S-1/A: Security Midwest Bancorp Launches Stock Offering

Security Midwest Bancorp, Inc. is offering up to 1,322,500 shares at $10.00 each in connection with Security Bank's mutual-to-stock conversion, aiming to boost capital and expand lending.

Summary

• Security Midwest Bancorp, Inc., the proposed holding company for Security Bank, s.b., is offering between 850,000 and 1,150,000 shares of common stock at $10.00 per share, with a potential increase to 1,322,500 shares due to demand or market conditions.
• The offering is part of Security Bank's conversion from a mutual to a stock form of organization, with estimated net proceeds ranging from $7.15 million to $11.875 million.
• At least 85% of the net proceeds will be contributed to Security Bank to enhance financial strength, support lending and deposit growth, and facilitate withdrawal from a multiple-employer defined benefit pension plan.
• The pension plan withdrawal is estimated to result in a $1.4 million pre-tax charge and a $1.0 million decrease in equity/regulatory capital, but is expected to generate annual pre-tax cost savings of $156,000.
• Security Bank's business strategy includes growing its loan portfolio (especially commercial real estate and commercial & industrial loans), increasing operating efficiencies, and modestly expanding its Cannabis-Related Business (CRB) Program.
• At December 31, 2024, CRB deposits were approximately $58.6 million (29.4% of total deposits), and CRB loan balances were $23.3 million (20.4% of total loans); CRB fee income for 2024 was $958,000 (48.5% of noninterest income).
• For the year ended December 31, 2024, Security Bank reported total assets of $214.5 million, total deposits of $199.4 million, total equity of $14.0 million, and net income of $683,000.
• For the three months ended March 31, 2025, net income increased by 48.9% to $402,000 compared to $270,000 for the same period in 2024, with non-performing loans to total loans improving to 0.78% from 3.39% year-over-year.
• The offering is expected to expire on June 20, 2025, but may be extended with regulatory approval.

Sentiment

Score: 6

Explanation: The filing outlines a strategic mutual-to-stock conversion and capital raise, supported by recent improvements in net income, asset quality, and efficiency. However, significant risks related to the concentration of the CRB program, the initial financial impact of the pension plan withdrawal, and expected dilution for shareholders temper the overall positive sentiment. The pro forma valuation also indicates a discount to peers, suggesting a cautious market outlook.

Positives

• The capital raise will enhance financial strength and support existing and future lending and deposit growth.
• Increased commercial lending capacity will enable the company to originate more commercial real estate and commercial and industrial loans, and serve larger commercial borrowers.
• Withdrawal from the multiple-employer defined benefit pension plan is expected to result in annual pre-tax cost savings of $156,000.
• Net income for the three months ended March 31, 2025, increased by 48.9% to $402,000 compared to $270,000 for the same period in 2024.
• Asset quality significantly improved, with non-performing loans as a percentage of total loans decreasing to 1.08% at December 31, 2024, from 3.73% at December 31, 2023, and further to 0.78% at March 31, 2025.
• The allowance for credit losses as a percentage of non-performing loans improved to 94.32% at December 31, 2024, and 129.13% at March 31, 2025, indicating better coverage of potential losses.
• The efficiency ratio improved to 76.46% for the three months ended March 31, 2025, from 80.97% for the same period in 2024, indicating better cost control.
• Interest rate spread increased to 3.00% and net interest margin increased to 3.74% for the three months ended March 31, 2025, compared to the prior year period.
• The strategic focus on modestly growing the CRB Program and increasing core deposits provides a stable, low-cost funding source and fee income.

Negatives

• A significant portion of noninterest income (48.5% for 2024) is derived from CRB fees, posing a concentration risk if federal enforcement changes or the industry faces adverse conditions.
• One individual CRB customer accounted for 16.0% of total deposits at December 31, 2024, creating a significant deposit concentration risk.
• The estimated $1.4 million pre-tax charge and $1.0 million decrease in equity/regulatory capital from the pension plan withdrawal will negatively impact financial results.
• Operating expenses are expected to increase due to costs associated with operating as a public company and the implementation of stock-based benefit plans.
• Stockholders will experience dilution from the employee stock ownership plan (7% of shares sold) and future stock-based benefit plans (up to 13% total).
• The return on equity is expected to remain low initially until the additional capital from the offering is fully deployed.
• A limited trading market for the common stock is anticipated, which could hinder liquidity and impact the market price.
• There is no initial intention to pay cash dividends on the common stock.
• Pro forma pricing ratios at the midpoint of the offering range indicated a significant discount (e.g., 39.0% on price-to-book value) compared to the peer group averages.
• Unrealized losses on available-for-sale investment securities totaled $6.6 million at December 31, 2024, and $5.5 million at March 31, 2025.
• The increase in certificates of deposit has led to a higher cost of funds, which could continue in the future.

Risks

• Strict enforcement of federal laws regarding cannabis could result in the inability to continue the CRB Program, adversely affecting financial condition and results of operations.
• Adverse changes to FinCEN guidance or federal enforcement priorities regarding cannabis could require immediate termination of CRB activities.
• The cannabis industry is relatively new, highly competitive, and faces strong opposition, which could adversely affect CRB customers and demand for cannabis products.
• A significant amount of deposits are held by one CRB customer (16.0% of total deposits), and a material reduction in this balance could restrict future growth and adversely affect financial condition.
• The actual cost of withdrawing from the multiple-employer defined benefit pension plan may be greater than the estimated $1.4 million pre-tax charge.
• Increasing origination of commercial real estate and commercial and industrial loans involves higher credit risks, larger potential losses, and dependence on successful business operations.
• The geographic concentration of the loan portfolio in Sangamon County, Illinois, makes the company vulnerable to local economic downturns.
• The allowance for credit losses may not be sufficient to cover actual loan losses, potentially requiring future additions and decreasing earnings.
• Uncertainties associated with increased commercial loan originations may result in errors in judging collectability due to limited borrower experience.
• The level of commercial real estate loan portfolio (303% of total capital at Dec 31, 2024) may subject the company to additional regulatory scrutiny and potential restrictions.
• Emphasis on real estate loans exposes the company to lending risks from declines in real estate values.
• The protracted judicial foreclosure process may adversely impact recoveries on non-performing loans.
• Environmental liability risk is associated with lending activities or properties owned through foreclosure.
• Future changes in interest rates could negatively affect operating results and asset values, with a 200 basis point decrease in rates estimated to cause a 17.4% decrease in Economic Value of Equity (EVE) and a 9.4% decrease in net interest income.
• Failure to grow the loan portfolio or manage growth effectively could negatively affect financial condition and results of operations.
• Dependence on the management team and other key personnel means loss of their services or inability to hire additional personnel could harm the business.
• Strong competition within market areas from larger financial institutions and non-bank entities may limit growth and profitability.
• The company's smaller size may make it more difficult to compete effectively with larger institutions in terms of marketing, technology, and compensation.
• Changes in laws and regulations, and the cost of regulatory compliance, may adversely affect operations and increase costs.
• Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws could result in fines or sanctions.
• Stringent capital requirements may adversely impact return on equity, require additional capital, or limit dividend payments or share repurchases.
• The Federal Reserve Board may require the company to commit capital resources to support Security Bank, which may not be readily available.
• Inability to raise additional capital in the future on acceptable terms could impair expansion and growth strategy.
• Monetary policies and regulations of the Federal Reserve Board could adversely affect business, financial condition, and results of operations.
• Reliance on reduced reporting and disclosure requirements as an emerging growth company and smaller reporting company could make common stock less attractive to investors.
• Inflation can have an adverse impact on the business and customers, increasing operating costs and potentially affecting loan repayment ability.
• A worsening of economic conditions could reduce demand for products/services and/or increase non-performing loans.
• Significant operational risks exist due to reliance on technology, including potential failures, interruptions, or security breaches.
• Reliance on third-party vendors for key business infrastructure exposes the company to additional cybersecurity and operational risks.
• Risks and losses from fraudulent activities could adversely impact financial performance.
• The cost of additional finance and accounting systems, procedures, and controls to satisfy public company reporting requirements will increase expenses.
• Funding sources may prove insufficient to replace deposits at maturity and support future growth, potentially leading to liquidity issues.
• Higher levels of certificates of deposit have significantly increased the cost of funds and could continue to do so.
• Changes in accounting standards could affect reported earnings, potentially retroactively.
• Changes in management's estimates and assumptions (e.g., allowance for credit losses, deferred tax assets, fair value measurements) may materially impact financial statements.
• Legal and regulatory proceedings could adversely affect the company's business, brand, or financial condition.
• Failure to maintain the company's reputation as a community bank could materially adversely affect performance.
• The State of Illinois' financial difficulties could adversely impact certain borrowers and the economic vitality of the state.
• Severe weather, natural disasters, and other external events could significantly affect operations and results.
• The future price of common stock may be less than the $10.00 purchase price in the offering.
• Broad discretion in using the proceeds of the stock offering; failure to effectively deploy net proceeds may have an adverse effect on financial performance.
• A limited trading market in common stock is expected, which would hinder the ability to sell shares and may lower the market price.
• The capital raised in the stock offering may negatively impact return on equity until the business plan is fully implemented.
• Stock-based benefit plans will increase expenses and are likely to dilute ownership interest.
• Various factors, including provisions in articles of incorporation and bylaws and federal banking laws, may make takeover attempts more difficult.
• A significant percentage of common stock will be held by directors, executive officers, and benefit plans, potentially limiting public float.
• Federal regulations restrict takeovers for three years following the conversion, which may negatively affect stock value.
• The company may take additional steps, such as increasing purchase limitations or extending the offering, if the minimum number of shares is not sold.
• Orders to purchase common stock in the subscription or community offerings are irrevocable unless specific conditions are met.
• The distribution of subscription rights could have adverse income tax consequences if deemed to have an ascertainable value.

Future Outlook

The company anticipates increasing net interest income by effectively deploying the proceeds from the stock offering, primarily into commercial real estate and commercial and industrial loans. It aims to improve its efficiency ratio and modestly grow its Cannabis-Related Business (CRB) Program. However, the return on equity is expected to remain low initially due to increased expenses associated with operating as a public company and the implementation of stock-based benefit plans. The company also plans to withdraw from its defined benefit pension plan, expecting annual cost savings after an initial charge.

Management Comments

• "We believe that our community orientation and personal service distinguishes us from larger banks that operate in our market area."
• "Our low-cost source of funds obtained through our CRB Program provides us with cash to originate higher levels of loans."
• "We believe that we can enhance our net income by controlling our operating expenses while still maintaining quality control over our operations and concurrently expanding the products and services we offer to customers."
• "We believe that our smaller size allows us to be more responsive to the needs of our customers, both with respect to engaging in new business activities and with respect to customer service and responsiveness."
• "We believe that maintaining strong asset quality is paramount to our long-term success."
• "We intend to take steps to improve our efficiency ratio going forward, providing for related increases in net income due to reduced noninterest expense as a percentage of total interest income and noninterest income."
• "We intend to continue to grow this program modestly going forward."
• "We believe the current general economic conditions in our primary market area are healthy and stable."
• "Management believes that we have good working relations with our employees."

Industry Context

The banking and financial services industry is highly competitive, with numerous commercial banks, savings institutions, credit unions, and non-banking entities operating in Security Bank's market area. Many larger competitors possess greater resources and offer a broader range of services. The company's CRB Program operates in a relatively new and evolving industry, subject to significant regulatory uncertainty and potential competition from larger, well-funded businesses if cannabis legality is enhanced. The company aims to differentiate itself through community orientation and personal service, leveraging its smaller size for responsiveness, while also investing in technology to expand products and services.

Comparison to Industry Standards

• Pro forma pricing ratios at the midpoint of the offering range indicated a discount of 39.0% on a price-to-book value basis compared to the peer group average.
• Pro forma pricing ratios at the midpoint of the offering range indicated a discount of 40.69% on a price-to-tangible book value basis compared to the peer group average.
• Pro forma pricing ratios at the midpoint of the offering range indicated a discount of 46.2% on a price-to-core earnings basis compared to the peer group average.
• The average asset size of the peer group ($641.2 million) significantly exceeded Security Bank's asset size ($214.5 million as of December 31, 2024).
• The independent appraiser made downward adjustments for Security Midwest Bancorp's financial condition (lower pro forma capital, higher historical non-performing assets), liquidity of the stock issue (lower shares outstanding, lower market capitalization), and marketing of the issue (stock market volatility) compared to the peer group.
• Peer group companies included BV Financial, Inc. ($911.8 million), Catalyst Bancorp, Inc. ($276.7 million), Central Plains Bancshares, Inc. ($484.3 million), Home Federal Bancorp, Inc. of Louisiana ($607.8 million), IF Bancorp, Inc. ($885.1 million), Magyar Bancorp, Inc. ($1,008.4 million), NSTS Bancorp, Inc. ($278.7 million), PB Bankshares, Inc. ($451.3 million), SR Bancorp, Inc. ($1,064.5 million), and Texas Community Bancshares, Inc. ($443.4 million).

Management Changes

Corporate Governance

Legal Proceedings

• Not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. No legal proceedings are expected to have a material effect on financial condition or results of operations.

Related Party Transactions

• Aggregate loans outstanding to executive officers, directors, and their related interests totaled $8.5 million at December 31, 2024.
• All related party loans were made in the ordinary course of business on substantially the same terms as for unaffiliated third parties and did not involve more than normal risk.
• Deposits from related parties totaled approximately $9.881 million at December 31, 2024.
• Security Bank paid $18,141 to lease parking spaces from a company majority-owned by Director Myers for the year ended December 31, 2024.
• Commercial loans were made to entities with minority ownership by Director Kopecky and entities controlled by Director Marriott, and residential and commercial loans to Director Stone and her affiliates, all on market terms.

Stakeholder Impact

• Shareholders: Opportunity to acquire an ownership interest in a newly public company, potential for long-term growth from capital deployment, but face potential dilution from stock-based benefit plans and a likely limited trading market for the stock. Anti-takeover provisions may limit the ability to realize a premium in a change of control event.
• Depositors: Continuity of deposit accounts, interest rates, and FDIC insurance. Eligible depositors will receive an interest in a liquidation account in the unlikely event of Security Bank's liquidation post-conversion.
• Employees and Management: Opportunity to participate in an Employee Stock Ownership Plan (ESOP) and future stock-based benefit plans, providing incentives and aligning interests with shareholders. Key executives have employment agreements to ensure management stability.
• Customers: Continued access to existing financial products and services, with plans to enhance and expand offerings, including the CRB Program. The capital raise is intended to support increased lending capacity.
• Creditors: Enhanced financial strength and regulatory capital of Security Bank due to the capital infusion from the offering, potentially improving creditworthiness.

Next Steps

• A special meeting of members is scheduled for June 23, 2025, to approve the plan of conversion.
• The stock offering is expected to be completed as soon as practicable after the registration statement becomes effective.
• Security Midwest Bancorp will register as a bank holding company upon completion of the conversion.
• Security Bank intends to withdraw from the multiple-employer defined benefit pension plan, with an anticipated withdrawal date no sooner than June 30, 2025.
• One or more stock-based benefit plans are intended to be implemented after the completion of the conversion, subject to stockholder approval and regulatory restrictions (not sooner than six months post-conversion).
• Feldman Financial Advisors, Inc. will update its appraisal before the completion of the conversion and offering.

Key Dates

Recommendation

The mutual-to-stock conversion and capital raise are strategic moves designed to enhance Security Bank's financial strength, support growth initiatives, and provide management incentives. Recent financial performance shows positive trends in net income, asset quality, and efficiency, particularly in the most recent quarter. However, the company faces notable risks, including a high concentration in the cannabis banking sector, the initial financial impact of the pension plan withdrawal, and expected dilution from stock-based plans. The pro forma valuation indicates a substantial discount to its peer group, suggesting that the market may not immediately value the stock at a premium. A 'hold' recommendation is appropriate to observe the successful deployment of capital, effective management of CRB-related risks, and the company's ability to improve its efficiency and profitability metrics in a competitive environment before considering a stronger position.

Keywords

Mutual-to-stock conversion, Security Midwest Bancorp, Security Bank, Common stock offering, Banking, Financial services, Cannabis banking, CRB program, Commercial real estate loans, Commercial and industrial loans, Regulatory capital, Financial performance, Risk management, Corporate governance, Illinois, Springfield, OTCQB