10-Q: Security Midwest Bancorp Q3: Equity Soars Post-Conversion

Security Midwest Bancorp reports mixed Q3 results with a net income decrease, but a significant increase in shareholder equity following its stock conversion and strategic investment restructuring.

Summary

• Net income for the three months ended September 30, 2025, decreased by $90,000 (24.3%) to $281,057 compared to the same period in 2024.
• Net income for the nine months ended September 30, 2025, increased by $124,000 (13.7%) to $1,032,150 compared to the same period in 2024.
• Total assets decreased by $10.7 million (5.0%) to $203.9 million at September 30, 2025, from $214.5 million at December 31, 2024.
• Shareholders' equity significantly increased by $9.3 million (66.5%) to $23.2 million at September 30, 2025, primarily due to the completion of a common stock offering, which generated $6.7 million in net proceeds.
• Total deposits decreased by $19.6 million (9.8%) to $179.8 million at September 30, 2025, with a notable $13.4 million decrease in cannabis-related business (CRB) deposits.
• The company completed its conversion from a mutual to a stock form of organization on July 31, 2025, with its common stock beginning to quote on the OTCQB Market on August 1, 2025, under the symbol "SBMW".
• A strategic initiative was launched in October 2025 to restructure the investment securities portfolio, involving the sale of $8.0 million in lower-yielding securities at a $419,000 pretax loss, and a commitment to borrow up to $40.0 million from the FHLB to purchase higher-yielding securities.

Sentiment

Score: 7

Explanation: The company demonstrated strong capital growth through its stock conversion and improved net interest income and asset quality. However, the quarterly net income decline and significant deposit outflow, particularly from CRB accounts, present areas of concern. Strategic moves to restructure investments and grow specific loan segments indicate proactive management.

Positives

• Net income for the nine months ended September 30, 2025, increased by $124,000 (13.7%) to $1,032,150.
• Shareholders' equity increased substantially by $9.3 million (66.5%) to $23.2 million, driven by the $6.7 million net proceeds from the common stock offering.
• Net interest income increased by $149,000 (8.2%) for the three months and $627,000 (12.0%) for the nine months ended September 30, 2025, due to higher loan yields and lower deposit interest expense.
• The average yield on loans increased by 28 basis points to 6.75% for the three months and 53 basis points to 6.56% for the nine months ended September 30, 2025.
• The average cost of deposits decreased by 64 basis points to 1.75% for the three months and 40 basis points to 1.79% for the nine months ended September 30, 2025.
• Asset quality improved significantly, with nonperforming loans decreasing by $552,563 to $679,350 and loans past due 30 days or greater decreasing by $1.08 million to $509,454 at September 30, 2025, compared to December 31, 2024.
• The allowance for credit losses as a percentage of nonperforming loans increased to 169.4% at September 30, 2025, from 94.3% at December 31, 2024, indicating stronger coverage.
• No provision for credit losses was recorded for the three months ended September 30, 2025, and the provision for the nine months decreased by $19,134 (68.6%) to $8,750.
• Loan originations for the nine months ended September 30, 2025, increased by $6 million (28.6%) to $27 million.
• The company maintains a "well capitalized" status under regulatory guidelines.

Negatives

• Net income for the three months ended September 30, 2025, decreased by $90,000 (24.3%) to $281,057.
• Total assets decreased by $10.7 million (5.0%) to $203.9 million at September 30, 2025.
• Cash and cash equivalents decreased by $8.7 million (20.1%) to $34.8 million.
• Total deposits decreased by $19.6 million (9.8%) to $179.8 million, including a $13.4 million decrease in CRB deposits.
• Interest income decreased by $93,000 (3.6%) for the three months ended September 30, 2025, primarily due to lower interest on investment securities and interest-bearing deposits.
• Noninterest income decreased by $11,000 (2.4%) for the three months ended September 30, 2025, mainly due to lower service fees on deposits.
• Noninterest expense increased by $265,000 (14.7%) for the three months and $495,000 (9.2%) for the nine months ended September 30, 2025, largely due to increased salaries and employee benefits.
• The subsequent event of restructuring the investment portfolio resulted in a $419,000 pretax loss on sale of securities in October 2025.
• The Bank intends to withdraw from a multi-employer defined benefit plan, which will require an estimated payment of $1.4 million to be recorded as a current period expense when paid.

Risks

• General economic conditions, including potential recessionary conditions and/or increases in unemployment, could adversely affect financial performance.
• Adverse changes in the financial services industry, securities, and local real estate markets (including real estate values) pose a risk.
• The ability to access cost-effective funding and maintain adequate liquidity is crucial, especially given recent deposit decreases.
• Significant increases in loan losses, including the inability to resolve classified and non-performing assets, could impact financial health.
• Credit risks associated with lending activities, including changes in loan delinquencies and write-offs, and the adequacy of the allowance for credit losses.
• Inflation and changes in the interest rate environment could reduce margins and yields, impact the fair value of financial instruments, or increase loan defaults.
• A high concentration of loans secured by real estate located in the company's market area makes it susceptible to local economic downturns.
• Changes in laws or government regulations or policies affecting financial institutions, including those related to the cannabis industry, could impact operations.
• The ability to control costs and expenses, particularly those associated with operating as a public reporting company, is a challenge.
• Failure or breach of operational or security systems or infrastructure, including cyberattacks, presents a significant threat.

Future Outlook

The company intends to continue its strategy of growing its loan portfolio, with a focus on owner-occupied one-to-four family residential real estate loans and commercial loans. It also aims to increase its core deposit base, emphasizing consumer and business demand deposits through enhanced products and services, including mobile banking and expanded CRB services. A recent strategic move involves restructuring the investment securities portfolio by selling lower-yielding assets and reinvesting in higher-yielding ones, partially funded by a $40.0 million FHLB borrowing, with an anticipated recovery of the initial loss within 18 months through enhanced yields.

Management Comments

• "Our strategy is to grow our loan portfolio, with a focus on owner-occupied oneto four-family residential real estate loans and commercial loans (both commercial real estate and commercial and industrial)."
• "We intend to continue our efforts to increase our core deposit base, with an emphasis on growth in consumer and business demand deposits."
• "Management believes the declines in fair value for these securities are not attributable to credit related events."
• "The Bank expects to recover the amortized cost basis over the term of the securities."
• "Management believes, as of September 30, 2025, that the Bank met all capital adequacy requirements to which it is subject."
• "There are no conditions or events since that notification that management believes have changed the Bank's category [as well capitalized]."

Industry Context

The banking sector is navigating a dynamic interest rate environment. Security Midwest Bancorp's increase in loan yields and decrease in deposit costs, leading to improved net interest margin, suggests effective asset/liability management in a rising rate or stable-high rate environment. The strategic shift to higher-yielding securities and leveraging FHLB advances indicates an active approach to optimizing returns on its investment portfolio, a common strategy among banks seeking to enhance profitability amidst market shifts. The focus on commercial and industrial lending, alongside residential real estate, aligns with broader trends of banks diversifying their loan portfolios. The continued engagement with cannabis-related businesses (CRB) highlights a niche market, though the decrease in CRB deposits suggests potential challenges or strategic adjustments in this segment.

Comparison to Industry Standards

• The company's Common Equity Tier 1 Capital Ratio of 21.42% and Total Capital Ratio of 22.42% at September 30, 2025, significantly exceed the "well capitalized" regulatory requirements of 6.50% and 10.00% respectively. This indicates a very strong capital position compared to regulatory benchmarks for U.S. banks.
• The net interest margin increased to 4.06% for the three months and 3.93% for the nine months ended September 30, 2025. This is generally considered a healthy margin in the banking industry, often exceeding the average for many regional and community banks, especially given the current interest rate environment.
• The allowance for credit losses as a percentage of nonperforming loans at 169.4% suggests robust coverage of potential loan losses, which is a strong indicator of asset quality management compared to peers.

Corporate Governance

Legal Proceedings

• No pending legal proceedings other than routine matters occurring in the ordinary course of business.
• No material legal proceedings at September 30, 2025.

Related Party Transactions

• The Employee Stock Ownership Plan (ESOP) borrowed $622,850 from the Company for the purpose of purchasing 62,285 shares of the Company's stock.

Stakeholder Impact

• Shareholders: Significant increase in equity due to the stock offering, potential for improved future yields from investment restructuring, but also a one-time loss from security sales and a future expense from pension plan withdrawal.
• Employees: Establishment of an Employee Stock Ownership Plan (ESOP) provides a new benefit and ownership stake.
• Customers: Continued focus on enhancing products and services, including mobile banking and cash management, and expanding CRB services, aims to benefit customers.
• Depositors: A liquidation account has been established for eligible savings account holders post-conversion. The decrease in overall deposits, especially CRB, might indicate shifts in customer behavior or competitive pressures.
• Creditors: The company maintains strong capital ratios and liquidity, which is positive for creditors. The FHLB borrowing commitment indicates access to funding.

Next Steps

• The company intends to continue growing its loan portfolio, focusing on owner-occupied one-to-four family residential real estate loans and commercial loans.
• Efforts will continue to increase the core deposit base, with an emphasis on consumer and business demand deposits, by enhancing products and services, including mobile banking and expanding CRB services into other states.
• The Bank intends to withdraw from a multi-employer defined benefit plan, which will require an estimated payment of $1.4 million to be recorded as a current period expense when paid.
• The company has initiated a strategy to restructure its investment securities portfolio in October 2025, involving the sale of lower-yielding securities and reinvestment into higher-yielding ones, with an anticipated recovery of the loss within 18 months.
• The company has committed to borrow up to $40.0 million from the FHLB to invest in higher-yielding investment securities as part of its restructuring strategy.

Key Dates

Recommendation

The company has undergone a significant corporate restructuring with its conversion to a stock-form holding company and a successful capital raise, substantially boosting shareholder equity. While the nine-month net income shows growth and asset quality has improved, the quarterly net income decline and a notable decrease in deposits, particularly from CRB accounts, warrant caution. The strategic investment portfolio restructuring, while incurring an immediate loss, aims for higher future yields, but its success and the impact of the $1.4 million pension withdrawal expense need to be monitored. Given these mixed signals and the ongoing transition, a "hold" recommendation allows investors to observe the execution of new strategies and the stabilization of deposit trends before making further investment decisions.

Keywords

Banking, Financial Services, SEC Filing, 10-Q, Quarterly Report, Security Midwest Bancorp, SBMW, Net Income, Shareholders Equity, Deposits, Loans, Credit Quality, Interest Rates, Investment Securities, Stock Conversion, Cannabis-Related Business (CRB), Employee Stock Ownership Plan (ESOP), Financial Performance, Asset Quality, Capital Adequacy, Market Risk, Liquidity, Illinois Banking