Financial performance and position

  • Earnings: Net earnings were $9.0 million, down 14.7% from $10.5 million in 2015. Diluted EPS was $2.31 versus $2.77. Interest income was $29.2 million; non-interest income was $14.9 million.
  • Interest income and margins: Net interest income increased 0.5% to $26.0 million, while tax-equivalent net interest margin declined to 3.45% from 3.51%. Average interest-earning assets grew 2.9%; their average yield declined to 3.84% from 3.90%.
  • Expenses and credit costs: Non-interest expense was $29.1 million, essentially flat year over year. The company recorded a $500,000 loan-loss provision, compared with a $700,000 provision credit in 2015. Net charge-offs were $1.1 million in 2016.
  • Assets and loans: Total assets grew 3.8% to $911.4 million. Net loans were $420.5 million, nearly unchanged; gross loans were $425.8 million. Investment securities available-for-sale rose to $385.6 million from $353.4 million.
  • Deposits, debt, and liquidity: Deposits increased 3.7% to $741.5 million, with growth in non-interest-bearing, checking/money-market, and savings balances. Borrowings totaled $72.9 million, including $39.1 million of FHLB advances, $21.3 million of subordinated debentures, and $12.5 million of other borrowings. Cash and available-for-sale securities totaled $405.6 million. The company reported $38.7 million of available FHLB borrowing capacity, $16.0 million of Federal Reserve capacity, and about $30.0 million of correspondent-bank lines, subject to stated conditions.
  • Cash flows: Operating activities provided $19.0 million; investing activities used $40.3 million, mainly for net securities purchases; financing activities provided $27.7 million, primarily from deposit growth. Cash and cash equivalents increased $6.4 million to $20.0 million.
  • Capital and returns: Stockholders’ equity was $85.0 million, or 9.32% of assets. The company’s total risk-based capital ratio was 18.46%; the Bank’s was 18.31%. Both were reported well-capitalized. Return on average assets was 1.00% and return on average equity 10.34%, down from 1.21% and 13.81%, respectively, in 2015.

Material changes versus 2015

  • Net earnings fell mainly because gains on loan sales declined $2.5 million as mortgage origination and sales volumes decreased following the departure of several mortgage lenders. Non-interest income fell 12.7% to $14.9 million.
  • Net interest income rose modestly on asset growth, but margin compressed as loan yields eased and funding costs increased. Management said it did not expect near-term margin improvement and warned it could decline further.
  • Asset quality was mixed: non-accrual loans increased to $2.7 million, or 0.64% of gross loans, from $2.2 million, or 0.51%; non-performing assets rose to $4.0 million, or 0.44% of assets, from $3.2 million, or 0.36%. The allowance declined to $5.3 million, or 1.26% of gross loans, from $5.9 million, or 1.39%.
  • Gross unrealized losses on available-for-sale securities increased to $4.2 million from $1.1 million. Other comprehensive income was a loss of $3.5 million, and accumulated other comprehensive income moved from positive $2.2 million to a loss of $1.3 million, largely reflecting securities valuation changes.
  • The effective tax rate declined to 20.5% from 27.1%. Early adoption of stock-compensation accounting guidance reduced 2016 tax expense by $308,000.

Outlook, risks, and unusual items

  • Management outlook: The Bank seeks growth in commercial, commercial real estate, and agricultural lending while maintaining credit standards. Management cited slow loan demand, economic weakness in Kansas agriculture, and low commodity prices as constraints; lower commodity prices have affected agricultural borrowers’ cash flows and collateral values.
  • Key risks: Interest-rate sensitivity, competition for loans and deposits, Kansas market concentration, agricultural and real-estate credit exposure, cybersecurity and operational risks, regulatory changes, and potential limits on funding or capital. Real-estate loans represented about 63.1% of gross loans; municipal securities were about 60.5% of the securities portfolio.
  • Rate sensitivity: The company’s one-year simulation estimated net interest income declines of 3.4% for a 100-basis-point rate increase and 6.6% for a 200-basis-point increase; a 100-basis-point decline was estimated to reduce it 1.0%.
  • Credit items: Higher non-accrual balances were primarily attributed to agricultural loans. The company recorded $1.1 million of net charge-offs, including an agricultural relationship, and reported $16.6 million of classified loans. Management considered the allowance adequate. The company also continued pursuing collection on a previously charged-off construction loan, having recovered about $2.4 million to date.
  • Other items: The company distributed a 5% stock dividend for the 16th consecutive year and paid cash dividends of $0.76 per share for 2016. It reported no material pending litigation. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not attest to internal controls. The company anticipated CECL adoption would increase its allowance, but the amount was uncertain.

Important facts for investors to verify

  • Whether mortgage production and loan-sale gains recover after the 2016 departure of mortgage lenders.
  • Trends in agricultural credit quality, non-accrual loans, classified loans, charge-offs, and allowance adequacy.
  • Whether deposit growth persists and how the $100.1 million of time deposits scheduled to mature in 2017 renews or reprices.
  • How interest-rate movements affect net interest margin, earnings, and the fair value of the securities portfolio.
  • The composition and valuation sensitivity of the municipal securities portfolio, and the effect of unrealized losses on equity.
  • The eventual allowance and implementation costs associated with CECL, and the availability of borrowing capacity under applicable collateral and lender requirements.