EDGAR 10-K Filing

Company CIK: 750574
Filing Year: 2022
Filename: 750574_10-K_2022_0001193125-22-068826.json

---

ITEM 1. BUSINESS
ITEM 1.
BUSINESS
Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company registered
with the Board of Governors
of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding
Company Act of 1956, as amended (the
“BHC Act”).
The Company was incorporated in Delaware in 1990, and in 1994 it succeeded
its Alabama predecessor as
the bank holding company controlling AuburnBank, an Alabama state
member bank with its principal office in Auburn,
Alabama (the “Bank”).
The Company and its predecessor have controlled the Bank since 1984.
As a bank holding
company, the Company
may diversify into a broader range of financial services and other business activities than currently
are permitted to the Bank under applicable laws and regulations.
The holding company structure also provides greater
financial and operating flexibility than is presently permitted to the Bank.
The Bank has operated continuously since 1907 and currently conducts its business
primarily in East Alabama, including
Lee County and surrounding areas.
The Bank has been a member of the Federal Reserve System since April 1995.
The
Bank’s primary regulators are the Federal
Reserve and the Alabama Superintendent of Banks (the “Alabama
Superintendent”).
The Bank has been a member of the Federal Home Loan Bank of Atlanta (the “FHLB”)
since 1991.
General
The Company’s business is conducted
primarily through the Bank and its subsidiaries.
Although it has no immediate plans
to conduct any other business, the Company may engage directly or indirectly in a number
of activities that the Federal
Reserve has determined to be so closely related to banking or managing or controlling banks
as to be a proper incident
thereto.
The Company’s principal executive offices
are located at 132 N. Gay Street, Auburn, Alabama 36830, and its telephone
number at such address is (334) 821-9200.
The Company maintains an Internet website at
www.auburnbank.com
.
The
Company’s website and the information
appearing on the website are not included or incorporated in, and are not part
of,
this report.
The Company files annual, quarterly and current reports, proxy statements, and
other information with the
SEC.
You
may read and copy any document we file with the SEC at the SEC’s
public reference room at 100 F Street, N.E.,
Washington, DC 20549.
Please call the SEC at 1-800-SEC-0330 for more information on the operation of the public
reference rooms.
The SEC maintains an Internet site at
www.sec.gov
that contains reports, proxy, and other
information,
where SEC filings are available to the public free of charge.
Services
The Bank offers checking, savings, transaction deposit accounts and
certificates of deposit, and is an active residential
mortgage lender in its primary service area.
The Bank’s primary service area includes the
cities of Auburn and Opelika,
Alabama and nearby surrounding areas in East Alabama, primarily in
Lee County.
The Bank also offers commercial,
financial, agricultural, real estate construction and consumer loan products
and other financial services.
The Bank is one of
the largest providers of automated teller services in East Alabama and
operates ATM
machines in 13 locations in its
primary service area.
The Bank offers Visa
®
Checkcards, which are debit cards with the Visa
logo that work like checks
but can be used anywhere Visa is accepted,
including ATM
s.
The Bank’s Visa
Checkcards can be used internationally
through the Plus
®
network.
The Bank offers online banking, bill payment and other electronic
services through its Internet
website,
www.auburnbank.com
.
Our online banking services, bill payment and electronic services are subject
to certain
cybersecurity risks.
See “Risk Factors - Our information systems may experience interruptions
and security breaches.”
Competition
The banking business in East Alabama, including Lee County,
is highly competitive with respect to loans, deposits, and
other financial services.
The area is dominated by a number of regional and national banks and bank
holding companies
that have substantially greater resources, and numerous offices and affiliates
operating over wide geographic areas.
The
Bank competes for deposits, loans and other business with these banks, as
well as with credit unions, mortgage companies,
insurance companies, and other local and nonlocal financial institutions, including
institutions offering services through the
mail, by telephone and over the Internet.
As more and different kinds of businesses enter the market for financial
services,
competition from nonbank financial institutions may be expected to
intensify further.
Among the advantages that larger financial institutions have
over the Bank are their ability to finance extensive advertising
campaigns, to diversify their funding sources, and to allocate and diversify their assets among
loans and securities of the
highest yield in locations with the greatest demand.
Many of the major commercial banks or their affiliates operating in
the
Bank’s service area offer services
which are not presently offered directly by the Bank and they typically have substantially
higher lending limits than the Bank.
Banks also have experienced significant competition for deposits from mutual
funds, insurance companies and other
investment companies and from money center banks’ offerings
of high-yield investments and deposits.
Certain of these
competitors are not subject to the same regulatory restrictions as the Bank.
Selected Economic Data
The U.S. Census Bureau estimates Lee County’s
population was 174,241 in 2020, and has increased approximately 24.2%
from 2010 to 2020.
The largest employers in the area are Auburn University,
East Alabama Medical Center, a Wal
-Mart
Distribution Center, Mando America Corporation,
and Briggs & Stratton.
Auto manufacturing and related suppliers are
increasingly important along Interstate Highway 85 to the east and west of
Auburn.
Kia Motors has a large automobile
factory in nearby West Point,
Georgia, and Hyundai Motors has a large automobile
factory in Montgomery,
Alabama.
Between 2010 and 2022, the Auburn-Opelika MSA grew an estimated 23.9%,
the second fastest growing MSA in
Alabama.
The Auburn-Opelika MSA population is estimated to grow 6.73% from 2022
to 2027.
During the same time,
household income is estimated to increase 13.34%, to $67,593.
Loans and Loan Concentrations
The Bank makes loans for commercial, financial and agricultural purposes, as
well as for real estate mortgages, real estate
acquisition, construction and development and consumer purposes.
While there are certain risks unique to each type of
lending, management believes that there is more risk associated
with commercial, real estate acquisition, construction and
development, agricultural and consumer lending than with residential real estate
mortgage loans.
To help manage these
risks, the Bank has established underwriting standards used in evaluating
each extension of credit on an individual basis,
which are substantially similar for each type of loan.
These standards include a review of the economic conditions
affecting the borrower, the borrower’s
financial strength and capacity to repay the debt, the underlying collateral and the
borrower’s past credit performance.
We apply these standards
at the time a loan is made and monitor them periodically
throughout the life of the loan.
See “Lending Practices” for a discussion of regulatory guidance on commercial real
estate
lending.
The Bank has loans outstanding to borrowers in all industries within our primary
service area.
Any adverse economic or
other conditions affecting these industries would also likely
have an adverse effect on the local workforce, other local
businesses, and individuals in the community that have entered
into loans with the Bank.
For example, the auto
manufacturing business and its suppliers have positively affected
our local economy, but automobile
manufacturing is
cyclical and adversely affected by increases in interest rates.
Decreases in automobile sales, including adverse changes due
to interest rate increases, and the economic effects of the impact
of COVID-19, including continuing supply chain
disruptions, could adversely affect nearby Kia and Hyundai automotive plants and their suppliers'
local spending and
employment, and could adversely affect economic conditions
in the markets we serve. However,
management believes that
due to the diversified mix of industries located within the Bank’s
primary service area, adverse changes in one industry may
not necessarily affect other area industries to the same degree or
within the same time frame.
The Bank’s primary service
area also is subject to both local and national economic conditions and fluctuations.
While most loans are made within our
primary service area, some residential mortgage loans are originated outside the
primary service area, and the Bank from
time to time has purchased loan participations from outside its primary
service area.
Human Capital
At December 31, 2021, the Company and its subsidiaries had 152
full-time equivalent employees, including 39 officers. In
response to the COVID-19 pandemic, our business continuity plan worked to provide
essential banking services to our
communities and customers, while protecting our employees’ health.
As part of our efforts to exercise social distancing in
accordance with the guidelines of the Centers for Disease Control and the Governor
of the State of Alabama, starting March
23, 2020, we limited branch lobby service to appointment only while continuing to operate
our branch drive-thru facilities
and ATMs.
We continue to provide
services through our online and other electronic channels. In addition,
we established
remote work access to help employees stay at home where job duties permit.
We experienced
little turnover as a result of the COVID-19 pandemic.
We also have
strong employee retention
historically.
Our average term of service is approximately 10 years.
We seek to provide
competitive compensation and benefits.
We encourage and support
the growth and development of our
employees and, wherever possible, seek to fill positions by promotion and transfer
from within the organization.
Career
development is advanced through ongoing performance and development conversations
with employees, internally
developed training programs and other training and development opportunities.
Our employees are encouraged to be active
in our communities as part of our commitment to these communities and our employees.
Statistical Information
Certain statistical information is included in response to Item 7 of this
Annual Report on Form 10-K.
Certain statistical
information is also included in response to Item 6, Item 7A and Item 8 of this Annual Report
on Form 10-K.
SUPERVISION AND REGULATION
The Company and the Bank are extensively regulated under federal and state laws applicable
to bank holding companies
and banks.
The supervision, regulation and examination of the Company and the Bank and
their respective subsidiaries by
the bank regulatory
agencies are primarily intended to maintain the safety and soundness
of depository institutions and the
federal deposit insurance system, as well as the protection of depositors,
rather than holders of Company capital stock and
other securities.
Any change in applicable law or regulation may have a material effect
on the Company’s business.
The
following discussion is qualified in its entirety by reference to the particular laws and
rules referred to below.
Bank Holding Company Regulation
The Company, as a bank holding company,
is subject to supervision, regulation and examination by the Federal Reserve
under the BHC Act.
Bank holding companies generally are limited to the business of banking,
managing or controlling
banks, and certain related activities.
The Company is required to file periodic reports and other information
with the
Federal Reserve.
The Federal Reserve examines the Company and its subsidiaries.
The State of Alabama currently does
not regulate bank holding companies.
The BHC Act requires prior Federal Reserve approval for,
among other things, the acquisition by a bank holding company
of direct or indirect ownership or control of more than 5% of the voting shares or
substantially all the assets of any bank, or
for a merger or consolidation of a bank holding company
with another bank holding company.
The BHC Act generally
prohibits a bank holding company from acquiring direct or indirect ownership
or control of voting shares of any company
that is not a bank or bank holding company and from engaging directly or indirectly in any
activity other than banking or
managing or controlling banks or performing services for its authorized
subsidiary.
A bank holding company may,
however, engage in or acquire an interest in a company that
engages in activities that the Federal Reserve has determined
by regulation or order to be so closely related to banking or managing or controlling banks
as to be a proper incident
thereto. On January 30, 2020, the Federal Reserve adopted new rules, effective
September 30, 2020 simplifying
determinations of control of banking organizations for BHC Act purposes.
Bank holding companies that are and remain “well-capitalized” and “well-managed,”
as defined in Federal Reserve
Regulation
Y,
and whose insured depository institution subsidiaries maintain
“satisfactory” or better ratings under the
Community Reinvestment Act of 1977 (the “CRA”), may elect to
become “financial holding companies.” Financial holding
companies and their subsidiaries are permitted to acquire or engage in activities
such as insurance underwriting, securities
underwriting, travel agency activities, broad insurance agency activities,
merchant banking and other activities that the
Federal Reserve determines to be financial in nature or complementary thereto.
In addition, under the BHC Act’s
merchant
banking authority and Federal Reserve regulations, financial holding companies
are authorized to invest in companies that
engage in activities that are not financial in nature, as long as the financial
holding company makes its investment, subject
to limitations, including a limited investment term, no day-to-day
management, and no cross-marketing with any depositary
institutions controlled by the financial holding company.
The Federal Reserve recommended repeal of the merchant
banking powers in its September 16, 2016 study pursuant to Section 620 of the Dodd
-Frank Wall Street Reform and
Consumer Protection Act of 2010 (the “Dodd-Frank Act”), but has taken no action.
The Company has not elected to
become a financial holding company,
but it may elect to do so in the future.
Financial holding companies continue to be subject to Federal Reserve supervision,
regulation and examination, but the
Gramm-Leach-Bliley Act of 1999 the “GLB Act”) applies the concept
of functional regulation to subsidiary activities.
For
example, insurance activities would be subject to supervision and regulation
by state insurance authorities.
The BHC Act permits acquisitions of banks by bank holding companies, subject
to various restrictions, including that the
acquirer is “well capitalized” and “well managed”.
Under the Alabama Banking Code, with the prior approval of the
Alabama Superintendent, an Alabama bank may acquire and operate
one or more banks in other states pursuant to a
transaction in which the Alabama bank is the surviving bank.
In addition, one or more Alabama banks may enter into a
merger transaction with one or more out-of-state banks,
and an out-of-state bank resulting from such transaction may
continue to operate the acquired branches in Alabama.
The Dodd-Frank Act permits banks, including Alabama banks, to
branch anywhere in the United States.
The Company is a legal entity separate and distinct from the Bank.
Various
legal limitations restrict the Bank from lending
or otherwise supplying funds to the Company.
The Company and the Bank are subject to Sections 23A and 23B of the
Federal Reserve Act and Federal Reserve Regulation W thereunder.
Section 23A defines “covered transactions,” which
include extensions of credit, and limits a bank’s
covered transactions with any affiliate to 10% of such bank’s
capital and
surplus.
All covered and exempt transactions between a bank and its affiliates
must be on terms and conditions consistent
with safe and sound banking practices, and banks and their subsidiaries are prohibited
from purchasing low-quality assets
from the bank’s affiliates.
Finally, Section 23A requires
that all of a bank’s extensions of credit
to its affiliates be
appropriately secured by permissible collateral, generally United States government
or agency securities.
Section 23B of
the Federal Reserve Act generally requires covered and other transactions among affiliates
to be on terms and under
circumstances, including credit standards, that are substantially the same as or at
least as favorable to the bank or its
subsidiary as those prevailing at the time for similar transactions with unaffiliated
companies.
Federal Reserve policy and the Federal Deposit Insurance Act, as amended
by the Dodd-Frank Act, require a bank holding
company to act as a source of financial and managerial strength to its FDIC-insured
subsidiaries and to take measures to
preserve and protect such bank subsidiaries in situations where additional
investments in a bank subsidiary may not
otherwise be warranted.
In the event an FDIC-insured subsidiary becomes subject to a capital restoration
plan with its
regulators, the parent bank holding company is required to guarantee performance
of such plan up to 5% of the bank’s
assets, and such guarantee is given priority in bankruptcy of the bank holding company.
In addition, where a bank holding
company has more than one bank or thrift subsidiary,
each of the bank holding company’s
subsidiary depository institutions
may be responsible for any losses to the FDIC’s
Deposit Insurance Fund (“DIF”), if an affiliated depository institution
fails.
As a result, a bank holding company may be required to loan money to a bank subsidiary in the
form of subordinate capital
notes or other instruments which qualify as capital under bank regulatory rules.
However, any loans from the holding
company to such subsidiary banks likely will be unsecured and subordinated
to such bank’s depositors and to other
creditors of the bank.
See “Capital.”
As a result of legislation in 2014 and 2018, the Federal Reserve has revised its Small Bank
Holding Company Policy
Statement (the “Small BHC Policy”) to expand it to include thrift holding companies and
increase the size of “small” for
qualifying bank and thrift holding companies from $500 million to up to $3
billion of pro forma consolidated assets.
The Federal Reserve confirmed in 2018 that the Company is eligible for treatment as
a small banking holding company
under the Small BHC Policy.
As a result, unless and until the Company fails to qualify under the Small BHC Policy,
the
Company’s capital adequacy
will continue to be evaluated on a bank only basis.
See “Capital.”
Bank Regulation
The Bank is a state bank that is a member of the Federal Reserve.
It is subject to supervision, regulation and examination
by the Federal Reserve and the Alabama Superintendent, which monitor
all areas of the Bank’s operations, including
loans,
reserves, mortgages, issuances and redemption of capital securities, payment of dividends,
establishment of branches,
capital adequacy and compliance with laws.
The Bank is a member of the FDIC and, as such, its deposits are insured by
the FDIC to the maximum extent provided by law,
and is subject to various FDIC regulations.
See “FDIC Insurance
Assessments.”
Alabama law permits statewide branching by banks.
The powers granted to Alabama-chartered banks by state law include
certain provisions designed to provide such banks competitive equality with
national banks.
The Federal Reserve has adopted the Federal Financial Institutions Examination
Council’s (“FFIEC”) rating system,
which
assigns each financial institution a confidential composite “CAMELS” rating based
on an evaluation and rating of six
essential components of an institution’s
financial condition and operations:
Capital Adequacy,
Asset Quality, Management,
Earnings, Liquidity and Sensitivity to market risk, as well as the quality of risk
management practices.
For most
institutions, the FFIEC has indicated that market risk primarily reflects exposures
to changes in interest rates.
When
regulators evaluate this component, consideration is expected to
be given to: management’s ability to identify,
measure,
monitor and control market risk; the institution’s
size; the nature and complexity of its activities and its risk profile; and the
adequacy of its capital and earnings in relation to its level of market risk exposure.
Market risk is rated based upon, but not
limited to, an assessment of the sensitivity of the financial institution’s
earnings or the economic value of its capital to
adverse changes in interest rates, foreign exchange rates, commodity prices or
equity prices; management’s ability to
identify, measure,
monitor and control exposure to market risk; and the nature and complexity of interest
rate risk exposure
arising from non-trading positions. Composite ratings are based on evaluations of an institution’s
managerial, operational,
financial and compliance performance. The composite CAMELS rating is not an
arithmetical formula or rigid weighting of
numerical component ratings. Elements of subjectivity and examiner judgment,
especially as these relate to qualitative
assessments, are important elements in assigning ratings.
The federal bank regulatory agencies are reviewing the CAMELS
rating system and their consistency.
The GLB Act and related regulations require banks and their affiliated
companies to adopt and disclose privacy policies,
including policies regarding the sharing of personal information with third parties.
The GLB Act also permits bank
subsidiaries to engage in “financial activities” similar to those permitted to financial
holding companies. In December 2015,
Congress amended the GLB Act as part of the Fixing America’s
Surface Transportation Act. This amendment
provided
financial institutions that meet certain conditions an exemption to the requirement to deliver
an annual privacy notice. On
August 10, 2018, the federal Consumer Financial Protection Bureau (“CFPB”)
announced that it had finalized conforming
amendments to its implementing regulation, Regulation
P.
A variety of federal and state privacy laws govern the collection, safeguarding, sharing
and use of customer information,
and require that financial institutions have policies regarding information privacy
and security. Some
state laws also protect
the privacy of information of state residents and require adequate security of
such data, and certain state laws may,
in some
circumstances, require us to notify affected individuals of security breaches
of computer databases that contain their
personal information. These laws may also require us to notify law enforcement, regulators
or consumer reporting agencies
in the event of a data breach, as well as businesses and governmental agencies that own data.
Community Reinvestment Act and Consumer Laws
The Bank is subject to the provisions of the CRA and the Federal Reserve’s
regulations thereunder.
Under the CRA, all
FDIC-insured institutions have a continuing and affirmative obligation,
consistent with their safe and sound operation, to
help meet the credit needs for their entire communities, including low-
and moderate-income neighborhoods.
The CRA
requires a depository institution’s primary
federal regulator to periodically assess the institution’s
record of assessing and
meeting the credit needs of the communities served by that institution, including low
-
and moderate-income neighborhoods.
The bank regulatory agency’s
CRA assessment is publicly available.
Further, consideration of the CRA is required of any
FDIC-insured institution that has applied to: (i) charter a national bank; (ii) obtain deposit
insurance coverage for a newly-
chartered institution; (iii) establish a new branch office that accepts
deposits; (iv) relocate an office; or (v) merge or
consolidate with, or acquire the assets or assume the liabilities of, an FDIC-insured
financial institution.
In the case of bank
holding company applications to acquire a bank or other bank holding company,
the Federal Reserve will assess the records
of each subsidiary depository institution of the applicant bank holding company,
and such records may be the basis for
denying the application.
A less than satisfactory CRA rating will slow,
if not preclude, acquisitions, and new branches and
other expansion activities and may prevent a company from becoming a
financial holding company.
CRA agreements with private parties must be disclosed and annual
CRA reports must be made to a bank’s primary
federal
regulator.
A financial holding company election, and such election and financial holding company
activities are permitted
to be continued, only if any affiliated bank has not received less than a
“satisfactory” CRA rating.
The federal CRA
regulations require that evidence of discriminatory,
illegal or abusive lending practices be considered in the CRA
evaluation.
On December 13, 2019, the FDIC and OCC issued a joint notice of proposed rulemaking
seeking comment on modernizing
the agencies’ CRA regulations. The OCC issued final revised CRA Rules effective
October 1, 2020, which were repealed
in 2021.
The Federal bank regulators are cooperating and working on new CRA regulations,
which are expected to be
proposed around the end of March 2022.
The Bank is also subject to, among other things, the Equal Credit Opportunity Act (the
“ECOA”) and the Fair Housing Act
and other fair lending laws, which prohibit discrimination based on race or
color, religion, national origin, sex and familial
status in any aspect of a consumer or commercial credit or residential real estate transaction.
The Department of Justice
(the “DOJ”), and the federal bank regulatory agencies have issued an Interagency
Policy Statement on Discrimination in
Lending to provide guidance to financial institutions in determining whether discrimination
exists, how the agencies will
respond to lending discrimination, and what steps lenders might take to prevent
discriminatory lending practices.
The DOJ
has prosecuted what it regards as violations of the ECOA, the Fair Housing Act,
and the fair lending laws, generally.
The federal bank regulators have updated their guidance several times on overdrafts, including overdrafts
incurred at
automated teller machines and point of sale terminals.
Overdrafts also have been a CFPB concern, and in 2021 began
refocusing on this issue with a view to “insure that banks continue to evolve their
businesses to reduce reliance on overdraft
and not sufficient funds fees.”
Among other things, the federal regulators require banks to monitor accounts and
to limit
the use of overdrafts by customers as a form of short-term, high-cost credit,
including, for example, giving customers who
overdraw their accounts on more than six occasions where a fee is charged
in a rolling 12 month period a reasonable
opportunity to choose a less costly alternative and decide whether to continue
with fee-based overdraft coverage.
It also
encourages placing appropriate daily limits on overdraft fees, and asks banks to
consider eliminating overdraft fees for
transactions that overdraw an account by a
de minimis
amount.
Overdraft
policies, processes, fees and disclosures are
frequently the subject of litigation against banks in various jurisdictions. The
federal bank regulators continue to consider
responsible small dollar lending, including overdrafts and related fee issues and
issued principals for offering small-dollar
loans in a responsible manner on May 20, 2020.
The CFPB proposed on February 6, 2019 to rescind its mandatory
underwriting standards for loans covered by its 2017 Payday,
Vehicle
Title and Certain High-Cost Installment Loans rule,
and has separately proposed delaying the effectiveness of such 2017
rule.
The CFPB has a broad mandate to regulate consumer financial products and
services, whether or not offered by banks or
their affiliates.
The CFPB has the authority to adopt regulations and enforce various laws,
including fair lending laws, the
Truth in Lending Act, the Electronic Funds Transfer
Act, mortgage lending rules, the Truth in Savings Act, the Fair
Credit
Reporting Act and Privacy of Consumer Financial Information rules.
Although the CFPB does not examine or supervise
banks with less than $10 billion in assets,
banks of all sizes are affected by the CFPB’s
regulations, and the precedents set
in CFPB enforcement actions and interpretations.
Residential Mortgages
CFPB regulations require that lenders determine whether a consumer
has the ability to repay a mortgage loan.
These
regulations establish certain minimum requirements for creditors
when making ability to repay determinations, and provide
certain safe harbors from liability for mortgages that are "qualified mortgages"
and are not “higher-priced.”
Generally,
these CFPB regulations apply to all consumer,
closed-end loans secured by a dwelling including home-purchase loans,
refinancing and home equity loans-whether first or subordinate lien. Qualified
mortgages must generally satisfy detailed
requirements related to product features, underwriting standards,
and requirements where the total points and fees on a
mortgage loan cannot exceed specified amounts or percentages of the total loan amount.
Qualified mortgages must have:
(1) a term not exceeding 30 years; (2) regular periodic payments that do not result in
negative amortization, deferral of
principal repayment, or a balloon payment; (3) and be supported with documentation of
the borrower and its credit. On
December 10, 2020, the CFPB issued final rules related to “qualified mortgage” loans.
Lenders are required under the law
to determine that consumers have the ability to repay mortgage loans before
lenders make those loans. Loans that meet
standards for QM loans are presumed to be loans for which consumers have the ability to
repay.
We focus our residential
mortgage origination on qualified mortgages and those that meet our investors’ requirements,
but
we may make loans that do not meet the safe harbor requirements for
“qualified mortgages.”
The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018
(the “2018 Growth Act”) provides that
certain residential mortgages held in portfolio by banks with less than $10 billion
in consolidated assets automatically are
deemed “qualified mortgages.” This relieves smaller institutions from
many of the requirements to satisfy the criteria listed
above for “qualified mortgages.” Mortgages meeting the “qualified
mortgage” safe harbor may not have negative
amortization, must follow prepayment penalty limitations included
in the Truth in Lending Act, and may not have
fees
greater than 3% of the total value of the loan.
The Bank generally services the loans it originates, including those it sells.
The CFPB’s mortgage servicing standards
include requirements regarding force-placed insurance, certain notices
prior to rate adjustments on adjustable rate
mortgages, and periodic disclosures to borrowers. Servicers are prohibited
from processing foreclosures when a loan
modification is pending, and must wait until a loan is more than 120 days delinquent
before initiating a foreclosure action.
Servicers must provide borrowers with direct and ongoing access to its personnel,
and provide prompt review of any loss
mitigation application. Servicers must maintain accurate and accessible
mortgage records for the life of a loan and until one
year after the loan is paid off or transferred. These standards increase the cost and compliance
risks of servicing mortgage
loans, and the mandatory delays in foreclosures could result in loss of value on collateral
or the proceeds we may realize
from a sale of foreclosed property.
The Federal Housing Finance Authority (“FHFA”)
updated, effective January 1, 2016, The Federal National
Mortgage
Association’s (“Fannie Mae’s”)
and the Federal Home Loan Mortgage Corporation (“Freddie Mac’s”)
(individually and
collectively, “GSE”) repurchase
rules, including the kinds of loan defects that could lead to a repurchase request to, or
alternative remedies with, the mortgage loan originator or seller.
These rules became effective January 1, 2016.
FHFA also
has updated these GSEs’ representations and warranties framework and
provided an independent dispute resolution
(“IDR”) process to allow a neutral third party to resolve demands after the GSEs’ quality
control and appeal processes have
been exhausted.
The Bank is subject to the CFPB’s
integrated disclosure rules under the Truth in Lending
Act and the Real Estate
Settlement Procedures Act, referred to as “TRID”, for credit transactions secured
by real property. Our residential
mortgage
strategy, product offerings,
and profitability may change as these regulations are interpreted and applied
in practice, and
may also change due to any restructuring of Fannie Mae and Freddie Mac
as part of the resolution of their conservatorships.
The 2018 Growth Act reduced the scope of TRID rules by eliminating the wait time
for a mortgage, if an additional creditor
offers a consumer a second offer with a lower annual percentage
rate. Congress encouraged federal regulators to provide
better guidance on TRID in an effort to provide a clearer understanding
for consumers and bankers alike. The law also
provides partial exemptions from the collection, recording and reporting requirements
under Sections 304(b)(5) and (6) of
the Home Mortgage Disclosure Act (“HMDA”), for those banks with fewer than 500
closed-end mortgages or less than
500 open-end lines of credit in both of the preceding two years, provided
the bank’s rating under the CRA for the previous
two years has been at least “satisfactory.”
On August 31, 2018, the CFPB issued an interpretive and procedural rule to
implement and clarify these requirements under the 2018 Growth
Act.
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”)
was enacted on March 27, 2020. Section 4013 of
the CARES Act, “Temporary
Relief From Troubled Debt Restructurings,” provides banks
the option to temporarily
suspend certain requirements under ASC 340-10 TDR classifications
for a limited period of time to account for the effects
of COVID-19. On April 7, 2020, the Federal Reserve and the other banking agencies and
regulators issued a statement,
“Interagency Statement on Loan Modifications and Reporting for Financial Institutions
Working With
Customers Affected
by the Coronavirus (Revised)” (the “Interagency Statement on COVID-19
Loan Modifications”), to encourage banks to
work prudently with borrowers and to describe the agencies’ interpretation of
how accounting rules under ASC 310-40,
“Troubled Debt Restructurings by Creditors,”
apply to covered modifications. The Interagency Statement on COVID-19
Loan Modifications was supplemented on June 23, 2020 by the Interagency Examiner
Guidance for Assessing Safety and
Soundness Considering the Effect of the COVID-19 Pandemic on Institutions.
If a loan modification is eligible, a bank may
elect to account for the loan under section 4013 of the CARES Act. If a loan modification is not eligible
under section
4013, or if the bank elects not to account for the loan modification under section 4013,
the Revised Statement includes
criteria when a bank may presume a loan modification is not a TDR in accordance
with ASC 310-40.
Section 4021 of the CARES Act allows borrowers under 1-to-4 family residential
mortgage loans sold to Fannie Mae to
request forbearance to the servicer after affirming that such borrower
is experiencing financial hardships during the
COVID-19 emergency.
Such forbearance will be up to 180 days, subject to up to a 180 day extension. During
forbearance,
no fees, penalties or interest shall be charged beyond those applicable
if all contractual payments were fully and timely
paid. Except for vacant or abandoned properties, Fannie Mae servicers
may not initiate foreclosures on similar procedures
or related evictions or sales until December 31, 2020. On February 9. 2021,
the forbearance period was extended to March
31, 2021 after being extended to February 28, 2021. Borrowers
who are on a COVID-19 forbearance plan as of February
28, 2021 may apply for an additional forbearance extension of up to three additional
months. The Bank sells mortgage
loans to Fannie Mae and services these on an actual/actual basis. As a result, the Bank is
not obligated to make any
advances to Fannie Mae on principal and interest on such mortgage loans
where the borrower is entitled to forbearance.
FinCEN published a request for information and comment on December 15,
2021 seeking ways to streamline, modernize
the United States AML and countering the financing of terrorists.
Anti-Money Laundering and Sanctions
The International Money Laundering Abatement and Anti-Terr
orism Funding Act of 2001 specifies “know your customer”
requirements that obligate financial institutions to take actions to verify the
identity of the account holders in connection
with opening an account at any U.S. financial institution.
Bank regulators are required to consider compliance with anti-
money laundering laws in acting upon merger and acquisition and
other expansion proposals under the BHC Act and the
Bank Merger Act, and sanctions for violations of this Act can be imposed
in an amount equal to twice the sum involved in
the violating transaction, up to $1 million.
Under the Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct
Terrorism Act of 2001
(the “USA PATRIOT
Act”), financial institutions are subject to prohibitions against specified
financial transactions and account relationships as well as to enhanced due diligence
and “know your customer” standards
in their dealings with foreign financial institutions and foreign customers.
The USA PATRIOT
Act requires financial institutions to establish anti-money laundering programs,
and sets forth
minimum standards, or “pillars” for these programs, including:
●
the development of internal policies, procedures, and controls;
●
the designation of a compliance officer;
●
an ongoing employee training program;
●
an independent audit function to test the programs; and
●
ongoing customer due diligence and monitoring.
Federal Financial Crimes Enforcement Network (“FinCEN”) rules effective
May 2018 require banks to know the beneficial
owners of customers that are not natural persons, update customer information
in order to develop a customer risk profile,
and generally monitor such matters.
On August 13, 2020, the federal bank regulators issued a joint statement clarifying that
isolated or technical violations or
deficiencies are generally not considered the kinds of problems that
would result in an enforcement action. The statement
addresses how the agencies evaluate violations of individual pillars of the Bank Secrecy
Act and anti-money laundering
(“AML/BSA”) compliance program. It describes how the agencies incorporate
the customer due diligence regulations and
recordkeeping requirements issued by the U.S. Department of the Treasury
(“Treasury”) as part of the internal controls
pillar of a financial institution's AML/BSA compliance program.
On September 16, 2020, FinCEN issued an advanced notice of proposed
rulemaking seeking public comment on a wide
range of potential regulatory amendments under the Bank Secrecy Act. The
proposal seeks comment on incorporating an
“effective and reasonably designed” AML/BSA program component
to empower financial institutions to allocate resources
more effectively.
This component also would seek to implement a common understanding
between supervisory
agencies
and financial institutions regarding the necessary AML/BSA program elements,
and would seek to impose minimal
additional obligations on AML programs that already comply under the existing supervisory
framework.
On October 23, 2020, FinCEN and the Federal Reserve invited comment on a proposed
rule that would amend the
recordkeeping and travel rules under the Bank Secrecy Act, which would lower the applicable
threshold from $3,000 to
$250 for international transactions and apply these to transactions using
convertible virtual currencies and digital assets
with legal tender status.
On January 1, 2021, Congress enacted the Anti-Money Laundering
Act of 2020 and the Corporate Transparency Act
(collectively, the “AML
Act”), to strengthen anti-money laundering and countering terrorism
financing programs. Among
other things, the AML Act:
•
specifies uniform disclosure of beneficial ownership information for all U.S. and
foreign entities conducting business
in the U.S.;
•
increases potential fines and penalties for BSA violations and improves
whistleblower incentives;
•
codifies the risk-based approach to AML compliance;
•
modernizes AML systems;
•
expands the duties and powers FinCEN; and
•
emphasizes coordination and information-sharing among financial institutions, U.S.
financial regulators and foreign
financial regulators.
The United States has imposed various sanctions upon various foreign countries,
such as China, Iran, North Korea, Russia
and Venezuela,
and their certain government officials and persons.
Banks are required to comply with these sanctions,
which require additional customer screening and transaction monitoring.
Other Laws and Regulations
The Company is also required to comply with various corporate governance and
financial reporting requirements under the
Sarbanes-Oxley Act of 2002, as well as related rules and regulations adopted
by the SEC, the Public Company Accounting
Oversight Board and Nasdaq. In particular,
the Company is required to report annually on internal controls as part of its
annual report pursuant to Section 404 of the Sarbanes-Oxley Act.
The Company has evaluated its controls, including compliance
with the SEC rules on internal controls, and expects to
continue to spend significant amounts of time and money on compliance with these rules.
If the Company fails to comply
with these internal control rules in the future, it may materially adversely affect
its reputation, its ability to obtain the
necessary certifications to its financial statements, its relations
with its regulators and other financial institutions with which
it deals, and its ability to access the capital markets and offer
and sell Company securities on terms and conditions
acceptable to the Company. The Company’s
assessment of its financial reporting controls as of December 31, 2021 are
included in this report with no material weaknesses reported.
Payment of Dividends and Repurchases of Capital
Instruments
The Company is a legal entity separate and distinct from the Bank. The Company’s
primary source of cash is dividends
from the Bank. Prior regulatory approval is required if the total of all dividends declared
by a state member bank (such as
the Bank) in any calendar year will
exceed the sum of such bank’s
net profits for the year and its retained net profits for the
preceding two calendar years, less any required transfers to surplus. During 2021,
the Bank paid total cash dividends of
approximately $3.7 million to the Company.
At December 31, 2021, the Bank could have declared and paid additional
dividends of approximately $8.3 million without prior regulatory approval.
In addition, the Company and the Bank are subject to various general regulatory policies
and requirements relating to the
payment of dividends, including requirements to maintain capital above regulatory
minimums. The appropriate federal and
state regulatory authorities are authorized to determine when the payment of dividends
would be an unsafe or unsound
practice, and may prohibit such dividends. The Federal Reserve has indicated that paying
dividends that deplete a state
member bank’s capital base to an inadequate
level would be an unsafe and unsound banking practice. The
Federal Reserve
has indicated that depository institutions and their holding companies should
generally pay dividends only out of current
year’s operating earnings.
Federal Reserve Supervisory Letter SR-09-4 (February 24, 2009),
as revised December 21, 2015, applies to dividend
payments, stock redemptions and stock repurchases.
Prior consultation with the Federal Reserve supervisory staff is
required before:
•
redemptions or repurchases of capital instruments when the bank
holding company is experiencing financial
weakness; and
•
redemptions and purchases of common or perpetual preferred stock
which would reduce such Tier 1 capital at
end of the period compared to the beginning of the period.
Bank holding company directors must consider different factors
to ensure that its dividend level is prudent relative to
maintaining a strong financial position, and is not based on overly optimistic earnings
scenarios, such as potential events
that could affect its ability to pay,
while still maintaining a strong financial position. As a general matter,
the Federal
Reserve has indicated that the board of directors of a bank holding company
should consult with the Federal Reserve and
eliminate, defer or significantly reduce the bank holding company’s
dividends if:
•
its net income available to shareholders for the past four quarters, net of dividends previously
paid during that
period, is not sufficient to fully fund the dividends;
•
its prospective rate of earnings retention is not consistent with its capital needs and overall
current and
prospective financial condition; or
•
It will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy
ratios.
The Basel III Capital Rules further limit permissible dividends, stock repurchases and discretionary
bonuses by the
Company and the Bank, respectively,
unless the Company and the Bank meet capital conservation buffer
requirement
effective January 1, 2019.
See "Basel III Capital Rules."
Under a new provision of the capital rules, effective January 1,
2021, if a bank’s capital ratios are
within its buffer
requirements, the maximum amount of capital distributions it can
make is based on its eligible retained income. Eligible
retained income equals the greater of:
•
net income for the four preceding calendar quarters, net of any distributions and associated
tax effects not
already reflected in net income; or
•
the average net income over the preceding four quarters.
Regulatory Capital Changes
Simplification
The federal bank regulators issued final rules on July 22, 2019 simplifying their capital rules.
The last of these changes
become effective on April 1, 2020.
The principal changes for standardized approaches institutions, such the
Company and
the Bank are:
●
Deductions from capital for certain items, such as temporary difference
DTAs, MSAs and investments
in
unconsolidated were decreased to those amounts that individually exceed 25%
of CET1;
●
Institutions can elect to deduct investments in unconsolidated subsidiaries or subject
them to capital requirements;
and
●
Minority interests would be includable up to 10% of (i) CET1 capital, (ii) Tier
1 capital and (iii) total capital.
HVCRE
In December 2019, the federal banking regulators published a final rule, effective
April 1, 2020, to implement the “high
volatility commercial real estate,” or “HVCRE” changes in Section 214 of the 2018
Growth Act.
The new rules define
HVCRE loans as loans secured by land or improved real property that:
●
finance or refinance the acquisition, development, or construction of real property;
●
the purpose of such loans must be to acquire, develop, or improve such real property into
income producing
property; and
●
the repayment of the loan must depend on the future income or sales proceeds
from, or refinancing of, such real
property.
Various
exclusions from HVCRE are specified.
Banking institutions and their holding companies are required to assign
150% risk weight to HVCRE loans.
Community Capital Rule
On October 29, 2019, the federal banking regulators adopted, effective January
1, 2020, an optional community banking
leverage ratio framework applicable to depository institutions and their
holding companies intended to reduce regulatory
burdens for qualifying community banking organizations that do
not use advanced approaches capital measures, and that
have:
●
less than $10 billion of assets;
●
a leverage ratio greater than 9%;
●
off-balance sheet exposures of 25% or less of total consolidated
assets; and
●
trading assets plus trading liabilities of less than 5% of total consolidated assets.
The leverage ratio would be Tier 1 capital
divided by average total consolidated assets, taking into account the capital
simplification discussed above and the CECL related capital transitions.
The community bank leverage ratio will be the sole capital measure, and electing institutions
will not have to calculate or
use any other capital measure.
It is estimated that 85% of depository institutions will be eligible to use this rule.
The
Company expects it would be eligible to make such election, if the Company determined
it desirable.
After preliminary
consideration, the Company believes that it would still need to calculate the regulatory
capital ratios, which investors would
find helpful in comparing the Company to others.
Capital
The Federal Reserve has risk-based capital guidelines for bank holding companies
and state member banks, respectively.
These guidelines required at year end 2019 a minimum ratio of capital to risk-weighted
assets (including certain off-balance
sheet activities, such as standby letters of credit) and capital conservation buffer
of 10.5%.
Tier 1 capital includes common
equity and related retained earnings and a limited amount of qualifying preferred
stock, less goodwill and certain core
deposit intangibles.
Voting
common equity must be the predominant form of capital.
Tier 2 capital consists of non-
qualifying preferred stock, qualifying subordinated, perpetual, and/or mandatory convertible
debt, term subordinated debt
and intermediate term preferred stock, up to 45% of pretax unrealized holding
gains on available for sale equity securities
with readily determinable market values that are prudently valued,
and a limited amount of general loan loss allowance.
Tier 1 and Tier
2 capital equals total capital.
In addition, the Federal Reserve has established minimum leverage ratio guidelines
for bank holding companies not subject
to the Small BHC Policy, and
state member banks, which provide for a minimum leverage ratio of Tier
1 capital to adjusted
average quarterly assets (“leverage ratio”) equal to 4%.
However, bank regulators expect banks and bank holding
companies to operate with a higher leverage ratio.
The guidelines also provide that institutions experiencing internal
growth or making acquisitions will be expected to maintain strong capital positions
substantially above the minimum
supervisory levels without significant reliance on intangible assets.
Higher capital may be required in individual cases and
depending upon a bank holding company’s
risk profile.
All bank holding companies and banks are expected to hold capital
commensurate with the level and nature of their risks including the volume and severity of
their problem loans.
Lastly, the
Federal Reserve’s guidelines indicate
that the Federal Reserve will continue to consider a “tangible Tier
1 leverage ratio”
(deducting all intangibles) in evaluating proposals for expansion or new activity.
The level of Tier 1 capital to risk-adjusted
assets is becoming more widely used by the bank regulators to measure capital adequacy.
The Federal Reserve has not
advised the Company or the Bank of any specific minimum leverage ratio or
tangible Tier 1 leverage ratio applicable to
them. Under Federal Reserve policies, bank holding companies are generally expected
to operate with capital positions well
above the minimum ratios. The Federal Reserve believes the risk-based
ratios do not fully take into account the quality of
capital and interest rate, liquidity,
market and operational risks. Accordingly,
supervisory assessments of capital adequacy
may differ significantly from conclusions based solely on the
level of an organization’s risk
-based capital ratio.
The Federal Deposit Insurance Corporation Improvement Act of 1991
(“FDICIA”), among other things, requires the federal
banking agencies to take “prompt corrective action” regarding depository
institutions that do not meet minimum capital
requirements.
FDICIA establishes five capital tiers: “well capitalized,” “adequately capitalized,”
“undercapitalized,”
“significantly undercapitalized” and “critically undercapitalized.”
A depository institution’s capital tier
will depend upon
how its capital levels compare to various relevant capital measures and certain
other factors, as established by regulation.
See
“Prompt Corrective Action Rules.”
Basel III Capital Rules
The Federal Reserve and the other bank regulators adopted in June 2013 final capital rules
for bank holding companies and
banks implementing the Basel Committee on Banking Supervision’s
“Basel III: A Global Regulatory Framework for more
Resilient Banks and Banking Systems.”
These new U.S. capital rules are called the “Basel III Capital Rules,” and generally
were fully phased-in on January 1, 2019.
The Basel III Capital Rules limit Tier 1 capital
to common stock and noncumulative perpetual preferred stock, as well as
certain qualifying trust preferred securities and cumulative perpetual preferred
stock issued before May 19, 2010, each of
which were grandfathered in Tier 1 capital
for bank holding companies with less than $15 billion in assets.
The Company
had no qualifying trust preferred securities or cumulative preferred stock outstanding at December
31, 2020.
The Basel III
Capital Rules also introduced a new capital measure, “Common Equity Tier
I Capital” or “CET1.”
CET1 includes common
stock and related surplus, retained earnings and, subject to certain adjustments,
minority common equity interests in
subsidiaries.
CET1 is reduced by deductions for:
●
Goodwill and other intangibles, other than mortgage servicing assets (“MSRs”),
which are treated separately, net
of associated deferred tax liabilities (“DTLs”);
●
Deferred tax assets (“DTAs”)
arising from operating losses and tax credit carryforwards net of allowances and
DTLs;
●
Gains on sale from any securitization exposure; and
●
Defined benefit pension fund net assets (i.e., excess plan assets), net of associated DTLs.
The Company made a one-time election in 2015 and, as a result, CET1
will not be adjusted for certain accumulated other
comprehensive income (“AOCI”).
Additional “threshold deductions” of the following that are individually
greater than 10% of CET1 or collectively greater
than 15% of CET1 (after the above deductions are also made):
●
MSAs, net of associated DTLs;
●
DTAs arising from temporary
differences that could not be realized through net operating loss carrybacks,
net of
any valuation allowances and DTLs; and
●
Significant common stock investments in unconsolidated financial institutions,
net of associated DTLs.
As discussed below, recent regulations
change these items to simplify and improve their capital treatment.
Noncumulative perpetual preferred stock and Tier
1 minority interest not included in CET1, subject to limits, will qualify as
additional Tier I capital.
All other qualifying preferred stock, subordinated debt and qualifying minority interests
will be
included in Tier 2 capital.
In addition to the minimum risk-based capital requirements, a new “capital
conservation buffer” of CET1 capital of at least
2.5% of total risk weighted assets, will be required.
The capital conservation buffer will be calculated as the
lowest
of:
●
the banking organization’s
CET1 capital ratio minus 4.5%;
●
the banking organization’s
tier 1 risk-based capital ratio minus 6.0%; and
●
the banking organization’s
total risk-based capital ratio minus 8.0%.
Full compliance with the capital conservation buffer was required
by January 1, 2019. At such time, permissible dividends,
stock repurchases and discretionary bonuses will be limited to the following percentages
based on the capital conservation
buffer as calculated above, subject to any further regulatory
limitations, including those based on risk assessments and
enforcement actions:
Buffer %
Buffer % Limit
More than 2.50%
None
> 1.875% - 2.50%
60.0%
> 1.250% - 1.875%
40.0%
> 0.625% - 1.250%
20.0%
≤ 0.625
- 0 -
Effective March 20, 2020, the Federal Reserve and the other
federal banking regulators adopted an interim final rule that
amended the capital conservation buffer in light of the disruptive
effects of the COVID-19 pandemic. The interim final rule
was adopted as a final rule on August 26, 2020. The new rule revises the definition of
“eligible retained income” for
purposes of the maximum payout ratio to allow banking organizations
to more freely use their capital buffers to promote
lending and other financial intermediation activities, by making the limitations on
capital distributions more gradual. The
eligible retained income is now the greater of (i) net income for the four preceding quarters,
net of distributions and
associated tax effects not reflected in net income; and (ii) the average
of all net income over the preceding four quarters.
The interim final rule only affects the capital buffers, and banking
organizations were encouraged to make prudent capital
distribution decisions.
The various capital elements and total capital under the Basel III Capital Rules, as fully phased
in on January 1, 2019 are:
Fully Phased In
January 1, 2019
Minimum CET1
4.50%
CET1 Conservation Buffer
2.50%
Total CET1
7.0%
Deductions from CET1
100%
Minimum Tier 1 Capital
6.0%
Minimum Tier 1 Capital
plus
conservation buffer
8.5%
Minimum Total Capital
8.0%
Minimum Total Capital
plus
conservation buffer
10.5%
Changes in Risk-Weightings
The Basel III Capital Rules significantly change the risk weightings used to determine risk
weighted capital adequacy.
Among various other changes, the Basel III Capital Rules apply a 250% risk-weighting
to MSRs, DTAs that
cannot be
realized through net operating loss carry-backs and significant (greater
than 10%) investments in other financial
institutions.
A 150% risk-weighted category applies to “high volatility commercial real estate
loans,” or “HVCRE,” which
are credit facilities for the acquisition, construction or development of real property,
excluding one-to-four family
residential properties or commercial real estate projects where: (i) the loan-to-value ratio
is not in excess of interagency real
estate lending standards; and (ii) the borrower has contributed capital
equal to not less than 15% of the real estate’s
“as
completed” value before the loan was made.
The Basel III Capital Rules also changed some of the risk weightings used to determine
risk-weighted capital adequacy.
Among other things, the Basel III Capital Rules:
●
Assigned a 250% risk weight to MSRs;
●
Assigned up to a 1,250% risk weight to structured securities, including private label
mortgage securities, trust
preferred CDOs and asset backed securities;
●
Retained existing risk weights for residential mortgages, but assign a 100%
risk weight to most commercial real
estate loans and a 150% risk-weight for HVCRE;
●
Assigned a 150% risk weight to past due exposures (other than sovereign exposures
and residential mortgages);
●
Assigned a 250% risk weight to DTAs,
to the extent not deducted from capital (subject to certain maximums);
●
Retained the existing 100% risk weight for corporate and retail loans; and
●
Increased the risk weight for exposures to qualifying securities firms from 20% to
100%.
HVCRE loans currently have a risk weight of 150%. Section 214 of the 2018
Growth Act, restricts the federal bank
regulators from applying this risk weight except to certain ADC loans. The federal
bank regulators issued a notice of a
proposed rule on September 18, 2018 to implement Section 214
of the 2018 Growth Act, by revising the definition
HVCRE. If this proposal is adopted, it is expected that this proposal could
reduce the Company’s risk weighted assets
and
thereby may increase the Company’s
risk-weighted capital.
The Financial Accounting Standards Board’s
(the “FASB”) Accounting Standards
Update (“ASU”) No. 2016-13 “Financial
Instruments - Credit Losses (Topic
326): Measurement of Credit Losses on Financial Instruments” on June 16, 2016,
which
changed the loss model to take into account current expected credit losses (“CECL”)
in place of the incurred loss method.
The Federal Reserve and the other federal banking agencies adopted
rules effective on April 1, 2019 that allows banking
organizations to phase in the regulatory capital effect of a reduction
in retained earnings upon adoption of CECL over a
three year period.
On May 8, 2020, the agencies issued a statement describing the measurement of expected
credit losses
using the CECL methodology,
and updated concepts and practices in existing supervisory guidance that
remain applicable.
CECL is effective for the Company beginning January 1, 2023
and has not been adopted early. CECL’s
effects upon the
Company have not yet been determined.
Prompt Corrective Action Rules
All of the federal bank regulatory agencies’ regulations establish risk-adjusted
measures and relevant capital levels that
implement the “prompt corrective action” standards.
The relevant capital measures are the total risk-based capital ratio,
Tier 1 risk-based capital ratio, Common equity tier
1 capital ratio, as well as, the leverage capital ratio.
Under the
regulations, a state member bank will be:
●
well capitalized if it has a total risk-based capital ratio of 10% or greater,
a Tier 1 risk-based capital ratio of 8% or
greater, a Common equity tier 1 capital ratio
of 6.5% or greater, a leverage capital ratio of 5% or
greater and is not
subject to any written agreement, order,
capital directive or prompt corrective action directive by a federal bank
regulatory agency to maintain a specific capital level for any capital
measure;
●
“adequately capitalized” if it has a total risk-based capital ratio of 8% or greater,
a Tier 1 risk-based capital ratio of
6% or greater, a Common Equity Tier
1 capital ratio of 4.5% or greater, and generally has a leverage capital
ratio
of 4% or greater;
●
“undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier
1 risk-based capital ratio of less
than 6%, a Common Equity Tier 1 capital ratio of less than 4.5%
or generally has a leverage capital ratio of less
than 4%;
●
“significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a
Tier 1 risk-based capital
ratio of less than 4%, a Common Equity Tier 1 capital ratio
of less than 3%, or a leverage capital ratio of less than
3%; or
●
“critically undercapitalized” if its tangible equity is equal to or less than 2% to total assets.
The federal bank regulatory agencies have authority to require additional capital,
and have indicated that higher capital
levels may be required in light of market conditions and risk.
Depository institutions that are “adequately capitalized” for bank regulatory purposes
must receive a waiver from the FDIC
prior to accepting or renewing brokered deposits, and cannot pay interest rates or brokered
deposits that exceeds market
rates by more than 75 basis points.
Banks that are less than “adequately capitalized” cannot accept
or renew brokered
deposits.
FDICIA generally prohibits a depository institution from making any capital distribution
(including paying
dividends) or paying any management fee to its holding company,
if the depository institution thereafter would be
“undercapitalized”.
Institutions that are “undercapitalized” are subject to growth limitations and are
required to submit a
capital restoration plan for approval.
A depository institution’s parent holding company
must guarantee that the institution will comply with such capital
restoration plan.
The aggregate liability of the parent holding company is limited to the lesser
of 5% of the depository
institution’s total assets at the time it became
undercapitalized and the amount necessary to bring the institution into
compliance with applicable capital standards.
If a depository institution fails to submit an acceptable plan, it is treated
as if
it is “significantly undercapitalized”.
If the controlling holding company fails to fulfill its obligations under FDICIA and
files (or has filed against it) a petition under the federal Bankruptcy Code, the claim against
the holding company’s capital
restoration obligation would be entitled to a priority in such bankruptcy proceeding
over third party creditors of the bank
holding company.
Significantly undercapitalized
depository institutions may be subject to a number of requirements and restrictions,
including orders to sell sufficient voting stock to become “adequately
capitalized”, requirements to reduce total assets, and
cessation of receipt of deposits from correspondent banks.
“Critically undercapitalized” institutions are subject to the
appointment of a receiver or conservator.
Because the Company and the Bank exceed applicable capital requirements,
Company and Bank management do not believe that the provisions
of FDICIA have had or are expected to have any
material effect on the Company and the Bank or their respective operations.
Section 201 of the 2018 Growth Act provides that banks and bank holding companies
with consolidated assets of less than
$10 billion that meet a “community bank leverage ratio,” established by the federal
bank regulators between 8% and 10%,
are deemed to satisfy applicable risk-based capital requirements necessary to
be considered “well capitalized.” The federal
banking agencies have the discretion to determine that an institution does not qualify
for such treatment due to its risk
profile. An institution’s risk profile
may be assessed by its off-balance sheet exposure, trading of assets and liabilities,
notional derivatives’ exposure, and other methods.
The federal bank regulators implemented a CARES Act provision by replacing
interim final rules adopted in March 2020,
temporarily reducing the community bank leverage ratio threshold. The threshold is 8% through
the end of 2020, 8.5% for
2021, and 9% beginning January 1, 2022. Two
quarter grace periods are allowed to permit banks that temporarily fall
below these thresholds to remain well-capitalized for regulatory purposes.
FDICIA
FDICIA directs that each federal bank regulatory agency prescribe standards for depository
institutions and depository
institution holding companies relating to internal controls, information systems,
internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth composition,
a maximum ratio of classified assets to capital,
minimum earnings sufficient to absorb losses, a minimum ratio
of market value to book value for publicly traded shares,
safety and soundness, and such other standards as the federal bank regulatory agencies
deem appropriate.
Enforcement Policies and Actions
The Federal Reserve and the Alabama Superintendent monitor compliance
with laws and regulations.
The CFPB monitors
compliance with laws and regulations applicable to consumer financial products
and services.
Violations of laws and
regulations, or other unsafe and unsound practices, may result in these agencies imposing
fines, penalties and/or restitution,
cease and desist orders, or taking other formal or informal enforcement actions.
Under certain circumstances, these
agencies may enforce these remedies directly against officers,
directors, employees and others participating in the affairs
of
a bank or bank holding company, in the
form of fines, penalties, or the recovery,
or claw-back, of compensation.
The
federal prudential banking regulators have been bringing more
enforcement actions recently.
Fiscal and Monetary Policy
Banking is a business that depends on interest rate differentials.
In general, the difference between the interest paid by a
bank on its deposits and its other borrowings, and the interest received by a bank on its loans and
securities holdings,
constitutes the major portion of a bank’s earnings.
Thus, the earnings and growth of the Company and the Bank, as well as
the values of, and earnings on, its assets and the costs of its deposits and other liabilities are
subject to the influence of
economic conditions generally,
both domestic and foreign, and also to the monetary and fiscal policies of the United States
and its agencies, particularly the Federal Reserve.
The Federal Reserve regulates the supply of money through various
means, including open market dealings in United States government securities,
the setting of discount rate at which banks
may borrow from the Federal Reserve, and the reserve requirements on deposits.
The Federal Reserve has been paying interest on depository institutions’ required and
excess reserve balances since October
2008.
The payment of interest on excess reserve balances was expected to give the Federal
Reserve greater scope to use its
lending programs to address conditions in credit markets while also
maintaining the federal funds rate close to the target
rate established by the Federal Open Market Committee.
The Federal Reserve has indicated that it may use this authority to
implement a mandatory policy to reduce excess liquidity,
in the
event of inflation or the threat of inflation.
In April 2010, the Federal Reserve Board amended Regulation D (Reserve
Requirements of Depository Institutions)
authorizing the Reserve Banks to offer term deposits to certain institutions.
Term deposits,
which are deposits with
specified maturity dates, will be offered through a Term
Deposit Facility.
Term deposits will be
one of several tools that
the Federal Reserve could employ to drain reserves when policymakers judge that
it is appropriate to begin moving to a less
accommodative stance of monetary policy.
In 2011, the Federal Reserve repealed its historical Regulation
Q to permit banks to pay interest on demand deposits.
On March 3, 2020, the Federal Reserve reduced the Federal Funds rate target by 50
basis points to 1.00-1.25%. The Federal
Reserve further reduced the Federal Funds Rate target by an additional
100 basis points to 0-0.25% on March 16, 2020. The
Federal Reserve established various liquidity facilities pursuant to section 13(3)
of the Federal Reserve Act to help stabilize
the financial system.
As a result of inflation, the decline in serious COVID-19 cases, and the strengthening of
the economy
following the March 2020 outbreak of the COVID-19 pandemic, the Federal
Reserve is considering increasing the discount
rate and reducing its holdings of securities.
In light of disruptions in economic conditions caused by the outbreak of COVID-19 and the
stress in U.S. financial markets,
the Federal Reserve, Congress and the Department of the Treasury
took a host of fiscal and monetary measures to minimize
the economic effect of COVID-19.
The CARES Act provided a $2 trillion stimulus package and various
measures to provide relief from the COVID-19
pandemic, including:
●
The Paycheck Protection Program (“PPP”), which expands eligibility for special new SBA
guaranteed loans,
forgivable loans and other relief to small businesses affected
by COVID-19.
●
A new $500 billion federal stimulus program for air carriers and other companies in severely
distressed sectors of
the American economy. The lending
programs impose stock buyback, dividend, executive compensation, and
other restrictions on direct loan recipients.
●
Optional temporary suspension of certain requirements under ASC 340-10 TDR
classifications for a limited period
of time to account for the effects of COVID-19.
●
The creation of rapid tax rebates and expansion of unemployment benefits to
provide relief to individuals.
●
Substantial federal spending and significant changes for health care companies,
providers, and patients.
Over $525 billion of PPP loans were made in 2020.
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits,
and Venues
Act (the “Economic Aid
Act”) was signed into law. The
Economic Aid Act provides a second $900 billion stimulus package, including
$325 billion
in additional PPP loans, changed the eligibility rules to focus more on smaller business,
further enhances other Small
Business Association programs.
The nature and timing of any changes in monetary policies and their effect
on the Company and the Bank cannot be
predicted. The turnover of a majority of the Federal Reserve Board and
the members of its FOMC and the appointment of a
new Federal Reserve Chairman may result in changes in policy and the timing and amount
of monetary policy
normalization.
FDIC Insurance Assessments
The Bank’s deposits are insured
by the FDIC’s DIF,
and the Bank is subject to FDIC assessments for its deposit insurance.
Assessments by the FDIC to pay interest on Financing Corporation (“FICO”)
bonds ended in September 2019.
Since 2011, and as discussed above under “Recent Regulatory
Developments”, the FDIC has been calculating assessments
based on an institution’s average consolidated
total assets less its average tangible equity (the
“FDIC Assessment Base”) in
accordance with changes mandated by the Dodd-Frank Act.
The FDIC changed its assessment rates which shifted part of
the burden of deposit insurance premiums toward depository institutions relying on
funding sources other than deposits.
In 2016, the FDIC again changed its deposit insurance pricing and eliminated all risk categories
and now uses “financial
ratios method” based on CAMELS composite ratings to determine assessment
rates for small established institutions with
less than $10 billion in assets (“Small Banks”).
The financial ratios method sets a maximum assessment for CAMELS 1
and 2 rated banks, and set minimum assessments for lower rated institutions.
All basis points are annual amounts.
The following table shows the FDIC assessment schedule for 2020
applicable to Small Banks, such as the Bank.
Established Small Institution
CAMELS Composite
1 or 2
4 or 5
Initial Base Assessment Rule
3 to 16 basis points
6 to 30 basis points
16 to 30 basis points
Unsecured Debt Adjustment
-5 to 0 basis points
-5 to 0 basis points
-5 to 0 basis points
Total Base Assessment
Rate
1.5 to 16 basis points
3 to 30 basis points
11 to 30 basis points
On March 15, 2016 the FDIC implemented Dodd-Frank Act provisions by raising the DIF’s
minimum Reserve Ratio from
1.15% to 1.35%.
The FDIC imposed a 4.5 basis point annual surcharge on insured depository
institutions with total
consolidated assets of $10 billion or more (“Large Banks”).
The new rules grant credits to smaller banks for the portion of
their regular assessments that contribute to increasing the reserve ratio from 1.15%
to 1.35%.
The FDIC’s reserve ratio reached 1.36%
on September 30, 2018, exceeding the minimum requirement.
As a result, deposit
insurance surcharges on Large Banks ceased, and smaller
banks will receive credits against their deposit assessments from
the FDIC for their portion of assessments that contributed to the growth in the reserve ratio
from 1.15% to 1.35%.
The
Bank’s credit was $0.2 million, and
was received and applied against the Bank’s deposit
insurance assessments during 2019
and 2020.
Given the extraordinary growth in deposits in the first six months of 2020 due
to the pandemic and government
stimulus, the reserve ratio declined below 1.35% to 1.30%. The FDIC issued a restoration
plan on September 15, 2020
designed to restore the reserve ratio to at least the statutory minimum of 1.35%
within 8 years. Although the FDIC
maintained current assessment rates, the FDIC may increase deposit assessment rates
by up to two basis points without
notice, or more following notice and a comment period, to meet the required reserve
ratio.
On June 22, 2020, the FDIC issued a final rule designed to mitigate the deposit insurance
assessment effect of the PPP and
the related liquidity programs established by the Federal Reserve. Specifically
,
the rule removes the effects of participating
in PPP and liquidity facilities from the various risk measures used to calculate
assessment rates and provides an offset to
assessments for the increase in assessment base rates attributed to participation
in the PPP and liquidity facilities.
Prior to June 30, 2016, when the new assessment system became effective,
the Bank’s overall rate for assessment
calculations was 9 basis points or less, which was within the range of assessment
rates for the lowest “risk category” under
the former FDIC assessment rules.
The Company recorded FDIC insurance premiums expenses of $0.3
and $0.1 million in
2021 and 2020, respectively.
Lending Practices
The federal bank regulatory agencies released guidance in 2006
on “Concentrations in Commercial Real Estate Lending”
(the “Guidance”).
The Guidance defines CRE loans as exposures secured by raw land, land development
and construction
(including 1-4 family residential construction), multi-family property,
and non-farm nonresidential property where the
primary or a significant source of repayment is derived from rental income associated
with the property (that is, loans for
which 50% or more of the source of repayment comes from third party,
non-affiliated, rental income) or the proceeds of the
sale, refinancing, or permanent financing of this property.
Loans to REITs and unsecured
loans to developers that closely
correlate to the inherent risks in CRE markets would also be considered
CRE loans under the Guidance.
Loans on owner
occupied CRE are generally excluded.
In December 2015, the Federal Reserve and other bank regulators issued an
interagency statement to highlight prudent risk management practices
from existing guidance that regulated financial
institutions and made recommendations regarding maintaining capital levels
commensurate with the level and nature of
their CRE concentration risk.
The Guidance requires that appropriate processes be in place to identify,
monitor and control risks associated with real
estate lending concentrations.
This could include enhanced strategic planning, CRE underwriting policies, risk
management, internal controls, portfolio stress testing and risk exposure limits as
well as appropriately designed
compensation and incentive programs.
Higher allowances for loan losses and capital levels may also be required.
The
Guidance is triggered when either:
Total reported
loans for construction, land development, and other land of 100% or more of a bank’s
total capital; or
Total reported
loans secured by multifamily and nonfarm nonresidential properties and
loans for construction, land
development, and other land are 300% or more of a bank’s
total risk-based capital.
This Guidance was supplemented by the Interagency Statement on Prudent
Risk Management for Commercial Real Estate
Lending (December 18, 2015).
The Guidance also applies when a bank has a sharp increase in CRE loans or
has significant
concentrations of CRE secured by a particular property type.
The Guidance did not apply to the Bank’s
CRE lending activities during 2020 or 2021.
At December 31, 2021, the Bank
had outstanding $32.4 million in construction and land development loans and $229.8
million in total CRE loans (excluding
owner occupied), which represent approximately 30.8% and 218.5%,
respectively, of the Bank’s
total risk-based capital at
December 31, 2021.
The Company has always had significant exposures to loans secured
by commercial real estate due to
the nature of its markets and the loan needs of both its retail and commercial customers.
The Company believes its long
term experience in CRE lending, underwriting policies, internal controls, and other policies
currently in place, as well as its
loan and credit monitoring and administration procedures, are generally appropriate
to manage its concentrations as
required under the Guidance.
In 2013, the Federal Reserve and other banking regulators issued their “Interagency Guidance
on Leveraged Lending”
highlighting standards for originating leveraged transactions and
managing leveraged portfolios, as well as requiring banks
to identify their highly leveraged transactions, or HLTs.
The Government Accountability Office issued a statement
on
October 23, 2017 that this guidance constituted a “rule” for purposes of the Congressional
Review Act, which provides
Congress with the right to review the guidance and issue a joint resolution for
signature by the President disapproving it.
No such action was taken, and instead, the federal bank regulators issued a September
11, 2018 “Statement Reaffirming
the
Role of Supervisory Guidance.”
This Statement indicated that guidance does not have the force or effect
of law or provide
the basis for enforcement actions, but this guidance can outline supervisory agencies’
views of supervisory expectations and
priorities, and appropriate practices.
The federal bank regulators continue to identify elevated risks in leveraged loans and
shared national credits.
The Bank did not have any
loans at year-end 2021 or 2020 that were leveraged loans
subject to the Interagency Guidance
on Leveraged Lending or that were shared national credits.
Other Dodd-Frank Act Provisions
In addition to the capital, liquidity and FDIC deposit insurance changes discussed above,
some of the provisions of the
Dodd-Frank Act we believe may affect us are set forth below.
Executive Compensation
The Dodd-Frank Act provides shareholders of all public companies with a say on executive
compensation.
Under the
Dodd-Frank Act, each company must give its shareholders the opportunity to
vote on the compensation of its executives, on
a non-binding advisory basis, at least once every three years.
The Dodd-Frank Act also adds disclosure and voting
requirements for golden parachute compensation that is payable to
named executive officers in connection with sale
transactions.
The SEC is required under the Dodd-Frank Act to issue rules obligating companies to disclose
in proxy materials for annual
shareholders meetings, information that shows the relationship between executive
compensation actually paid to their
named executive officers and their financial performance,
taking into account any change in the value of the shares of a
company’s stock and dividends or
distributions.
The Dodd-Frank Act also provides that a company’s
compensation
committee may only select a consultant, legal counsel or other advisor on
methods of compensation after taking into
consideration factors to be identified by the SEC that affect the independence
of a compensation consultant, legal counsel
or other advisor.
Section 954 of the Dodd-Frank Act added section 10D to the Exchange Act.
Section 10D directs the SEC to adopt rules
prohibiting a national securities exchange or association from listing a company
unless it develops, implements, and
discloses a policy regarding the recovery or “claw-back” of executive compensation
in certain circumstances.
The policy
must require that, in the event an accounting restatement due to material noncompliance
with a financial reporting
requirement under the federal securities laws, the company will recover
from any current or former executive officer any
incentive-based compensation (including stock options) received
during the three year period preceding the date of the
restatement, which is in excess of what would have been paid based
on the restated financial statements.
There is no
requirement of wrongdoing by the executive, and the claw-back is
mandatory and applies to all executive officers.
Section
954 augments section 304 of the Sarbanes-Oxley Act, which requires the CEO and
CFO to return any bonus or other
incentive or equity-based compensation received during the 12
months following the date of similarly inaccurate financial
statements, as well as any profit received from the sale of employer securities during the period,
if the restatement was due
to misconduct.
Unlike section 304, under which only the SEC may seek recoupment, the Dodd
-Frank Act requires the
Company to seek the return of compensation.
The SEC adopted rules in September 2013 to implement pay ratios pursuant to Section 953
of the Dodd-Frank Act, which
apply to fiscal year 2017 annual reports and proxy statements.
The SEC proposed Rule 10D-1 under Section 954 on July
1, 2015 which would direct Nasdaq and the other national securities exchanges to adopt
listing standards requiring
companies to adopt policies requiring executive officers to pay back erroneously
awarded incentive-based compensation.
In February 2017, the acting SEC Chairman indicated interest in reconsidering
the pay ratio rule.
The Dodd-Frank Act, Section 955, requires the SEC, by rule, to require that each company
disclose in the proxy
materials
for its annual meetings whether an employee or board member is permitted to
purchase financial instruments designed to
hedge or offset decreases in the market value of equity securities granted
as compensation or otherwise held by the
employee or board member.
The SEC proposed implementing rules in February 2015, though the rules
have not been
implemented to date.
Section 956 of the Dodd-Frank Act prohibits incentive-based compensation arrangements
that encourage inappropriate risk
taking by covered financial institutions, are deemed to be excessive, or that
may lead to material losses.
In June 2010, the
federal bank regulators adopted Guidance on Sound Incentive Compensation Policies,
which, although targeted to larger,
more complex organizations than the Company,
includes principles that have been applied to smaller organizations
similar
to the Company.
This Guidance applies to incentive compensation to executives as well as employees,
who, “individually
or a part of a group, have the ability to expose the relevant banking organization to
material amounts of risk.”
Incentive
compensation should:
Provide employees incentives that appropriately balance risk and reward;
Be compatible with effective controls and risk-management;
and
Be supported by strong corporate governance, including active and effective
oversight by the organization’s
board
of directors.
The federal bank regulators, the SEC and other regulators proposed regulations implementing
Section 956 in April 2011,
which would have been applicable to, among others, depository institutions and
their holding companies with $1 billion or
more in assets.
An advance notice of a revised proposed joint rulemaking under Section 956
was published by the financial
services regulators in May 2016, but these rules have not been adopted.
Debit Card Interchange
Fees
The “Durbin Amendment” to the Dodd-Frank Act and implementing Federal Reserve
regulations provide that interchanged
transaction fees for electronic debit transactions be “reasonable” and proportional
to certain costs associated with
processing the transactions.
The Durbin Amendment and the Federal Reserve rules thereunder are not
applicable to banks
with assets less than $10 billion.
Other Legislative and Regulatory Changes
Various
legislative and regulatory proposals, including substantial changes in banking,
and the regulation of banks, thrifts
and other financial institutions, compensation, and the regulation of financial
markets and their participants and financial
instruments, and the regulators of all of these, as well as the taxation of these entities, are being considered
by the executive
branch of the federal government, Congress and various state governments, including
Alabama.
President Biden has frozen new rulemaking generally,
and has rescinded various of his predecessor’s executive orders,
including the February 3, 2017 executive order containing “Core Principles
for Regulating the United States Financial
System” (“Core Principles”).
The Core Principles directed the Secretary of the Treasury
to consult with the heads of
Financial Stability Oversight Council’s
members and report to the President periodically thereafter on how laws and
government policies promote the Core Principles and to identify laws, regulations,
guidance and reporting that inhibit
financial services regulation.
The President has also issued an Executive Order 14036 on Promoting Competition
in the
American Economy (July 9, 2021), which may affect the federal
bank regulators’ reviews of bank and bank holding
company mergers.
The OCC, the FDIC and the CFPB have made proposals to further scrutinize
mergers, especially where
the confirming institutions have assets greater than $100 million.
The President’s Working
Group and various agencies
have also been working on the regulation of crypto assets, including stable coin, and access
to the payments system.
The 2018 Growth Act, which, was enacted on May 24, 2018, amends the Dodd
-Frank Act, the BHC Act, the Federal
Deposit Insurance Act and other federal banking and securities laws to provide
regulatory relief in these areas:
•
consumer credit and mortgage lending;
•
capital requirements;
•
Volcker
Rule compliance;
•
stress testing and enhanced prudential standards;
•
increased the asset threshold under the Federal Reserve’s
Small BHC Policy from $1 billion to $3 billion; and
•
capital formation.
We believe the 2018
Growth Act has positively affected our business.
The following provisions of the 2018 Growth Act
may be especially helpful to banks of our size as regulations adopted in 2019
became effective:
•
“qualifying community banks,” defined as institutions with total consolidated
assets of less than $10 billion, which
meet a “community bank leverage ratio” of 8.00% to 10.00%, may be deemed to
have satisfied applicable risk
based capital requirements as well as the capital ratio requirements;
•
section 13(h) of the BHC Act, or the “Volcker
Rule,” is amended to exempt from the Volcker
Rule, banks with
total consolidated assets valued at less than $10 billion (“community banking organizations”),
and trading assets
and liabilities comprising not more than 5.00% of total assets;
•
“reciprocal deposits” will not be considered “brokered deposits” for
FDIC purposes, provided such deposits
do not
exceed the lesser of $5 billion or 20% of the bank’s total
liabilities; and
The Volcker
Rule change may enable us to invest in certain collateralized loan obligations that are treated
as “covered
funds” prohibited to banking entities by the Volcker
Rule. Reciprocal deposits, such as CDARs, may expand our funding
sources without being subjected to FDIC limitations and potential insurance assessments
increases for brokered deposits.
On July 9, 2019, the federal banking agencies, together with the SEC and the
Commodities Futures Trading Commission
(“CFTC”), issued a final rule excluding qualifying community banking organizations
from the Volcker
Rule pursuant to the
2018 Growth Act. The Volcker
Rule change may enable us to invest in certain collateralized loan obligations that are
treated as “covered funds” and other investments prohibited to banking entities by the Volcker
Rule.
The applicable agencies also issued final rules simplifying the Volcker
Rule proprietary trading restrictions effective
January 1, 2020. On June 25, 2020, the agencies adopted a final rule simplifying
the Volcker
Rule’s covered fund
provisions effective October 1, 2020.
The FDIC announced on December 19, 2018 a final rule allows reciprocal deposits to be
excluded from “brokered
deposits” up to the lesser of $5 billion or 20% of their total liabilities.
Institutions that are not both well capitalized and
well rated are permitted to exclude reciprocal deposits from brokered
deposits in certain circumstances.
The FDIC issued comprehensive changes to its brokered deposit rules effective
April 1, 2021. The revised rules establishes
new standards for determining whether an entity meets the statutory definition of
“deposit broker,” and identifies a number
of business that automatically meet the “primary purpose exception” from a
“deposit broker.”
The revisions also provide
an application process for entities that seek a “primary purpose exception,” but do
not meet one of the designated
exceptions.”
The new rules may provide us greater future flexibility,
but we had no brokered deposits at December 31,
2020 or 2021, and historically have not relied on brokered deposits.
On November 20, 2020, the Federal Reserve and the other federal bank regulators
issued temporary relief for community
banks with less than $10 billion in total assets as of December 31, 2019
related to certain regulations and reporting
requirements that largely result from growth due to the various relief and stimulus
actions in response to the COVID-19
pandemic. In particular, the interim final rule permits these
institutions to use asset data as of December 31, 2019, to
determine the applicability of various regulatory asset thresholds during calendar
years 2020 and 2021. For the same
reasons, the Federal Reserve temporarily revised the instructions to a number of its regulatory
reports to provide that
community banking organizations may use asset data as of December
31, 2019, in order to determine reporting
requirements for reports due in calendar years 2020 or 2021.
On November 30, 2020, the bank regulators issued a statement urging banks
to cease entering into new contracts using U.S.
dollar LIBOR rates as soon as practicable and in any event by December 31, 2021,
to effect orderly, and safe and sound
LIBOR transition. Banks were reminded that operating with insufficient
fallback interest rates could undermine financial
stability and banks’ safety and soundness.
Any alternative reference rate may be used that a bank determines is appropriate
for its funding and customer needs.
Alabama passed the LIBOR Discontinuance and Replacement Act of 2021
in April 202
to deal with the LIBOR transition.
Congress is also considering LIBOR transition legislation.
Certain of these new rules, and proposals, if adopted, these proposals could significantly
change the regulation or
operations of banks and the financial services industry.
New regulations and statutes are regularly proposed
that contain
wide-ranging proposals for altering the structures, regulations and competitive
relationships of the nation’s financial
institutions.

---

ITEM 1A. RISK FACTORS
ITEM 1A. RISK FACTORS
Any of the following risks could harm our business, results of operations and financial
condition and an investment in our
stock.
The risks discussed below also include forward-looking statements, and our
actual results may differ substantially
from those discussed in these forward-looking statements.
Operational Risks
Market conditions and economic cyclicality may adversely affect our industry.
We believe the following,
among other things, may affect us in 2022:
●
The COVID-19 pandemic disrupted the economy beginning late in the first quarter
of 2020, and continues.
Auburn University, government
agencies and businesses were limited to remote work and gatherings
were limited.
Supply chains continue to be disrupted and unemployment spiked and remains
high.
Hotels, motels, restaurants,
retail and shopping centers were especially affected.
●
Extraordinary monetary and fiscal stimulus in 2020 and in early 2021
have offset certain of the pandemic’s
adverse economic effects.
Inflation is running at levels unseen in decades and the Federal Reserve is
contemplating raising target interest rates and reducing its securities
holdings.
The nature and timing of any future
changes in monetary and fiscal policies and their effect on us cannot be
predicted.
●
Market developments, including unemployment, price levels, stock and
bond market volatility, and changes,
including those resulting from COVID-19 and the pace of vaccination and expected
declines in serious COVID-19
cases, and Russia’s invasion of Ukraine affect
consumer confidence levels, economic activity and inflation.
Changes in payment behaviors and payment rates may increase in delinquencies and
default rates, which could
affect our earnings and credit quality.
●
Our ability to assess the creditworthiness of our customers and those we do business
with, and the values of our
assets and loan collateral may be adversely affected and less
predictable as a result of the pandemic and
government responses.
The accounting for loan modifications and deferrals may provide only temporary
relief.
The process we use to estimate losses inherent in our credit exposure or estimate the
value of certain assets
requires difficult, subjective, and complex judgments, including
forecasts of economic conditions and how those
economic predictions might affect the ability of our borrowers
to repay their loans or the value of assets.
●
The end of the LIBOR reference rate is currently scheduled for most tenors by June 30, 2023,
although U.S. bank
regulators informed banks November 30, 2020 that they should stop using LIBOR
for new loans and contracts and
derivatives, including hedging, and involves risks of potential marked disruption and costs
of compliance and
conversion.
New hedges may not be as effective as hedges based on LIBOR.
Nonperforming and similar assets take significant time to resolve
and may adversely affect our results of operations
and
financial condition.
Our nonperforming loans were 0.10% of total loans as of December 31,
2021, and we had $0.4 million in other real estate
owned (“OREO”).
Non-performing assets may adversely affect our net income in various
ways.
We do
not record interest
income on nonaccrual loans or OREO and these assets require higher loan administration
and other costs, thereby adversely
affecting our income.
Decreases in the value of these assets, or the underlying collateral, or
in the related borrowers’
performance or financial condition, whether or not due to economic and
market conditions beyond our control, could
adversely affect our business, results of operations and
financial condition.
In addition, the resolution of nonperforming
assets requires commitments of time from management, which can be detrimental
to the performance of their other
responsibilities. Our non-performing assets may be adversely affected
by loan deferrals and modifications made in response
to the pandemic and the moratoria on foreclosures and evictions.
There can be no assurance that we will not experience
increases in nonperforming loans in the future, much of which is affected
by the economy and the levels of interest rates,
generally.
Our allowance for loan losses may prove
inadequate or we may be negatively affected by credit risk exposures.
We periodically review
our allowance for loan losses for adequacy considering economic conditions and
trends, collateral
values and credit quality indicators, including past charge-off experience
and levels of past due loans and nonperforming
assets.
We cannot be
certain that our allowance for loan losses will be adequate over time to
cover credit losses in our
portfolio because of unanticipated adverse changes in the economy,
including the continuing effects of the pandemic and
fiscal and monetary response to COVID-19, loan modifications and deferrals,
market conditions or events adversely
affecting specific customers, industries or markets, including
disruptions of supply chains and war, and changes
in
borrower behaviors.
Certain borrowers may not recover fully or may fail as a result of COVID
-19 effects.
If the credit
quality of our customer base materially decreases, if the risk profile of the
market, industry or group of customers changes
materially or weaknesses in the real estate markets worsen, borrower payment
behaviors change, or if our allowance for
loan losses is not adequate, our business, financial condition, including our liquidity
and capital, and results of operations
could be materially adversely affected.
CECL, a new accounting standard for estimating loan losses, is effective
for the
Company beginning January 1, 2023, and its effects upon the Company
have not yet been determined.
Changes in the real estate markets, including
the secondary market for residential mortgage loans,
may continue to
adversely affect us.
The CFPB’s mortgage and servicing rules,
including TRID rules for closed end credit transactions, enforcement actions,
reviews and settlements, affect the mortgage markets and our
mortgage operations.
The CFPB requires that lenders
determine whether a consumer has the ability to repay a mortgage loan have limited
the secondary market for and liquidity
of many mortgage loans that are not “qualified mortgages.”
Recently adopted changes to the CFPB’s
qualified mortgage
rules are reportedly being reconsidered.
The Tax Cuts and Jobs
Act’s (the “2017 Tax
Act”) limitations on the deductibility of residential mortgage interest and state
and local property and other taxes and federal moratoria on single-family
foreclosures and rental evictions could adversely
affect consumer behaviors and the volumes of housing sales,
mortgage and home equity loan originations, as well as the
value and liquidity of residential property held as collateral by lenders such as the Bank, and
the secondary markets for
single and multi-family loans.
Acquisition, construction and development loans for residential development
may be
similarly adversely affected.
Fannie Mae and Freddie Mac (“GSEs”), have been in conservatorship since September
2008.
Since Fannie Mae and
Freddie Mac dominate the residential mortgage markets, any changes in their
operations and requirements, as well as their
respective restructurings and capital, could adversely affect the
primary and secondary mortgage markets, and our
residential mortgage businesses, our results of operations and the returns on capital
deployed in these businesses.
The
timing and effects of resolution of these government sponsored
enterprises cannot be predicted.
Weaknesses in real estate
markets the FHFA’s
moratoria on foreclosures and real estate owned evictions may adversely
affect the length of time and costs required to manage and dispose
of, and the values realized from the sale of our OREO.
We may be contractually
obligated to repurchase
mortgage loans we sold to third parties on terms unfavorable
to us.
As part of its routine business, the Company originates mortgage loans that it subsequently
sells in the secondary market,
including to governmental agencies and GSEs.
In connection with the sale of these loans, the Company makes customary
representations and warranties, the breach of which may result in the Company
being required to repurchase the loan or
loans.
Furthermore, the amount paid may be greater than the fair value of the loan or loans at the time
of the repurchase.
Although mortgage loan repurchase requests made to us have been limited, if these increased,
we may have to establish
reserves for possible repurchases and adversely affect our results of operation
and financial condition.
Mortgage servicing rights requirements
may change and require
us to incur additional costs and risks.
The CFPB’s residential mortgage servicing
standards may adversely affect our costs to service residential
mortgage loans,
and together with the Basel III Rules and the effects of lower interest rates
from COVID-19 stimulus, may decrease the
returns on, and values of, our MSRs.
This could reduce our income from servicing these types of loans and
make it more
difficult and costly to timely realize the value of collateral securing
such loans upon a borrower default.
In contrast, rising
interest rates would be expected to reduce mortgage refinancings and extend the duration
of our MSRs.
The soundness of other financial institutions could adversely affect us.
We routinely execute
transactions with counterparties in the financial services industry,
including brokers and dealers,
central clearinghouses, banks, including our correspondent banks and other
financial institutions.
Our ability to engage in
routine investment and banking transactions, as well as the quality and values of our investments
in holdings of other
obligations of other financial institutions such as the FHLB, could be adversely affected
by the actions, financial condition,
and profitability of such other financial institutions, including the FHLB
and our correspondent banks.
Financial services
institutions are interrelated as a result of shared credits, trading, clearing, counterparty and
other relationships.
Any losses,
defaults by, or failures of, the institutions
we do business with could adversely affect our holdings of the equity in
such
other institutions, our participation interests in loans originated by other institutions,
and our business, including our
liquidity, financial condition and
earnings.
Our concentration of commercial real
estate loans could result in further increased
loan losses, and adversely affect our
business, earnings, and financial condition.
Commercial real estate, or CRE, is cyclical and poses risks of possible loss due to concentration
levels and risks of the
assets being financed, which include loans for the acquisition and development of land and
residential construction.
The
federal bank regulatory agencies released guidance in 2006 on “Concentrations
in Commercial Real Estate Lending.”
The
guidance defines CRE loans as exposures secured by raw land, land development
and construction loans (including 1-4
family residential construction loans), multi-family property,
and non-farm non-residential property,
where the primary or a
significant source of repayment is derived from rental income associated
with the property (that is, loans for which 50% or
more of the source of repayment comes from third party,
non-affiliated, rental income) or the proceeds of the sale,
refinancing, or permanent financing of the property.
Loans to REITs
and unsecured loans to developers that closely
correlate to the inherent risks in CRE markets are also CRE loans.
Loans on owner occupied commercial real estate are
generally excluded from CRE for purposes of this guidance.
Excluding owner occupied commercial real estate, we had
50.0% of our portfolio in CRE loans at year-end 2021 compared to 43.6% at year-end 2020.
The banking regulators
continue to give CRE lending scrutiny and require banks with higher levels
of CRE loans to implement improved
underwriting, internal controls, risk management policies and portfolio
stress testing, as well as higher levels of allowances
for possible losses and capital levels as a result of CRE lending growth and exposures.
Lower demand for CRE, and
reduced availability of, and higher interest rates and costs for,
CRE lending could adversely affect our CRE loans and sales
of our OREO, and therefore our earnings and financial condition, including our capital and
liquidity.
At year-end 2021, 21% of our total loans were CRE loans to
hotels/motels, retail and shopping centers and restaurants,
businesses that were severely affected
by the effects of COVID-19.
Our future success is dependent on our ability
to compete effectively in highly competitive markets.
The East Alabama banking markets which we operate are
highly competitive and our future growth and success will
depend on our ability to compete effectively in these markets.
We compete for loans, deposits
and other financial services
with other local, regional and national commercial banks, thrifts, credit unions,
mortgage lenders, and securities and
insurance brokerage firms.
Lenders operating nationwide over the internet are growing rapidly.
Many of our competitors
offer products and services different from us, and
have substantially greater resources, name recognition and market
presence than we do, which benefits them in attracting business.
In addition, larger competitors may be able to price loans
and deposits more aggressively than we are able to and have broader and more diverse customer
and geographic bases to
draw upon.
Out of state banks may branch into our markets.
Fintech and other non-bank competitors also complete for our
customers, and may partner with other banks and/or seek to enter the payments system.
Failures of other banks with offices
in our markets could also lead to the entrance of new,
stronger competitors in our markets.
Our success depends on local economic conditions.
Our success depends on the general economic conditions in the geographic
markets we serve in Alabama.
The local
economic conditions in our markets have a significant effect on our
commercial, real estate and construction loans, the
ability of borrowers to repay these loans and the value of the collateral securing these loans.
Adverse changes in the
economic conditions of the Southeastern United States in general, or in one or
more of our local markets, including the
continuous effects from COVID-19 and the timing, strength
and breadth of the recovery from the pandemic, could
negatively affect our results of operations and our profitability.
Our local economy is also affected by the growth of
automobile manufacturing and related suppliers located in our markets and
nearby.
Auto sales are cyclical and are affected
adversely by higher interest rates.
Attractive acquisition opportunities may not be available to us in
the future.
While we seek continued organic growth, we also may consider
the acquisition of other businesses.
We expect that other
banking and financial companies, many of which have significantly
greater resources, will compete with us to acquire
financial services businesses.
This competition could increase prices for potential acquisitions that we believe are
attractive.
Also, acquisitions are subject to various regulatory approvals.
If we fail to receive the appropriate regulatory
approvals, we will not be able to consummate an acquisition that
we believe is in our best interests, and regulatory
approvals could contain conditions that reduce the anticipated benefits of any transaction.
Among other things, our
regulators consider our capital, liquidity,
profitability, regulatory compliance
and levels of goodwill and intangibles when
considering acquisition and expansion proposals.
Any acquisition could be dilutive to our earnings and shareholders’
equity per share of our common stock.
Future acquisitions and expansion activities may
disrupt our business, dilute shareholder
value and adversely affect our
operating results.
We regularly evaluate
potential acquisitions and expansion opportunities, including new branches and
other offices.
To the
extent that we grow through acquisitions, we cannot assure you that
we will be able to adequately or profitably manage this
growth.
Acquiring other banks, branches, or businesses, as well as other geographic and product
expansion activities,
involve various risks including:
●
risks of unknown or contingent liabilities, and potential asset quality issues;
●
unanticipated costs and delays;
●
risks that acquired new businesses will not perform consistent with our growth
and profitability expectations;
●
risks of entering new markets or product areas where we have limited experience;
●
risks that growth will strain our infrastructure, staff, internal
controls and management, which may require
additional personnel, time and expenditures;
●
difficulties, expenses and delays of integrating the operations and personnel of
acquired institutions;
●
potential disruptions to our business;
●
possible loss of key employees and customers of acquired institutions;
●
potential short-term decreases in profitability; and
●
diversion of our management’s
time and attention from our existing operations and business.
Technological
changes affect our business, and we may have fewer resources
than many competitors to invest in
technological improvements.
The financial services industry is undergoing rapid
technological changes with frequent introductions of new technology
driven products and services and growing demands for mobile and user-based
banking applications. In addition to allowing
us to analyze our customers better, the effective
use of technology may increase efficiency and may enable
financial
institutions to reduce costs, risks associated with fraud and compliance
with anti-money laundering and other laws, and
various operational risks. Largely unregulated “fintech” businesses
have increased their participation in the lending and
payments businesses, and have increased competition in these businesses. Our
future success will depend, in part, upon our
ability to use technology to provide products and services that meet our customers’ preferences
and create additional
efficiencies in operations, while avoiding cyber-attacks
and disruptions, data breaches and anti-money laundering
violations. The COVID-19 pandemic and increased remote work has accelerated
electronic banking activity and the need
for increased operational efficiencies.
We
may need to make significant additional capital investments in technology,
including cyber and data security,
and we may not be able to effectively implement new technology
-driven products and
services, or such technology may prove less effective than anticipated.
Many larger competitors have substantially greater
resources to invest in technological improvements and, increasingly,
non-banking firms are using technology to compete
with traditional lenders for loans and other banking services.
As a result, our competition from service providers not
located in our markets has increased.
Operational risks are inherent
in our businesses.
Operational risks and losses can result from internal and external fraud; gaps or
weaknesses in our risk management or
internal audit procedures; errors by employees or third parties, including our
vendors, failures to document transactions
properly or obtain proper authorizations; failure to comply with applicable regulatory requirements
in the various
jurisdictions where we do business or have customers; failures in our estimates
models that rely on; equipment failures,
including those caused by natural disasters, or by electrical, telecommunications
or other essential utility outages; business
continuity and data security system failures, including those caused by computer
viruses, cyberattacks, unforeseen
problems encountered while implementing major new computer systems or,
failures to timely and properly upgrade and
patch existing systems or inadequate access to data or poor response capabilities in
light of such business continuity and
data security system failures; or the inadequacy or failure of systems and controls,
including those of our vendors or
counterparties.
The COVID-19 pandemic presented operational challenges to
maintaining continuity of operations of
customer services while protecting our employees’ and customers’ safety.
In addition, we face certain risks inherent in the
ownership and operation
of our bank premises and other real-estate, including liability for accidents on our properties.
Although we have implemented risk controls and loss mitigation actions, and substantial
resources are devoted to
developing efficient procedures, identifying and rectifying
weaknesses in existing procedures and training staff and
potential environmental risks, it is not possible to be certain that such actions
have been or will be effective in controlling
these various operational risks that evolve continuously.
Potential gaps in our risk management policies and internal audit procedures
may leave us exposed unidentified or
unanticipated risk, which could negatively affect our business.
Our enterprise risk management and internal audit program is designed to
mitigate material risks and loss to us. We
have
developed and continue to develop risk management and internal audit policies
and procedures to reflect the ongoing
review of our risks and expect to continue to do so in the future. Nonetheless, our policies
and procedures may not be
comprehensive and may not identify timely every risk to which we are exposed,
and our internal audit process may fail to
detect such weaknesses or deficiencies in our risk management framework.
Many of our risk management models and
estimates use observed historical market behavior to model or project
potential future exposure.
Models used by our
business are based on assumptions and projections. These models
may not operate properly or our inputs and assumptions
may be inaccurate, or changes in economic conditions, customer behaviors
or regulations.
As a result, these methods may
not fully predict future exposures, which can be significantly greater than
historically.
Other risk management methods
depend upon the evaluation of information regarding markets, clients, or
other matters that are publicly available or
otherwise accessible to us. This information may not always be accurate,
complete, up-to-date or properly evaluated.
Furthermore, there can be no assurance that we can effectively review
and monitor all risks or that all of our employees will
closely follow our risk management policies and procedures, nor can there be any assurance
that our risk management
policies and procedures will enable us to accurately identify all risks and limit our exposures
based on our assessments. In
addition, we may have to implement more extensive
and perhaps different risk management policies and procedures
as our
regulation changes.
For example, the Federal Reserve and the OCC are in the initial stages of proposing
climate risk
management criteria and potential climate risk stress tests.
The SEC is expected to require more disclosure on climate
risks, also.
All of these could adversely affect our financial condition and results
of operations.
Any failure to protect
the confidentiality of customer information could adversely affect our reputation
and have a material
adverse effect on our business, financial condition and results
of operations
.
Various
laws enforced by the bank regulators and other agencies protect the privacy and security of
customers’ non-public
personal information. Many of our employees have access to, and routinely process
personal information of clients through
a variety of media, including information technology systems.
Our internal processes and controls are designed to protect
the confidentiality of client information we hold and that is accessible to us and our employees.
It is possible that an
employee could, intentionally or unintentionally,
disclose or misappropriate confidential client information or our data
could be the subject of a cybersecurity attack.
Such personal data could also be compromised via intrusions into our
systems or those of our service providers or persons we do business with such as credit
bureaus, data processors and
merchants who accept credit or debit cards for payment. If we fail to
maintain adequate internal controls, or if our
employees fail to comply with our policies and procedures, misappropriation
or inappropriate disclosure or misuse of client
information could occur. Such
internal control inadequacies or non-compliance could materially damage our
reputation,
lead to remediation costs and civil or criminal penalties.
These could have a material adverse effect on our business,
financial condition and results of operations.
Our information systems may experience interruptions and
security breaches.
We rely heavily on communications
and information systems, including those provided by third-party service
providers, to
conduct our business.
Any failure, interruption, or security breach of these systems could result in failures
or disruptions
which could affect our customers’ privacy and our customer
relationships, generally.
Our business continuity plans,
including those of our service providers, to provide back-up and restore service
may not be effective in the case of
widespread outages due to severe weather,
natural disasters, pandemics, or power, communications
and other failures.
Our systems and networks, as well as those of our third-party service providers,
are subject to security risks and could be
susceptible to cyber-attacks, such as denial of service attacks,
hacking, terrorist activities or identity theft.
Cybercrime risks
have increased as electronic and mobile banking activities increased as a result
of the COVID-19 pandemic, and may
increase as a result of the Russia invasion of Ukraine.
Other financial service institutions and their service providers have
reported material security breaches in their websites or other systems, some of
which have involved sophisticated and
targeted attacks, including use of stolen access credentials, malware,
ransomware, phishing and distributed denial-of-
service attacks, among other means.
Such cyber-attacks may also seek to disrupt the operations of public companies
or
their business partners, effect unauthorized fund transfers, obtain unauthorized
access to confidential information, destroy
data, disable or degrade service, or sabotage systems.
Denial of service attacks have been launched against a number of
financial services institutions, and we may be subject to these types of attacks in
the future. Hacking and identity theft risks,
in particular, could cause serious reputational harm.
Despite our cybersecurity policies and procedures and our Board
of Director’s and Management’s efforts
to monitor and
ensure the integrity of the system we use, we may not be able to anticipate the rapidly evolving
security threats, nor may we
be able to implement preventive measures effective against
all such threats. The techniques used by cyber criminals change
frequently, may not be recognize
d
until launched and can originate from a wide variety of sources, including outside groups
such as external service providers, organized crime affiliates,
terrorist organizations or hostile foreign governments. These
risks may increase in the future as the use of mobile banking and other internet
electronic banking continues to grow.
Security breaches or failures may have serious adverse financial and other consequences,
including significant legal and
remediation costs, disruptions to operations, misappropriation of confidential information,
damage to systems operated by
us or our third-party service providers, as well as damages to our customers and our
counterparties. In addition, these events
could damage our reputation, result in a loss of customer business, subject us to additional
regulatory scrutiny, or expose
us
to civil litigation and possible financial liability,
any of which could have a material adverse effect on
our financial
condition and results of operations.
We may be unable
to attract and retain key people to support our business.
Our success depends, in large part, on our ability to attract and retain key people.
We compete
with other financial services
companies for people primarily on the basis of compensation and benefits,
support services and financial position. Intense
competition exists for key employees with demonstrated ability,
and we may be unable to hire or retain such employees.
Effective succession planning is also important to our long-term
success. The unexpected loss of services of one or more of
our key persons and failure to ensure effective transfer of knowledge
and smooth transitions involving such persons could
have a material adverse effect on our business due to loss of their skills,
knowledge of our business, their years of industry
experience and the potential difficulty of promptly finding qualified
replacement employees.
Proposed rules implementing the executive compensation provisions of the
Dodd-Frank Act may limit the type and
structure of compensation arrangements and prohibit the payment of “excessive
compensation” to our executives. These
restrictions could negatively affect our ability to compete with other companies
in recruiting and retaining key personnel.
Severe weather and natural disasters, including
as a result of climate change, pandemics, epidemics,
acts of war or
terrorism or other external events could
have significant effects on our business.
Severe weather and natural disasters, including hurricanes, tornados,
drought and floods, epidemics and pandemics, acts of
war or terrorism or other external events could have a significant effect on our
ability to conduct business.
Such events
could affect the stability of our deposit base, impair the ability of borrowers
to repay outstanding loans, impair the value of
collateral securing loans, cause significant property damage, result in loss of revenue
and/or cause us to incur additional
expenses.
Although management has established disaster recovery and business continuity
policies and procedures, the
occurrence of any such event could have a material adverse effect
on our business, which, in turn, could have a material
adverse effect on our financial condition and results of operations.
The COVID-19 pandemic, trade wars, tariffs, and similar events and
disputes, domestic and international, have adversely
affected, and may continue to adversely affect economic
activity globally,
nationally and locally.
Market interest rates have
declined significantly during 2020, and remain low,
but may begin increasing in early 2022 due to inflation.
Such events
also may adversely affect business and consumer confidence,
generally.
We and our customers,
and our respective
suppliers, vendors and processors may be adversely affected
by rising costs and shortages of needed equipment and
supplies.
Any such adverse changes may adversely affect our profitability,
growth asset quality and financial condition.
Financial Risks
Our ability to realize our deferred
tax assets may be reduced in the future
if our estimates of future taxable income from
our operations and tax planning strategies do not support this amount, and the amount
of net operating loss carry-forwards
realizable for income tax purposes may be reduced
under Section 382 of the Internal Revenue Code by sales of our capital
securities.
We are
allowed to carry-back losses for two years for Federal income tax purposes.
As of December 31, 2022, we had a
net deferred tax asset of $0.4 million with gross deferred tax assets of $1.7
million.
These and future deferred tax assets
may be further reduced in the future if our estimates of future taxable income from our
operations and tax planning
strategies do not support the amount of the deferred tax asset.
The amount of net operating loss carry-forwards realizable
for income tax purposes potentially could be further reduced under Section 382
of the Internal Revenue Code by a
significant offering and/or other sales of our capital securities.
Current bank capital rules also reduce the regulatory capital
benefits of deferred tax assets.
Our cost of funds may increase as a result
of general economic conditions, interest rates, inflation
and competitive
pressures.
The Federal Reserve shifted to a more accommodating monetary policy in
Summer 2019. During 2020, the Federal Reserve
reduced its federal funds target to 0-0.25% and has made significant
monthly purchases of U.S. Treasury and agency
mortgage-backed securities to help stimulate the economy,
market interest rates have increased, possibly as a result of
increased government borrowings to finance rounds of fiscal stimulus and
increased inflation expectations resulting from
such stimulus and expected increases in economic growth from fiscal and
monetary stimulus and COVID-19 vaccinations.
Our costs of funds may increase as a result of general economic conditions, increasing
interest rates and competitive
pressures, and potential inflation resulting from continued government deficit spending
and monetary policies, and
anticipated changes by the Federal Reserve to a less accommodative monetary policy.
Traditionally,
we have obtained
funds principally through local deposits and borrowings from other institutional
lenders, which we believe are a cheaper
and more stable source of funds than borrowings.
Increases in interest rates may cause consumers to shift their funds to
more interest bearing instruments and to increase the competition for and costs of
deposits.
If customers move money out
of bank deposits and into other investment assets or from transaction deposits to higher interest
bearing time deposits, we
could lose a relatively low cost source of funds, increasing our funding costs and reducing our
net interest income and net
income. Additionally, any
such loss of funds could result in lower loan originations and growth, which could
materially and
adversely affect our results of operations and financial condition.
Our profitability and liquidity may be
affected by changes in interest rates and interest
rate levels, the shape of the yield
curve and economic conditions.
Our profitability depends upon net interest income, which is the difference
between interest earned on interest-earning
assets, such as loans and investments, and interest expense on interest-bearing liabilities,
such as deposits and borrowings.
Net interest income will be adversely affected if market interest
rates on the interest we pay on deposits and borrowings
increases faster than the interest earned on loans and investments.
Interest rates, and consequently our results of operations,
are affected by general economic conditions (national, international and
local) and fiscal and monetary policies, as well as
expectations of interest rate changes, fiscal and monetary policies and the shape of the
yield curve.
Our income is primarily
driven by the spread between these rates. As a result, a steeper yield curve,
meaning long-term interest rates are
significantly higher than short-term interest rates, would
provide the Bank with a better opportunity to increase net interest
income. Conversely, a
flattening yield curve could further pressure our net interest margin
as our cost of funds increases
relative to the spread we can earn on our assets. In addition, net interest income could
be affected by asymmetrical changes
in the different interest rate indexes, given that not all of our assets or liabilities
are priced with the same index.
The
interest rate reductions by the Federal Reserve and the effects of the
COVID-19 pandemic have reduced market rates,
which adversely affected our net interest income and our results of operations.
The production of mortgages and other loans and the value of collateral
securing our loans are dependent on demand within
the markets we serve, as well as interest rates.
Lower interest rates typically increase mortgage originations, decrease MSR
values, and facilitate pandemic-related trends to single family houses.
Increases in market interest rates would tend to
decrease mortgage originations, increase MSR values and potentially increase
net interest spread depending upon the yield
curve and the magnitude and duration of interest rate increase.
Liquidity risks could affect operations and jeopardize
our financial condition.
Liquidity is essential to our business.
An inability to raise funds through deposits, borrowings, proceeds from loan
repayments or sales proceeds from maturing loans and securities, and other sources
could have a negative effect on our
liquidity.
Our funding sources include federal funds purchased, securities sold under
repurchase agreements, core and non-
core deposits, and short- and long-term debt.
We
maintain a portfolio of securities that can be used as a source of liquidity.
We are
also members of the FHLB and the Federal Reserve Bank of Atlanta, where we can obtain advances
collateralized
with eligible assets.
There are other sources of liquidity available to the Company or the Bank
should they be needed,
including our ability to acquire additional
non-core deposits.
We may be able, depending
upon market conditions, to
otherwise borrow money or issue and sell debt and preferred or common securities in public
or private transactions.
Our
access to funding sources in amounts adequate to finance or capitalize our activities
on terms which are acceptable to us
could be impaired by factors that affect us specifically,
or the financial services industry or the economy in general.
General conditions that are not specific to us, such as disruptions in the financial
markets or negative views and
expectations about the prospects for the financial services industry could
adversely affect us.
The COVID-19 pandemic generally has increased our deposits and at banks, generally,
while reducing the interest rates
earned on loans and securities.
Such excess liquidity and the resulting balance sheet growth requires capital support
and
may reduce returns on assets and equity.
Changes in accounting and tax rules applicable to banks could adversely
affect our financial conditions and results of
operations.
From time to time, the FASB
and the SEC change the financial accounting and reporting standards that govern the
preparation of our financial statements.
These changes can be difficult to predict and can materially impact
how we record
and report our financial condition and results of operations.
In some cases, we could be required to apply a new or revised
standard retroactively, resulting
in us restating prior period financial statements
.
The
FASB’s
guidance under ASU No.
2016-13 includes significant changes to the manner in which banks’ allowance
for loan losses will be effective for us
beginning January 1, 2023.
Instead of using historical losses, the CECL model is forward-looking with respect
to expected
losses over the life of loans and other instruments, and could materially affect our
results of operations and financial
condition, including the variability of our results of operations and our regulatory
capital, notwithstanding a three-year
phase-in of CECL for regulatory capital purposes.
We may need
to raise additional capital in the future, but that capital
may not be available when it is needed or on
favorable terms.
We anticipate that our current
capital resources will satisfy our capital requirements for the foreseeable
future under
currently effective rules.
We may,
however, need to raise additional capital to
support our growth or currently
unanticipated losses, or to meet the needs of our communities, resulting from failures or
cutbacks by our competitors.
Our
ability to raise additional capital, if needed, will depend, among other things,
on conditions in the capital markets at that
time, which are limited by events outside our control, and on our financial performance.
If we cannot raise additional
capital on acceptable terms when needed, our ability to further expand our
operations through internal growth and
acquisitions could be limited.
Our associates may take excessive risks which could negatively affect our financial
condition and business.
Banks are in the business of accepting certain risks.
Our executive officers and other members of management,
sales
intermediaries, investment professionals, product managers, and
other associates, make decisions and choices that involve
exposing us to risk. We endeavor,
in the design and implementation of our compensation programs and practices, to avoid
giving our associates incentives to take excessive risks; however,
associates may nonetheless take such risks.
Similarly,
although we employ controls and procedures designed to prevent misconduct,
to monitor associates’ business decisions and
prevent them from taking excessive risks, these controls and procedures
may not be effective. If our associates take
excessive risks, risks to our reputation, financial condition and business operations
could be materially and adversely
affected.
Our ability to continue to pay dividends to shareholders
in the future is subject to our profitability,
capital, liquidity and
regulatory requirements
and these limitations may prevent or limit future
dividends.
Cash available to pay dividends to our shareholders is derived primarily from dividends paid
to the Company by the Bank.
The ability of the Bank to pay dividends, as well as our ability to pay dividends to our shareholders,
will continue to be
subject to and limited by laws limiting dividend payments by the Bank, the results of operations
of our subsidiaries and our
need to maintain appropriate liquidity and capital at all levels of our business consistent
with regulatory requirements and
the needs of our businesses.
See “Supervision and Regulation”.
A limited trading market exists for our common shares,
which could result in price volatility.
Your
ability to sell or purchase common shares depends upon the existence of an active trading
market for our common
stock.
Although our common stock is quoted on the Nasdaq Global Market under the trading
symbol “AUBN,” our historic
trading volume has been limited historically.
As a result, you may be unable to sell or purchase shares of our common
stock at the volume, price and time that you desire.
Additionally, whether the purchase
or sales prices of our common stock
reflects a reasonable valuation of our common stock also is affected
by limited trading market, and thus the price you
receive for a thinly-traded stock such as our common stock, may not reflect its true or intrinsic
value.
The limited trading
market for our common stock may cause fluctuations in the market value of our common
stock to be exaggerated, leading
to price volatility in excess of that which would occur in a more active trading
market.
Legal and Regulatory Risks
The Company is an entity separate and distinct from
the Bank.
The Company is an entity separate and distinct from the Bank. Company transactions
with the Bank are limited by Sections
23A and 23B of the Federal Reserve Act and Federal Reserve Regulation
W.
We depend upon the Bank’s
earnings and
dividends, which are limited by law and regulatory policies and actions, for cash to pay the
Company’s debt and corporate
obligations, and to pay dividends to our shareholders.
If the Bank’s ability to pay dividends to the Company
was
terminated or limited, the Company’s liquidity
and financial condition could be materially and adversely affected.
Legislative and regulatory changes
The Biden Administration is appointing new members to FDIC and Federal
Reserve Board, and has appointed an acting
Comptroller of the Currency and a new full time CFPB director.
This Administration and its appointees propose changes to
bank regulation and corporate tax changes that could have an adverse effect
on our results of operations and financial
conditions.
We are
subject to extensive regulation that could limit or restrict
our activities and adversely affect our earnings.
We and our subsidiaries are
regulated by several regulators, including the Federal Reserve, the
Alabama Superintendent,
the SEC and the FDIC.
Our success is affected by state and federal laws and regulations affecting
banks and bank holding
companies, and the securities markets, and our costs of compliance could adversely affect
our earnings.
Banking
regulations are primarily intended to protect depositors, and the FDIC Deposit Insurance
Fund (“DIF”), not shareholders.
The financial services industry also is subject to frequent legislative and regulatory
changes and proposed changes.
In
addition, the interpretations of regulations by regulators may change and statutes
may be enacted with retroactive impact.
From time to time, regulators raise issues during examinations of us which,
if not determined satisfactorily,
could have a
material adverse effect on us. Compliance with applicable
laws and regulations is time consuming and costly and may
affect our profitability. The
position of the President and his administration that took office
in January 2021 with respect to
regulation of banks and bank holding companies is not yet fully known, but
their views and actions could have a material
adverse effect on financial services regulation, generally.
Litigation and regulatory actions could harm
our reputation and adversely affect our results
of operations and financial
condition.
A substantial legal liability or a significant regulatory action against us, as well as regulatory
inquiries or investigations,
could harm our reputation, result in material fines or penalties, result in significant
legal and other costs, divert management
resources away from our business, and otherwise have a material adverse
effect on our ability to expand on our existing
business, financial condition and results of operations. Even if we ultimately
prevail in litigation, regulatory investigation or
action, our ability to attract new customers, retain our current customers and recruit and
retain employees could be
materially and adversely affected. Regulatory inquiries and litigation
may also adversely affect the prices or volatility of
our securities specifically, or the
securities of our industry,
generally.
We are
required to maintain
capital to meet regulatory requirements,
and if we fail to maintain sufficient capital, our
financial condition, liquidity and results of operations
would be adversely affected.
We and the Bank
must meet regulatory capital requirements and maintain sufficient
liquidity, including liquidity
at the
Company, as well as the Bank.
If we fail to meet these capital and other regulatory requirements, including
more rigorous
requirements arising from our regulators’ implementation of Basel III,
our financial condition, liquidity and results of
operations would be materially and adversely affected.
Our failure to remain “well capitalized” and “well managed”,
including meeting the Basel III capital conservation buffers,
for bank regulatory purposes, could affect customer
confidence, our ability to grow, our
costs of funds and FDIC insurance, our ability to raise brokered deposits,
our ability to
pay dividends on our common stock and our ability to make acquisitions, and
we may no longer meet the requirements for
becoming a financial holding company.
These could also affect our ability to use discretionary bonuses
to attract and retain
quality personnel.
The Basel III Capital Rules include a minimum ratio of common equity
tier 1 capital, or CET1, to risk-
weighted assets of 4.5% and a capital conservation buffer of 2.5% of risk-weighted
assets.
See
“Supervision and
Regulation-Basel III Capital Rules.”
Although we currently have capital ratios that exceed all these minimum levels and
a strategic plan to maintain these levels, we or the Bank may be unable to continue
to satisfy the capital adequacy
requirements for various reasons, which may include:
•
losses and/or increases in the Bank’s credit
risk assets and expected losses resulting from the deterioration in the
creditworthiness of borrowers and the issuers of equity and debt securities;
•
difficulty in refinancing or issuing instruments upon redemption or
at maturity of such instruments to raise capital
under acceptable terms and conditions;
•
declines in the value of our securities portfolios;
•
revisions to the regulations or their application by our regulators that increase our capital requirements;
•
reduced total earnings on our assets will reduce our internal generation of capital
available to support our balance
sheet growth;
•
reductions in the value of our MSRs and DTAs;
and other adverse developments; and
•
unexpected growth and an inability to increase capital timely.
A failure to remain “well capitalized,” for bank regulatory purposes, including
meeting the Basel III Capital Rule’s
conservation buffer, could adversely affect
customer confidence, and our:
•
ability to grow;
•
the costs of and availability of funds;
•
FDIC deposit insurance premiums;
•
ability to raise or replace brokered deposits;
•
ability to pay or increase dividends on our capital stock.
•
ability to make discretionary bonuses to attract and retain quality personnel;
•
ability to make acquisitions or engage in new activities;
•
flexibility if we become subject to prompt corrective action restrictions;
•
ability to make payments of principal and interest on our capital instruments; and
The Federal Reserve may require
us to commit capital resources
to support the Bank.
As a matter of policy, the Federal
Reserve expects a bank holding company to act as a source of financial and
managerial
strength to a subsidiary bank and to commit resources to support such subsidiary bank. The
Federal Reserve may require a
bank holding company to make capital injections into a troubled subsidiary bank.
In addition, the Dodd-Frank Act amended
the FDI Act to require that all companies that control a FDIC-insured depository institution
serve as a source of financial
strength to their depository institution subsidiaries. Under these requirements,
we could be required to provide financial
assistance to the Bank should it experience financial distress, even if further investment
was not otherwise warranted. See
“Supervision and Regulation.”
Our operations are subject to risk of loss from
unfavorable fiscal, monetary and political developments in the
U.S.
Our businesses and earnings are affected by the fiscal, monetary and other
policies and actions of various U.S.
governmental and regulatory authorities. Changes in these are beyond our control
and are difficult to predict and,
consequently, changes in these
policies could have negative effects on our activities and results of operations.
Failures of
the executive and legislative branches to agree on spending plans and budgets previously
have led to Federal government
shutdowns, which may adversely affect the U.S. economy.
Additionally, any prolonged
government shutdown may inhibit
our ability to evaluate the economy,
generally, and affect
government workers who are not paid during such events, and
where the absence of government services and data could adversely affect consumer
and business sentiment, our local
economy and our customers and therefore our business.
Litigation and regulatory investigations are
increasingly common in our businesses and may result
in significant financial
losses and/or harm to our reputation.
We face risks of litigation
and regulatory investigations and actions in the ordinary course of operating
our businesses,
including the risk of class action lawsuits. Plaintiffs in class
action and other lawsuits against us may seek very large and/or
indeterminate amounts, including punitive and treble damages. Due to the vagaries of litigation,
the ultimate outcome of
litigation and the amount or range of potential loss at particular points in time may be difficult
to ascertain. We
do not have
any material pending litigation or regulatory matters affecting
us.
Failures to comply with the fair lending laws, CFPB regulati
ons or the Community Reinvestment Act, or CRA, could
adversely affect us.
The Bank is subject to, among other things, the provisions of the Equal Credit Opportunity
Act, or ECOA, and the Fair
Housing Act, both of which prohibit discrimination based on race or
color, religion, national origin, sex and familial status
in any aspect of a consumer, commercial credit or
residential real estate transaction. The DOJ and the federal bank
regulatory agencies have issued an Interagency Policy Statement on Discrimination
in Lending have provided guidance to
financial institutions to evaluate whether discrimination exists and how the
agencies will respond to lending discrimination,
and what steps lenders might take to prevent discriminatory lending practices.
Failures to comply with ECOA, the Fair
Housing Act and other fair lending laws and regulations, including CFPB
regulations, could subject us to enforcement
actions or litigation, and could have a material adverse effect
on our business financial condition and results of operations.
Our Bank is also subject to the CRA and periodic CRA examinations. The CRA requires
us to serve our entire
communities, including low-
and moderate-income neighborhoods. Our CRA ratings could
be adversely affected by actual
or alleged violations of the fair lending or consumer financial protection
laws. Even though we have maintained an
“satisfactory” CRA rating since 2000, we cannot predict our future CRA ratings.
Violations of fair lending laws or if our
CRA rating falls to less than “satisfactory” could adversely affect
our business, including expansion through branching or
acquisitions.
COVID-19 Risks
The COVID-19 pandemic may continue to adversely affect our business, financial
condition and results of operations. The
ultimate effects of the pandemic on us will depend on the severity,
scope and duration of the pandemic, its cumulative
economic effects, governmental actions in response
to the pandemic, and the restoration of a more
normal economy.
The COVID-19 national health emergency has significantly disrupted
the United States and international economies and
financial markets. We
expect that the COVID-19 pandemic and its effects
will continue to adversely affect our business,
financial condition and results of operations in future periods. The spread of COVID-19
has caused illness, quarantines,
cancellation of events and travel, business and school shutdowns, reductions in business
activity and financial transactions,
supply chain interruptions and overall economic and financial market instability.
The State of Alabama and many other
states have taken preventative and protective actions, such as imposing a statewide
mask mandate, restrictions on travel,
business operations, public gatherings, social distancing, advising or requiring
individuals to limit or forego their time
outside of their homes, and ordering temporary closures of non-essential businesses.
Though various of these measures
have been relaxed or eliminated, the pandemic has moved in disruptive and unpredictable
waves.
The travel, hospitality and food and beverage industries, restaurants, retailers and auto
manufacturers, and their suppliers
have been severely affected. A significant number of layoffs,
furloughs of employees, as well as remote work have
occurred in these and other industries, including government offices, schools and
universities. Auburn University held
virtual classes only from March 16, 2020 through the summer session.
The auto industry’s production
and sales continue to
be adversely affected
by supply chain disruptions.
Hyundai and Kia are major direct and indirect employers in our area.
The ultimate effects of the COVID-19 pandemic on the economy,
generally, our markets, and on us cannot
be predicted.
The timing and effects of the COVID-19 pandemic on our business, results
of operations and financial condition may
include, among various other consequences, the following. These effects
depend on the severity, scope
and duration of the
pandemic, its cumulative economic effects, and the effectiveness
of healthcare, business and governmental actions
addressing the pandemic’s effects,
including vaccinations.
•
Employees’ health could be adversely affected, necessitating their recovery
away from work;
•
Unavailability of key personnel necessary to conduct our business activities;
•
Our operating effectiveness may be reduced as our employees
work from home or suffer from the COVID-19
virus;
•
Shelter in place, remote work or other restrictions and interruptions of our business and contact
with our
customers;
•
Sustained closures of our branch lobbies or the offices of our customers;
•
Declines in demand for loans and other banking services and products, and reduced usage
and interchange fees
on our payment cards;
•
Continuing large scale fiscal and monetary stimulus actions
may stabilize the economy, but
may increase
economic and market risks, including valuation “bubbles,” volatility in various assets and
inflation;
•
Inflation and increases in interest rates may result from fiscal stimulus and
monetary stimulus, and the Federal
Reserve has indicated it is willing to permit inflation to run moderately above its 2% target
for some time, but is
considering raising interest rates and reducing its securities holdings as a result of inflation
that is substantially
higher than the Federal
Reserve’s target range;
•
Increased savings and debt reduction by consumers could reduce demand for credit
and our earning assets;
•
Significant volatility in United States financial markets and our investment securities
portfolio, including credit
concerns in municipal securities;
•
Declines in the credit quality of our loan portfolio, owing to the effects
of the COVID-19 pandemic in the
markets we serve, leading to increased provisions for loan losses and increases in our allowance
for possible
credit losses;
•
Declines in the value of collateral for loans, including real estate collateral, especially in industries
such as
travel, hospitality, restaurants
and retailers;
•
Declines in the net worth and liquidity of borrowers, impairing their ability to pay timely their
loan obligations
to us;
•
Generally low market interest rates that reduce our net interest income and our profitability;
•
Loan deferrals and loan modifications, and mortgage foreclosure
moratoria, including those mandated by law,
or
which are encouraged by our regulators, may increase our expense and risks of collectability,
reduce our cash
flows and liquidity and adversely affect our results of operations and
financial condition;
•
The end of temporary regulatory accounting and capital relief for banks regarding the effects
of the COVID-19
pandemic, including loan deferrals and modifications, could increase our TDRs and require
additions to our
allowance for loan losses, which may adversely affect our income,
financial condition and capital;
•
Our waiver of various fees and service charges to support our customers
and communities will adversely affect
our results of operation and our liquidity and financial position;
•
The COVID-19 pandemic may change customer financial behaviors and
payment practices. Electronic banking
could become more popular with less customers doing business at our offices;
•
Certain of our assets, including loans and securities, may become impaired,
which would adversely affect our
results of operation and financial condition and mortgage loan foreclosure
moratoria may limit our ability to
timely act to protect our interests in the loan collateral;
•
Reductions in income or losses will adversely affect our capital and growth
of capital, including our capital for
bank regulatory purposes;
•
Losses or reductions in net income may adversely affect the growth or
amount of dividends we can pay on our
common stock;
•
The effects of government fiscal and monetary policies, including
changes in such policies, or the effects of
COVID-19 relief programs are discontinued, on the economy and financial stability,
generally, and on our
business, results of operations and financial condition cannot be predicted;
•
Cybercriminals may increase their attempts to compromise business and consumer
emails, including an increase
in phishing attempts, and fraudulent vendors or other parties may view the pandemic
as an opportunity to prey
upon consumers and businesses during this time.
•
The restoration of financial stability and economic growth may depend
on the health care system developing and
deploying COVID-19 testing and contact tracing, and delivery of COVID-19 vaccines,
which promote consumer
and employee health and confidence in the economy.
These factors, together or in combination with other events or occurrences that are unknown
or anticipated, may materially
and adversely affect our business, financial condition and results of operations.
Our stock price may reflect securities market conditions
The ongoing COVID-19
pandemic has resulted in substantial securities market volatility,
especially for bank stocks and
has, and may continue to, adversely affect the market of our common
stock. The spread, intensification and duration of
COVID-19 pandemic, as well as the effectiveness of governmental,
fiscal and monetary policies, and regulatory responses
to the pandemic, further affect the financial markets and the market prices
for securities generally, and the
market prices for
bank stocks, including our common stock.
The stock market’s gains due to a concentration
of high growth companies has
been adversely affected by inflation and expectation of higher interest rates and
the Russia invasion of Ukraine in February
2022.
The COVID-19 global pandemic could result in
deterioration of asset quality and an increase in credit
losses.
Many businesses have had, and may continue to have lower revenues and cash
flows and many consumers will have lower
income as a result of COVID-19. These could result in an inability to repay loans timely in
full, reduce our asset quality and
reduce our deposits. Loan modifications and payment deferrals may also increase
our credit risks, especially when
temporary regulatory relief for these actions expires. Our business, results of operations, liquidity
and financial condition
could be adversely affected.
As a participating lender in the PPP,
the Bank is subject to additional risks of litigation from the
Bank’s
customers or other
parties regarding
the Bank’s
processing of loans for the PPP and risks that the SBA may
not fund some or all PPP loan
guaranties.
The CARES Act, Paycheck Protection Program and Healthcare Enhancement
Act and Economic Aid Act appropriated
more than $1 trillion in funding for PPP loans administered through by the SBA and
the U.S. Department of the Treasury.
Under the PPP,
eligible small businesses and other entities and individuals can apply for loans from existing
SBA lenders
and other approved PPP lenders, subject to numerous limitations and eligibility
criteria. The Bank is participating as a
lender in the PPP and made a total of $56.7 million of PPP loans in 2020 and 2021.
The PPP loans charge 1% interest
annually.
Forgiveness of these loans has been slow,
and PPP loans earn less than market rates.
Since the opening of the
PPP,
various banks have been subject to litigation regarding the process and procedures used in processing applications
for
the PPP,
and greater governmental attention is directed at preventing fraud.
We may be exposed
to similar litigation risks,
from both customers and non-customers that approached the Bank regarding PPP
loans we extended. If any such litigation
is filed against the Bank and is not resolved favorably to the Bank, it may result in financial
liability or adversely affect our
reputation. Litigation can be costly, regardless
of outcome. Any financial liability,
litigation costs or reputational damage
caused by PPP related litigation could have a material adverse effect on our
business, financial condition and results of
operations.
The Bank also has credit risk on PPP loans, if the SBA determines deficiencies
in the manner in which PPP loans were
originated, funded or serviced by the Bank, such as an issue with the eligibility of a borrower to
receive a PPP loan, or
obtain forgiveness of a PPP properly,
including those related to the ambiguities in the laws, rules and guidance
regarding
the PPP’s operation. In the event of a loss resulting
from a default on a PPP loan and a determination by the SBA that there
were one or more deficiencies in the manner in which the PPP loan was originated,
funded, or serviced by the Company,
the SBA may deny its liability under the PPP loan guaranty,
reduce the amount of the guaranty, or,
if it has already paid
under the guaranty, seek recovery of any
loss related to the deficiency from the Company.
Similar issues may also result in
the denial of forgiveness of PPP loans, which could expose us to potential borrower
bankruptcies and potential losses and
additional costs.
At December 31, 2021 we had $8.1 million PPP loans outstanding and had not realized
any losses on such loans.

---

ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 1B. UNRESOLVED
STAFF COMMENTS
None.

---

ITEM 2. PROPERTIES
ITEM 2. DESCRIPTION OF PROPERTY
The Bank conducts its business from its main office and seven full-service
branches.
The Bank also operates loan
production offices in Auburn and Phenix City,
Alabama.
The Bank owns its main campus in downtown Auburn, Alabama, which comprises
over 5 acres and includes the Bank's
temporary main office, operations center,
drive-through facility,
and parking deck.
The operations center, built as a theater
in 1968, and remodeled by the Bank after purchasing it in 1985, has approximately 23,000
square feet of space. All of the
Bank’s loan servicing, data processing activities,
and other operations, are located in the operations building.
Currently,
the
Bank’s temporary main office
is located in the operations center as the Bank completes Phase I of its main campus
redevelopment plan.
The temporary main office branch offers the full line of the Bank’s
services and has one ATM.
The
Bank’s drive-through facility located
on the main office campus was constructed in October 2012.
This drive-through
facility has five drive-through lanes, including an ATM,
and a walk-up teller window.
Phase I of the redevelopment plan includes the construction of a new headquarters building,
the AuburnBank Center, and a
parking deck.
Construction activities for Phase I commenced during the second half of 2020
and the parking deck was
completed in April of 2021.
The parking deck has approximately 500 parking spaces, is open to the public and charges
hourly, monthly,
and special event rates, and is expected to provide for future parking needs on the Bank’s
main campus,
including the new headquarters building.
The new headquarters building will have approximately 90,000
square feet of
space and is expected to be complete in the second quarter of 2022.
Upon completion of Phase I, the Bank’s main office,
Auburn loan production office, and all of its back-office operations
will be relocated to the new headquarters building.
The
Bank expects to lease approximately 46,000 square feet of office space
and approximately 5,000 square feet of retail space
in the new headquarters building to third party tenants.
In January 2019, the Bank purchased a parcel that adjoins the operations center in order
to improve ingress and egress to
the Bank’s main campus.
The building improvements currently on this adjoining parcel, as
well as the operations building,
will be demolished under Phase II of the Bank's campus redevelopment plan.
In February 2022, the Company entered into
an agreement, subject to a 180 day inspection period and customary closing conditions,
to sell this combined parcel of
approximately 0.85 acres to a hotel developer.
As part of the agreement, the Bank will negotiate a long-term lease with the
hotel developer for 100 to 150 parking spaces in the Bank’s
parking deck.
Upon closing, the Company currently expects
this sale to be accretive to 2022 earnings by approximately $0.70 per share.
The Opelika branch is located in Opelika, Alabama. This branch, built in 1991,
is owned by the Bank and has
approximately 4,000 square feet of space. This branch offers the full line of the
Bank’s services and has drive-through
windows and an ATM.
This branch offers parking for approximately 36 vehicles.
The Bank’s Notasulga branch was opened
in August 2001. This branch is located in Notasulga, Alabama, about 15
miles
west of Auburn, Alabama. This branch is owned by the Bank and has approximately 1,344
square feet of space. The Bank
leased the land for this branch from a third party.
In May 2021,
the Bank’s land lease renewed for another one
year term.
This branch offers the full line of the Bank’s
services including safe deposit boxes and a drive-through window.
This
branch offers parking for approximately 11
vehicles, including a handicapped ramp.
In November 2002, the Bank opened a loan production office
in Phenix City, Alabama, about 35
miles south of Auburn,
Alabama. In November 2020,
the Bank renewed its lease for another year.
In February 2009, the Bank opened a branch located on Bent Creek Road in Auburn,
Alabama. This branch is owned by the
Bank and has approximately 4,000 square feet of space. This branch offers
the full line of the Bank’s services and
has
drive-through windows and a drive-up ATM.
This branch offers parking for approximately 29 vehicles.
In December 2011, the Bank opened a branch located
on Fob James Drive in Valley,
Alabama, about 30 miles northeast of
Auburn, Alabama.
This branch is owned by the Bank and has approximately 5,000 square feet of space.
This branch offers
the full line of the Bank’s services and has drive-through
windows and a drive-up ATM.
This branch offers parking for
approximately 35 vehicles.
Prior to December 2011, the Bank leased office
space for a loan production office in Valley,
Alabama.
The loan production office was originally opened in September 2004.
In February 2015, the Bank relocated its Auburn Kroger branch to a new location within the
Corner Village Shopping
Center, in Auburn, Alabama. In February 2015,
the Bank entered into a new lease agreement for five years with options for
two 5-year extensions. In February 2020, the Bank exercised its option to renew the lease
for another five years. The Bank
leases approximately 1,500 square feet of space for the Corner Village
branch. Prior to relocation, the Bank’s
Auburn
Kroger branch was located in the Kroger supermarket in the same shopping center.
The Auburn Kroger branch was
originally opened in August 1988. The Corner Village
branch offers the full line of the Bank’s
deposit and other services
including an ATM,
except safe deposit boxes.
In September 2015, the Bank relocated its Auburn Wal
-Mart Supercenter branch to a new location the Bank purchased in
December 2014 at the intersection of S. Donahue Avenue
and E. University Drive in Auburn, Alabama.
The South
Donahue branch, built in 2015, has approximately 3,600 square feet of space.
Prior to relocation, the Bank’s Auburn
Wal-
Mart Supercenter branch was located inside the Wal
-Mart shopping center on the south side of Auburn, Alabama.
The
Auburn Wal-Mart Supercenter
branch was originally opened in September 2000. The South Donahue branch offers
the full
line of the Bank’s services and has drive-through
windows and an ATM.
This branch offers parking for approximately 28
vehicles.
In May 2017, the Bank relocated its Opelika Kroger branch to a new location the Bank purchased
in August 2016 near the
Tiger Town
Retail Shopping Center and the intersection of U.S. Highway 280 and Frederick
Road in Opelika, Alabama.
The Tiger Town
branch, built in 2017, has approximately 5,500 square feet of space.
Prior to relocation, the Bank’s
Opelika Kroger branch was located inside the Kroger supermarket in the Tiger
Town retail center in Opelika,
Alabama. The
Opelika Kroger branch was
originally opened in July 2007. The Tiger Town
branch offers the full line of the Bank’s
services and has drive-through windows and an ATM.
This branch offers parking for approximately 36 vehicles.
In September 2018, the Bank opened a loan production office on East Samford
Avenue in Auburn,
Alabama.
The location
has approximately 2,500 square feet of space and is leased through 2028.
The loan production office was previously
located in the Center on the Bank’s
main campus. This location offers parking for approximately
16 vehicles.

---

ITEM 3. LEGAL PROCEEDINGS
ITEM 3.
LEGAL PROCEEDINGS
In the normal course of its business, the Company and the Bank from time to time are involved
in legal proceedings. The
Company’s management believe
there are no pending or threatened legal proceedings that, upon resolution, are expected
to
have a material adverse effect upon the Company’s
or the Bank’s financial condition
or results of operations.

---

ITEM 4. MINE SAFETY DISCLOSURE
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
PART
II

---

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY,
RELATED STOCKHOLDER
MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s Common Stock is listed
on the Nasdaq Global Market, under the symbol “AUBN”. As of March 7, 2022,
there were approximately 3,516,971 shares of the Company’s
Common Stock issued and outstanding, which were held by
approximately 369 shareholders of record. The following table sets forth, for the indicated
periods, the high and low closing
sale prices for the Company’s Common Stock
as reported on the Nasdaq Global Market, and the cash dividends declared to
shareholders during the indicated periods.
Closing
Cash
Price
Dividends
Per Share (1)
Declared
High
Low
First Quarter
$
48.00
$
37.55
$
0.26
Second Quarter
38.90
34.50
0.26
Third Quarter
35.36
33.25
0.26
Fourth Quarter
34.79
31.32
0.26
First Quarter
$
59.99
$
24.11
$
0.255
Second Quarter
63.40
36.81
0.255
Third Quarter
56.80
26.26
0.255
Fourth Quarter
43.00
36.75
0.255
(1)
The price information represents actual transactions.
The Company has paid cash dividends on its capital stock since 1985. Prior to this time, the
Bank paid cash dividends since
its organization in 1907, except during the Depression years of 1932
and 1933. Holders of Common Stock are entitled to
receive such dividends as may be declared by the Company’s
Board of Directors. The amount and frequency of cash
dividends will be determined in the judgment of the Board based upon a number of
factors, including the Company’s
earnings, financial condition, capital requirements and other relevant factors.
The Board currently intends to continue its
present dividend policies.
Federal Reserve policy could restrict future dividends on our Common Stock, depending
on our earnings and capital
position and likely needs. See “Supervision and Regulation - Payment of Dividends”
and “Management’s Discussion
and
Analysis of Financial Condition and Results of Operations - Capital Adequacy”.
The amount of dividends payable by the Bank is limited by law and regulation.
The need to maintain adequate capital in
the Bank also limits dividends that may be paid to the Company.
Performance Graph
The following performance graph compares the cumulative, total return on the
Company’s Common Stock
from
December 31, 2016 to December 31, 2021, with that of the Nasdaq Composite Index and
SNL Southeast Bank Index
(assuming a $100 investment on December 31, 2016). Cumulative total return represents
the change in stock price and the
amount of dividends received over the indicated period, assuming the reinvestment of
dividends.
Period Ending
Index
12/31/2016
12/31/2017
12/31/2018
12/31/2019
12/31/2020
12/31/2021
Auburn National Bancorporation, Inc.
100.00
127.56
106.32
182.85
146.96
117.06
NASDAQ Composite Index
100.00
129.64
125.96
172.18
249.51
304.85
S&P U.S. BMI Banks - Southeast Region Index
100.00
123.70
102.20
144.05
129.15
184.47
Issuer Purchases of Equity Securities
Period
Total Number of
Shares Purchased
Average Price Paid
per Share
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
The Approximate
Dollar Value
of Shares
that May Yet
Be Under
the Plans or
Programs(1)
October 1 - October 31, 2021
1,684
33.85
1,684
3,623,268
November 1 - November 30, 2021
7,169
33.85
7,169
3,380,597
December 1 - December 31, 2021
--
--
--
3,380,597
Total
8,853
33.85
8,853
3,380,597
(1) On March 9, 2021 the Company adopted a $5 million stock repurchase program that became effective April 1, 2021.
Securities Authorized for Issuance Under Equity Compensation Plans
See the information included under Part III, Item 12, which is incorporated
in response to this item by reference.
Unregistered Sale of Equity Securities
Not applicable.

---

ITEM 6. SELECTED FINANCIAL DATA
ITEM 6.
SELECTED FINANCIAL DATA
See Table 2 “Selected Financial
Data” and general discussion in Item 7, “Management’s
Discussion and Analysis of
Financial Condition and Results of Operations”.

---

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF
OPERATIONS
The following is a discussion of our financial condition at December 31,
2021 and 2020 and our results of operations for
the years ended December 31, 2021 and 2020. The purpose of this discussion is to provide
information about our financial
condition and results of operations which is not otherwise apparent from the
consolidated financial statements. The
following discussion and analysis should be read along with our consolidated
financial statements and the related notes
included elsewhere herein. In addition, this discussion and analysis contains forward-looking
statements, so you should
refer to Item 1A, “Risk Factors” and “Special Cautionary Notice Regarding Forward-Looking Statements”.
OVERVIEW
The Company was incorporated in 1990 under the laws of the State of Delaware and became a bank
holding company after
it acquired its Alabama predecessor,
which was a bank holding company established in 1984. The Bank, the Company's
principal subsidiary, is an Alabama
state-chartered bank that is a member of the Federal Reserve System and has operated
continuously since 1907. Both the Company and the Bank are headquartered
in Auburn, Alabama. The Bank conducts its
business primarily in East Alabama, including Lee County and surrounding areas.
The Bank operates full-service branches
in Auburn, Opelika, Notasulga and Valley,
Alabama.
The Bank also operates loan production offices in Auburn and
Phenix City, Alabama.
Summary of Results of Operations
Year ended December 31
(Dollars in thousands, except per share data)
Net interest income (a)
$
24,460
$
24,830
Less: tax-equivalent adjustment
Net interest income (GAAP)
23,990
24,338
Noninterest income
4,288
5,375
Total revenue
28,278
29,713
Provision for loan losses
(600)
1,100
Noninterest expense
19,433
19,554
Income tax expense
1,406
1,605
Net earnings
$
8,039
$
7,454
Basic and diluted net earnings per share
$
2.27
$
2.09
(a) Tax-equivalent.
See "Table 1 - Explanation of Non-GAAP Financial Measures".
Financial Summary
The Company’s net earnings were $8.0
million for the full year 2021, compared to $7.5 million for the full year 2020.
Basic and diluted net earnings per share were $2.27 per share for the full year 2021,
compared to $2.09 per share for the full
year 2020.
Net interest income (tax-equivalent) was $24.5
million in 2021, a 1% decrease compared to $24.8 million in 2020. This
decrease was primarily due to net interest margin compression
,
partially offset by balance sheet growth.
Net interest
margin (tax-equivalent) decreased to 2.55% in 2021,
compared to 2.92% in 2020, primarily due to the lower interest rate
environment and changes in our asset mix resulting from the significant increase
in deposits from government stimulus and
relief programs and customers’ increased savings.
At December 31, 2021, the Company’s allowance
for loan losses was $4.9 million, or 1.08% of total loans, compared to
$5.6 million, or 1.22%
of total loans, at December 31, 2020.
Excluding
Paycheck Protection Program (“PPP”) loans, which
are guaranteed by the SBA,
the Company’s allowance for loan losses
was 1.10% and 1.27% of total loans at December 31,
2021 and 2020, respectively
.
The Company recorded a negative provision for loan losses of $0.6
million in 2021 compared
to a charge of $1.1 million during 2020.
The negative provision for loan losses was primarily related to improvements in
economic conditions in our primary market area, and related improvements in our
asset quality.
The provision for loan
losses is based upon various estimates and judgements, including the absolute level
of loans, loan growth, credit quality and
the amount of net charge-offs.
Net charge-offs as a percent of average loans were 0.02% in 2021
,
compared to net
recoveries as a percent of average loans of 0.03% in 2020.
Noninterest income was $4.3 million in 2021 compared to $5.4
million in 2020.
The decrease was primarily due to a $0.8
million decrease in mortgage lending income in 2021 as refinance activity declined
in our primary market area and a $0.3
million non-taxable death benefit from bank-owned life insurance received
in 2020.
Noninterest expense was $19.4
million in 2021 compared to $19.6
million in 2020. The decrease was primarily due to a
reduction of $0.8
million in various expenses related to the redevelopment of the Company’s
headquarters in downtown
Auburn.
This decrease was mostly offset by increases in salaries and benefits expe
nse of $0.4 million and a $0.2 million
increase in FDIC and other regulatory assessments during 2021.
Income tax expense was $1.4
million in 2021 and $1.6 million in 2020 reflecting an effective tax rate of 14.89
%
and
17.72%, respectively.
This decrease was primarily due to an income tax benefit related to a New Markets Tax
Credit
investment funded in the fourth quarter of 2021.
The Company’s effective income
tax rate is principally impacted by tax-
exempt earnings from the Company’s investments
in municipal securities, bank-owned life insurance, and New Markets
Tax Credits.
The Company paid cash dividends of $1.04
per share in 2021, an increase of 2% from 2020. At December 31, 2021, the
Bank’s regulatory capital ratios
were well above the minimum amounts required to be “well capitalized” under current
regulatory standards with a total risk-based capital ratio of 17.06%,
a tier 1 leverage ratio of 9.35% and common equity tier
1 (“CET1”) of 16.23% at December 31, 2021.
COVID-19 Impact Assessment
The COVID-19 pandemic has occurred in waves of different
variants since the first quarter of 2020.
Vaccines
to protect
against and/or reduce the severity of COVID-19 were widely introduced at the beginning
of 2021.
At times, the pandemic
has severely restricted the level of economic activity in our markets. In response to the COVID
-19 pandemic, the State of
Alabama, and most other states, have taken preventative or protective actions to prevent the
spread of the virus, including
imposing restrictions on travel and business operations and a statewide mask mandate,
advising or requiring individuals to
limit or forego their time outside of their homes, limitations on gathering of people and social distancing,
and causing
temporary closures of businesses that have been deemed to be non-essential. Though certain
of these measures have been
relaxed or eliminated, especially as vaccination levels increased, such
measures could be reestablished in cases of new
waves, especially a wave of a COVID-19 variant that is more resistant
to existing vaccines.
COVID-19 has significantly affected local state, national and global
health and economic activity and its future effects are
uncertain and will depend on various factors, including, among others, the duration
and scope of the pandemic, especially
new variants of the virus, effective vaccines and drug treatments, together
with governmental, regulatory and private sector
responses. COVID-19 has had continuing significant effects
on the economy, financial
markets and our employees,
customers and vendors. Our business, financial condition and results of operations
generally rely upon the ability of our
borrowers to make deposits and repay their loans, the value of collateral underlying our
secured loans, market value,
stability and liquidity and demand for loans and other products and services we offer,
all of which are affected by the
pandemic.
We have implemented
a number of procedures in response to the pandemic to support the safety and well-being of our
employees, customers and shareholders.
•
We believe our business continuity
plan has worked to provide essential banking services to our communities and
customers, while protecting our employees’ health.
As part of our efforts to exercise social distancing in
accordance with the guidelines of the Centers for Disease Control and the Governor
of the State of Alabama,
starting March 23, 2020, we limited branch lobby service to appointment only while continuing
to operate our
branch drive-thru facilities and ATMs.
As permitted by state public health guidelines, on June 1, 2020, we re-
opened some of our branch lobbies.
In 2021, we opened our remaining branch lobbies.
We continue to provide
services through our online and other electronic channels.
In addition, we maintain remote work access to help
employees stay at home while providing continuity of service.
•
We are focused on servicing
the financial needs of our commercial and consumer clients with extensions
and
deferrals to loan customers effected by COVID-19, provided
such customers were not more than 30 days past due
at the time of the request; and
•
We
were an active PPP lender. PPP loans were forgivable,
in whole or in part, if the proceeds are used for payroll
and other permitted purposes in accordance with the requirements of the PPP.
These loans carry a fixed rate of
1.00% and a term of two years (loans made before June 5, 2020) or five years (loans
made on or after June 5,
2020), if not forgiven, in whole or in part.
Payments are deferred until either the date on which the Small Business
Administration (“SBA”) remits the amount of forgiveness proceeds
to the lender or the date that is 10 months after
the last day of the covered period if the borrower does not apply for forgiveness
within that 10-month period.
We
believe these loans and our participation in the program helped our customers and the communities
we serve.
COVID-19 has also had various economic effects, generally.
These include supply chain disruptions and manufacturing
delays, shortages of certain goods and services, reduced consumer expenditure on
hospitality and travel, and migration from
larger urban centers to less populated areas and remote work.
The demand for single family housing has exceeded existing
supplies.
When coupled with construction delays attributable to supply chain disruptions
and worker shortages, these
factors have caused housing prices and apartment rents to increase, generally.
Stimulative monetary and fiscal policy,
along with shortages of certain goods and services, and rising petroleum and food prices
have led to the highest inflation in
decades.
Although fiscal stimulus remains under consideration by the President and Congress,
the Federal Reserve is
considering increasing its target interest rates and reducing its holding of
securities to stem inflation.
A summary of PPP loans extended during 2020 follows:
(Dollars in thousands)
# of SBA
Approved
Mix
$ of SBA
Approved
Mix
SBA Tier:
$2 million to $10 million
-
-
%
$
-
-
%
$350,000 to less than $2 million
14,691
Up to $350,000
21,784
Total
%
$
36,475
%
We collected
approximately $1.5 million in fees related to our PPP loans during 2020.
Through December 31, 2021, we
have recognized all of these fees, net of related costs.
As of December 31, 2021, we had received payments and
forgiveness on all PPP loans extended during 2020.
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits,
and Venues
Act (the “Economic Aid
Act”) was signed into law. The
Economic Aid Act provides a second $900 billion stimulus package, including
$325 billion
in additional PPP loans.
The Economic Aid Act also permits the collection of a higher amount of PPP
loan fees by
participating banks.
A summary of PPP loans extended during 2021 under the Economic Aid
Act follows:
(Dollars in thousands)
# of SBA
Approved
Mix
$ of SBA
Approved
Mix
SBA Tier:
$2 million to $10 million
-
-
%
$
-
-
%
$350,000 to less than $2 million
6,494
Up to $350,000
13,757
Total
%
$
20,251
%
We collected
approximately $1.0 million in fees related to PPP loans under the Economic Aid Act.
Through December 31,
2021, we have recognized $0.7 million of these fees, net of related costs.
As of December 31, 2021, we have received
payments and forgiveness on 116
PPP loans under the Economic Aid Act, totaling $12.1 million.
The outstanding balance
for the remaining 138 PPP loans under the Economic Aid Act
was approximately $8.1 million at December 31, 2021.
We continue to closely
monitor this pandemic, and are working to continue our services during the pandemic
and to address
developments as those occur.
Our results of operations for year ended December 31, 2021, and our financial condition
at
that date reflect only the ongoing effects of the pandemic, and
may not be indicative of future results or financial
conditions, including possible changes in monetary or fiscal stimulus, and
the possible effects of the expiration or extension
of temporary accounting and bank regulatory relief measures in response to the
COVID-19 pandemic.
As of December 31, 2021,
all of our capital ratios were in excess of all regulatory requirements to be well capitalized.
The
effects of the COVID-19 pandemic on our borrowers could result in adverse changes
to credit quality and our regulatory
capital ratios.
We continue to
closely monitor this pandemic, and are working to continue our services during the pandemic
and to address developments as those occur.
CRITICAL ACCOUNTING POLICIES
The accounting and financial reporting policies of the Company conform
with U.S. generally accepted accounting
principles and with general practices within the banking industry.
In connection with the application of those principles, we
have made judgments and estimates which, in the case of the determination of our allowance
for loan losses, our
assessment of other-than-temporary impairment, recurring and
non-recurring fair value measurements, the valuation of
other real estate owned, and the valuation of deferred tax assets, were critical to the determination
of our financial position
and results of operations. Other policies also require subjective judgment and assumptions
and may accordingly impact our
financial position and results of operations.
Allowance for Loan Losses
The Company assesses the adequacy of its allowance for loan losses prior
to the end of each calendar quarter. The level of
the allowance is based upon management’s
evaluation of the loan portfolio, past loan loss experience, current asset quality
trends, known and inherent risks in the portfolio, adverse situations that may affect
a borrower’s ability to repay (including
the timing of future payment), the estimated value of any underlying collateral,
composition of the loan portfolio, economic
conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory
recommendations. This
evaluation is inherently subjective as it requires material estimates including the
amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible to significant change. Loans are
charged off, in whole or
in part, when management believes that the full collectability of the loan is unlikely.
A loan may be partially charged-off
after a “confirming event” has occurred which serves to validate that full repayment pursuant
to the terms of the loan is
unlikely.
The Company deems loans impaired when, based on current information and events, it is
probable that the Company will
be unable to collect all amounts due according to the contractual terms of the loan agreement.
Collection of all amounts due
according to the contractual terms means that both the interest and principal payments of a
loan will be collected as
scheduled in the loan agreement.
An impairment allowance is recognized if the fair value of the loan is less than the recorded
investment in the loan. The
impairment is recognized through the allowance. Loans that are impaired are
recorded at the present value of expected
future cash flows discounted at the loan’s effective
interest rate, or if the loan is collateral dependent, impairment
measurement is based on the fair value of the collateral, less estimated disposal costs.
The level of allowance maintained is believed by management to be adequate
to absorb probable losses inherent in the
portfolio at the balance sheet date. The allowance is increased by provisions charged
to expense and decreased by charge-
offs, net of recoveries of amounts previously charged-off.
In assessing the adequacy of the allowance, the Company also considers the results of its
ongoing internal, independent
loan review process. The Company’s loan
review process assists in determining whether there are loans in the portfolio
whose credit quality has weakened over time and evaluating the risk characteristics of the
entire loan portfolio. The
Company’s loan review process includes the judgment
of management, the input from our independent loan reviewers, and
reviews that may have been conducted by bank regulatory agencies as part of their examination
process. The Company
incorporates loan review results in the determination of whether or not it is probable
that it will be able to collect all
amounts due according to the contractual terms of a loan.
As part of the Company’s quarterly assessment
of the allowance, management divides the loan portfolio into five segments:
commercial and industrial, construction and land development, commercial real estate, residential
real estate, and consumer
installment loans. The Company
analyzes each segment and estimates an allowance allocation for each loan
segment.
The allocation of the allowance for loan losses begins with a process of estimating the
probable losses inherent for these
types of loans. The estimates for these loans are established by category and based
on the Company’s internal system of
credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s
internal system of
credit risk grades is based on its experience with similarly graded loans. For
loan segments where the Company believes it
does not have sufficient historical loss data, the Company may
make adjustments based, in part, on loss rates of peer bank
groups. At December 31, 2021 and 2020, and for the years then ended, the Company adjusted
its historical loss rates for the
commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.
The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s
estimate of
probable losses for several “qualitative and environmental” factors.
The allocation for qualitative and environmental
factors is particularly subjective and does not lend itself to exact mathematical calculation.
This amount represents
estimated probable inherent credit losses which exist, but have not yet been identified, as of
the balance sheet date, and are
based upon quarterly trend assessments in delinquent and nonaccrual loans, credit
concentration changes, prevailing
economic conditions, changes in lending personnel experience, changes in lending
policies or procedures and other
influencing factors.
These qualitative and environmental factors are considered for each of the five loan segments
and the
allowance allocation, as determined by the processes noted above, is increased or
decreased based on the incremental
assessment of these factors.
The Company regularly re-evaluates its practices in determining the allowance
for loan losses. Since the fourth quarter of
2016, the Company has increased its look-back period each quarter to incorporate
the effects of at least one economic
downturn in its loss history. The Company believes
the extension of its look-back period is appropriate due to the risks
inherent in the loan portfolio. Absent this extension, the early cycle periods in
which the Company experienced significant
losses would be excluded from the determination of the allowance for loan losses and its balance
would decrease. For the
year ended December 31, 2021, the Company increased its look-back period to
51 quarters to continue to include losses
incurred by the Company beginning with the first quarter of 2009. The Company
will likely continue to increase its look-
back period to incorporate the effects of at least one economic downturn in
its loss history. During 2020,
the Company
adjusted certain qualitative and economic factors related to changes in economic conditions
driven by the impact of the
COVID-19 pandemic and resulting adverse economic conditions, including
higher unemployment in our primary market
area.
During 2021, the Company adjusted certain qualitative and economic factors to reflect
improvements in economic
conditions in our primary market area.
Further adjustments may be made in the future as a result of the ongoing COVID-19
pandemic.
Assessment for Other-Than-Temporary
Impairment of Securities
On a quarterly basis, management makes an assessment to determine
whether there have been events or economic
circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily
impaired.
For debt securities with an unrealized loss, an other-than-temporary
impairment write-down is triggered when (1) the
Company has the intent to sell a debt security,
(2) it is more likely than not that the Company will be required to sell the
debt security before recovery of its amortized cost basis, or (3) the Company does not expect
to recover the entire amortized
cost basis of the debt security.
If the Company has the intent to sell a debt security or if it is more likely than not that it
will
be required to sell the debt security before recovery,
the other-than-temporary write-down is equal to the entire difference
between the debt security’s amortized cost
and its fair value.
If the Company does not intend to sell the security or it is not
more likely than not that it will be required to sell the security before recovery,
the other-than-temporary impairment write-
down is separated into the amount that is credit related (credit loss component) and the amount due
to all other factors.
The
credit loss component is recognized in earnings and is the difference between
the security’s amortized cost basis and
the
present value of its expected future cash flows.
The remaining difference between the security’s
fair value and the present
value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive
income, net of applicable taxes.
The Company is required to own certain stock as a condition of membership, such as
Federal Home Loan Bank (“FHLB”)
and Federal Reserve Bank (“FRB”).
These non-marketable equity securities are accounted for at cost
which equals par or
redemption value.
These securities do not have a readily determinable fair value as their ownership is restricted and
there is
no market for these securities.
The Company records these non-marketable equity securities as a component
of other
assets, which are periodically evaluated for impairment. Management considers
these non-marketable equity securities to
be long-term investments. Accordingly,
when evaluating these securities for impairment, management considers
the
ultimate recoverability of the par value rather than by recognizing temporary declines in
value.
Fair Value
Determination
U.S. GAAP requires management to value and disclose certain of the Company’s
assets and liabilities at fair value,
including investments classified as available-for-sale and derivatives.
ASC 820,
Fair Value
Measurements and Disclosures
,
which defines fair value, establishes a framework for measuring fair value in accordance
with U.S. GAAP and expands
disclosures about fair value measurements.
For more information regarding fair value measurements and disclosures,
please refer to Note 14, Fair Value,
of the consolidated financial statements that accompany this report.
Fair values are based on active market prices of identical assets or liabilities when available.
Comparable assets or
liabilities or a composite of comparable assets in active markets are used when identical assets
or liabilities do not have
readily available active market pricing.
However, some of the Company’s
assets or liabilities lack an available or
comparable trading market characterized by frequent transactions between
willing buyers and sellers. In these cases, fair
value is estimated using pricing models that use discounted cash flows and
other pricing techniques. Pricing models and
their underlying assumptions are based upon management’s
best estimates for appropriate discount rates, default rates,
prepayments, market volatility and other factors, taking into account current observable
market data and experience.
These assumptions may have a significant effect on the reported
fair values of assets and liabilities and the related income
and expense. As such, the use of different models and assumptions, as
well as changes in market conditions, could result in
materially different net earnings and retained earnings results.
Other Real Estate Owned
Other real estate owned (“OREO”), consists of properties obtained through foreclosure or
in satisfaction of loans and is
reported at the lower of cost or fair value, less estimated costs to sell at the date acquired with any loss
recognized as a
charge-off through the allowance for loan losses. Additional
OREO losses for subsequent valuation adjustments are
determined on a specific property basis and are included as a component of other noninterest
expense along with holding
costs. Any gains or losses on disposal of OREO are also reflected in noninterest expense.
Significant judgments and
complex estimates are required in estimating the fair value of OREO, and the period of time
within which such estimates
can be considered current is significantly shortened during periods of
market volatility. As a result, the net proceeds
realized from sales transactions could differ significantly from
appraisals, comparable sales, and other estimates used to
determine the fair value of OREO.
Deferred Tax
Asset Valuation
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available
evidence, it is more-likely-
than-not that some portion or the entire deferred tax asset will not be realized. The
ultimate realization of deferred tax assets
is dependent upon the generation of future taxable income during the periods
in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred
tax liabilities, projected future taxable income and tax
planning strategies in making this assessment. Based upon the level of taxable income over
the last three years and
projections for future taxable income over the periods in which the deferred tax assets are
deductible, management believes
it is more likely than not that we will realize the benefits of these deductible differences
at December 31, 2021. The amount
of the deferred tax assets considered realizable, however,
could be reduced if estimates of future taxable income are
reduced.
Average Balance
Sheet and Interest Rates
Year ended December 31
Average
Yield/
Average
Yield/
(Dollars in thousands)
Balance
Rate
Balance
Rate
Loans and loans held for sale
$
459,712
4.45%
$
465,378
4.74%
Securities - taxable
320,766
1.28%
234,420
1.68%
Securities - tax-exempt (a)
62,736
3.57%
63,029
3.72%
Total securities
383,502
1.66%
297,449
2.11%
Federal funds sold
38,659
0.15%
30,977
0.41%
Interest bearing bank deposits
77,220
0.13%
56,104
0.41%
Total interest-earning assets
959,093
2.81%
849,908
3.38%
Deposits:
NOW
178,197
0.12%
154,431
0.34%
Savings and money market
296,708
0.22%
242,485
0.44%
Certificates of deposits
159,111
1.03%
165,120
1.36%
Total interest-bearing deposits
634,016
0.39%
562,036
0.68%
Short-term borrowings
3,349
0.51%
1,864
0.48%
Total interest-bearing liabilities
637,365
0.39%
563,900
0.68%
Net interest income and margin (a)
$
24,460
2.55%
$
24,830
2.92%
(a) Tax-equivalent.
See "Table 1 - Explanation of Non-GAAP
Financial Measures".
RESULTS
OF OPERATIONS
Net Interest Income and Margin
Net interest income (tax-equivalent) was $24.5 million in 2021, compared
to $24.8 million in 2020.
This decrease was due
to a decline in the Company’s net interest
margin (tax-equivalent),
partially offset by balance sheet growth.
The tax-equivalent yield on total interest-earning assets decreased by 57 basis points
in 2021 from 2020 to 2.81%.
This
decrease was primarily due to the lower rate environment and changes in our asset
mix from the significant increase in
deposits from government stimulus and relief programs and customers’ increased savings.
The cost of total interest-bearing liabilities decreased 29 basis points to 0.39%
in 2021 compared to 0.68 in 2020.
The net
decrease in our funding costs was primarily due to lower prevailing market interest rates.
Our funding costs declined less
than the rates earned on our interest earning assets.
The Company continues to deploy various asset liability management strategies
to manage its risk to interest rate
fluctuations. The Company’s
net interest margin could experience pressure due to reduced earning asset
yields and
increased competition for quality loan opportunities.
Provision for Loan Losses
The provision for loan losses represents a charge to earnings necessary to provide
an allowance for loan losses that
management believes, based on its processes and estimates, should be adequate
to provide for the probable losses on
outstanding loans. The Company recorded a negative provision for loan losses of $0.6
million during 2021, compared to
$1.1 million in provision for loan losses during 2020.
The negative provision for loan losses was primarily related to
improvements in economic conditions in our primary market area.
The provision for loan losses is based upon various
factors, including the absolute level of loans, loan growth, the credit quality,
and the amount of net charge-offs or
recoveries.
Based upon its assessment of the loan portfolio, management adjusts the allowance
for loan losses to an amount it believes
should be appropriate to adequately cover its estimate of probable losses in the loan portfolio.
The Company’s allowance
for loan losses as a percentage of total loans was 1.08% at December 31, 2021, compared
to 1.22% at December 31, 2020.
Excluding PPP loans, which are guaranteed by the SBA, the Company’s
allowance for loan losses was 1.10% and 1.27% of
total loans at December 31, 2021 and 2020, respectively.
While the policies and procedures used to estimate the allowance
for loan losses, as well as the resulting provision for loan losses charged to operations,
are considered adequate by
management and are reviewed from time to time by our regulators, they are based on estimates
and judgments and are
therefore approximate and imprecise. Factors beyond our control (such as conditions
in the local and national economy,
local real estate markets, or industries) may have a material adverse effect
on our asset quality and the adequacy of our
allowance for loan losses resulting in significant increases in the provision
for loan losses.
Noninterest Income
Year ended December 31
(Dollars in thousands)
Service charges on deposit accounts
$
$
Mortgage lending
1,547
2,319
Bank-owned life insurance
Securities gains, net
Other
1,757
1,644
Total noninterest income
$
4,288
$
5,375
The decrease in service charges on deposit accounts was primarily driven by a decline
in consumer spending activity as a
result of the COVID-19 pandemic.
The Company’s income from mortgage lending
is primarily attributable to the (1) origination and sale of new mortgage
loans and (2) servicing of mortgage loans. Origination income, net, is comprised of gains
or losses from the sale of the
mortgage loans originated, origination fees, underwriting fees and other fees associated
with the origination of loans, which
are netted against the commission expense associated with these originations. The
Company’s normal practice is to
originate mortgage loans for sale in the secondary market and to either sell or
retain the MSRs when the loan is sold.
MSRs are recognized based on the fair value of the servicing right on the date the corresponding
mortgage loan is sold.
Subsequent to the date of transfer, the Company
has elected to measure its MSRs under the amortization method.
Servicing
fee income is reported net of any related amortization expense.
The Company evaluates MSRs for impairment on a quarterly basis.
Impairment is determined by grouping MSRs by
common predominant characteristics, such as interest rate and loan type.
If the aggregate carrying amount of a particular
group of MSRs exceeds the group’s aggregate fair
value, a valuation allowance for that group is established.
The valuation
allowance is adjusted as the fair value changes.
An increase in mortgage interest rates typically results in an increase in the
fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease
in the fair value of MSRs.
The following table presents a breakdown of the Company’s
mortgage lending income for 2021 and 2020.
Year ended December 31
(Dollars in thousands)
Origination income
$
1,417
$
2,300
Servicing fees, net
Total mortgage lending income
$
1,547
$
2,319
The Company’s income from mortgage lending
typically fluctuates as mortgage interest rates change and is primarily
attributable to the origination and sale of new mortgage loans. Origination income
decreased in 2021 compared to 2020 due
to a decrease in refinance activity in our primary market.
The decrease in origination income was partially offset by an
increase in servicing fees, net of related amortization expense as prepayment
speeds slowed during 2021, resulting in
decreased amortization expense.
Income from bank-owned life insurance decreased primarily due to $0.3
million in non-taxable death benefits received in
2020. The assets that support these policies are administered by the life insurance carriers
and the income we receive (i.e.,
increases or decreases in the cash surrender value of the policies and death benefits received)
on these policies is dependent
upon the returns the insurance carriers are able to earn on the underlying investments that
support these policies. Earnings
on these policies are generally not taxable.
Noninterest Expense
Year ended December 31
(Dollars in thousands)
Salaries and benefits
$
11,710
$
11,316
Net occupancy and equipment
1,743
2,511
Professional fees
1,052
FDIC and other regulatory assessments
Other
4,559
4,419
Total noninterest expense
$
19,433
$
19,554
The increase in salaries and benefits expense was primarily due to a decrease in deferred
costs related to the PPP loan
program, routine annual wage and benefit increases, and management increasing the
minimum hourly wage for banking
positions to $15.
The decrease in net occupancy and equipment was primarily due to a reduction
of various expenses related to the
redevelopment of the Company’s headquarters
in downtown Auburn.
This amount includes revised depreciation estimates
and other temporary relocation costs. For more information regarding changes
in accounting estimates, please refer to Note
1, Summary of Significant Accounting Policies, of the consolidated financial statements
that accompany this report.
The increase in FDIC and other regulatory assessments was primarily due to the expiration
of FDIC assessment credits
during 2020 and an increased assessment base during 2021.
Income Tax
Expense
Income tax expense was $1.4 million in 2021 and $1.6 million in 2020.
The Company’s effective income
tax rate was
14.89% in 2021, compared to 17.72% in 2020.
This change was primarily due to an income tax benefit related to a New
Markets Tax Credit investment
funded in the fourth quarter of 2021.
The Company’s effective income
tax rate is
principally impacted by tax-exempt earnings from the Company’s
investments in municipal securities, bank-owned life
insurance, and New Markets Tax
Credits.
BALANCE SHEET ANALYSIS
Securities
Securities available-for-sale were $421.9
million at December 31, 2021, compared to $335.2 million at December 31, 2020.
This increase reflects an increase in the amortized cost basis of securities available-for-sale
of $95.7 million, and a decrease
of $9.0 million in the fair value of securities available-for-sale.
The increase in the amortized cost basis of securities
available-for-sale was primarily attributable to management
allocating more funding to the investment portfolio following
the significant increases in customer deposits. The decrease in the fair value of securities
was primarily due to an increase
in long-term interest rates. The average annualized tax-equivalent
yields earned on total securities were 1.66%
in 2021 and
2.11%
in 2020.
The following table shows the carrying value and weighted average yield of securities available
-for-sale as of December
31, 2021 according to contractual maturity.
Actual maturities may differ from contractual maturities of mortgage-backed
securities (“MBS”) because the mortgages underlying the securities may be called
or prepaid with or without penalty.
December 31, 2021
1 year
1 to 5
5 to 10
After 10
Total
(Dollars in thousands)
or less
years
years
years
Fair Value
Agency obligations
$
5,007
49,604
69,802
-
124,413
Agency MBS
-
35,855
186,836
223,371
State and political subdivisions
15,743
57,547
74,107
Total available-for-sale
$
5,177
50,931
121,400
244,383
421,891
Weighted average yield (1):
Agency obligations
2.00%
1.36%
1.31%
-
1.36%
Agency MBS
-
3.42%
1.48%
1.34%
1.37%
State and political subdivisions
4.25%
2.85%
2.18%
2.77%
2.64%
Total available-for-sale
2.07%
1.40%
1.47%
1.68%
1.59%
(1) Yields are calculated based on amortized cost.
Loans
December 31
(In thousands)
Commercial and industrial
$
83,977
82,585
Construction and land development
32,432
33,514
Commercial real estate
258,371
255,136
Residential real estate
77,661
84,154
Consumer installment
6,682
7,099
Total loans
459,123
462,488
Less:
unearned income
(759)
(788)
Loans, net of unearned income
$
458,364
461,700
Total loans, net of unearned income,
were $458.4 million at December 31, 2021, and $461.7 million at December
31, 2020.
Excluding PPP loans, total loans, net of unearned income, were $450.5
million, an increase of $7.5 million, or 2% from
December 31, 2020.
This increase was primarily due to an increase in commercial and industrial loans
,
net of PPP,
of
$12.2 million, partially offset by a decrease in residential real estate loans of
$6.5 million, as lower rates increased refinance
activity and payoffs for consumer mortgage loans.
Four loan categories represented the majority of the loan portfolio at
December 31, 2021: commercial real estate (56%), residential real estate (17%),
commercial and industrial (18%) and
construction and land development (7%).
Approximately 25% of the Company’s commercial
real estate loans were
classified as owner-occupied at December 31, 2021.
Within the residential real estate portfolio
segment, the Company had junior lien mortgages of approximately $7.2 million,
or 2%, and $8.7 million, or 2%, of total loans, net of unearned income at December 31,
2021 and 2020, respectively.
For
residential real estate mortgage loans with a consumer purpose, the Company
had no loans that required interest only
payments at December 31, 2021 and 2020. The Company’s
residential real estate mortgage portfolio does not include any
option ARM loans, subprime loans, or any material amount of other high-risk consumer
mortgage products.
The average yield earned on loans and loans held for sale was 4.45% in 2021
and 4.74% in 2020.
The specific economic and credit risks associated with our loan portfolio include,
but are not limited to, the effects of
current economic conditions, including the COVID-19 pandemic’s
effects, on our borrowers’ cash flows, real estate market
sales volumes, valuations, availability and cost of financing properties,
real estate industry concentrations, competitive
pressures from a wide range of other lenders, deterioration in certain credits, interest rate
fluctuations, reduced collateral
values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration
of borrowers, fraud, and any
violation of applicable laws and regulations.
The Company attempts to reduce these economic and credit risks through its loan-to-value
guidelines for collateralized
loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial
position. Also, we have
established and periodically review,
lending policies and procedures. Banking regulations limit a bank’s
credit exposure by
prohibiting unsecured loan relationships that exceed 10% of its capital; or 20%
of capital, if loans in excess of 10% of
capital are fully secured. Under these regulations, we are prohibited from having secured
loan relationships in excess of
approximately $21.0 million. Furthermore, we have an internal limit
for aggregate credit exposure (loans outstanding plus
unfunded commitments) to a single borrower of $18.9
million. Our loan policy requires that the Loan Committee of the
Board of Directors approve any loan relationships that exceed this internal limit.
At December 31, 2021, the Bank had no
relationships exceeding these limits.
We periodically analyze
our commercial loan portfolio to determine if a concentration of credit
risk exists in any one or
more industries. We
use classification systems broadly accepted by the financial services industry in
order to categorize our
commercial borrowers. Loan concentrations to borrowers in the following classes
exceeded 25% of the Bank’s total risk-
based capital at December 31, 2021 (and related balances at December 31,
2020).
December 31
(In thousands)
Lessors of 1-4 family residential properties
$
47,880
$
49,127
Hotel/motel
43,856
42,900
Multi-family residential properties
42,587
40,203
Shopping centers
29,574
30,000
In light of disruptions in economic conditions caused by COVID-19, the financial regulators
have issued guidance
encouraging banks to work constructively with borrowers affected
by the virus in our community.
This guidance, including
the Interagency Statement on COVID-19 Loan Modifications and the Interagency Examiner
Guidance for Assessing Safety
and Soundness Considering the Effect of the COVID-19
Pandemic on Institutions, provides that the agencies will not
criticize financial institutions that mitigate credit risk through prudent actions
consistent with safe and sound practices.
Specifically, examiners
will not criticize institutions for working with borrowers as part of a risk
mitigation strategy
intended to improve existing loans, even if the restructured loans have or develop
weaknesses that ultimately result in
adverse credit classification.
Upon demonstrating the need for payment relief, the bank will work with qualified borrowers
that were otherwise current before the pandemic to determine the most appropriate
deferral option.
For residential
mortgage and consumer loans the borrower may elect to defer payments for up to three
months.
Interest continues to
accrue and the amount due at maturity increases.
Commercial real estate, commercial, and small business borrowers may
elect to defer payments for up to three months or pay scheduled interest payments for a
six-month period.
The bank
recognizes that a combination of the payment relief options may be prudent dependent
on a borrower’s business type.
As
of December 31, 2021, we had one COVID-19 loan deferral totaling $0.1
million, compared to $32.3 million, or 7% of total
loans at December 31, 2020.
The tables below provide information concerning the composition of these COVID-19
modifications as of December 31,
2021 and 2020.
COVID-19 Modifications
Modification Types
(Dollars in thousands)
# of Loans
Modified
Balance
% of Portfolio
Modified
Interest Only
Payment
P&I
Payments
Deferred
December 31, 2021:
Residential real estate
$
-
-
%
Total
$
-
%
-
%
%
December 31, 2020:
Commercial and industrial
$
-
%
%
-
%
Commercial real estate
31,399
-
Residential real estate
-
-
Total
$
32,273
%
%
%
COVID-19 Modifications within Commercial Real Estate
Segment
(Dollars in thousands)
# of Loans
Modified
Balance of
Loans Modified
% of Total
Loan Class
December 31, 2020:
Hotel/motel
$
26,427
%
Multifamily
3,530
Restaurants
1,442
There were no COVID-19 modifications within the commercial real estate segment at December
31, 2021.
Section 4013 of the CARES Act provides that a qualified loan modification is exempt by law
from classification as a TDR
pursuant to GAAP.
In addition, the Interagency Statement on COVID-19 Loan Modifications provides
circumstances in
which a loan modification is not subject to classification as a TDR if such loan is not eligible
for modification under
Section 4013.
Allowance for Loan Losses
The Company maintains the allowance for loan losses at a level that management believes
appropriate to adequately cover
the Company’s estimate of probable
losses inherent in the loan portfolio. The
allowance for loan losses was $4.9 million at
December 31, 2021 compared to $5.6 million at December 31, 2020,
which management believed to be adequate at each of
the respective dates. The judgments and estimates associated
with the determination of the allowance for loan losses are
described under “Critical Accounting Policies.”
A summary of the changes in the allowance for loan losses and certain asset quality ratios
for the years ended December 31,
2021 and 2020 are presented below.
Year ended December 31
(Dollars in thousands)
Allowance for loan losses:
Balance at beginning of period
$
5,618
4,386
Charge-offs:
Commercial and industrial
-
(7)
Commercial real estate
(254)
-
Residential real estate
(3)
-
Consumer installment
(37)
(38)
Total charge
-offs
(294)
(45)
Recoveries:
Commercial and industrial
Residential real estate
Consumer installment
Total recoveries
Net (charge-offs) recoveries
(79)
Provision for loan losses
(600)
1,100
Ending balance
$
4,939
5,618
as a % of loans
1.08
%
1.22
as a % of nonperforming loans
1,112
%
1,052
Net charge-offs (recoveries) as a % of average loans
0.02
%
(0.03)
As described under “Critical Accounting Policies”, management assesses the adequacy
of the allowance prior to the end of
each calendar quarter. The level of the allowance
is based upon management’s evaluation
of the loan portfolios, past loan
loss experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower’s ability to repay
(including the timing of future payment), the estimated value of any underlying
collateral, composition of the loan
portfolio, economic conditions, industry and peer bank loan loss rates, and other
pertinent factors. This evaluation is
inherently subjective as it requires various material estimates and judgments including
the amounts and timing of future
cash flows expected to be received on impaired loans that may be susceptible to
significant change. The ratio of our
allowance for loan losses to total loans outstanding was 1.08% at December 31,
2021, compared to 1.22% at December 31,
2020.
Excluding PPP loans, which are guaranteed by the SBA, the Company’s
allowance for loan losses was 1.10% and
1.27% of total loans at December 31, 2021 and 2020, respectively.
In the future, the allowance to total loans outstanding
ratio will increase or decrease to the extent the factors that influence our quarterly allowance
assessment, including the
duration and magnitude of COVID-19 effects, in their entirety either improve
or weaken.
In addition our regulators, as an
integral part of their examination process, will periodically review the Company’s
allowance for loan losses, and may
require the Company to make additional provisions to the allowance for loan losses based
on their judgment about
information available to them at the time of their examinations.
Nonperforming Assets
At December 31, 2021 the Company had $0.8
million in nonperforming assets compared to $0.5
million at December 31,
2020.
The table below provides information concerning total nonperforming assets
and certain asset quality ratios.
December 31
(Dollars in thousands)
Nonperforming assets:
Nonperforming (nonaccrual) loans
$
Other real estate owned
-
Total nonperforming assets
$
as a % of loans and other real estate owned
0.18
%
0.12
as a % of total assets
0.07
%
0.06
Nonperforming loans as a % of total loans
0.10
%
0.12
Accruing loans 90 days or more past due
$
-
The table below provides information concerning the composition of nonaccrual
loans at December 31, 2021 and 2020,
respectively.
December 31
(In thousands)
Nonaccrual loans:
Commercial real estate
$
Residential real estate
Total nonaccrual loans /
nonperforming loans
$
The Company discontinues the accrual of interest income when (1) there is a significant
deterioration in the financial
condition of the borrower and full repayment of principal and interest is not expected or
(2) the principal or interest is more
than 90 days past due, unless the loan is both well-secured and in the process of collection.
At December 31, 2021 and
2020, respectively, the Company
had $0.4
million and $0.5
million in loans on nonaccrual.
At December 31, 2021 there were no loans 90 days past due and still accruing interest, compared
to $0.1 million at
December 31, 2020.
The table below provides information concerning the composition of OREO at December
31, 2021 and 2020, respectively.
December 31
(In thousands)
Other real estate owned:
Commercial real estate
$
-
Total other real estate owned
$
-
Potential Problem Loans
Potential problem loans represent those loans with a well-defined weakness and
where information about possible credit
problems of borrowers has caused management to have serious doubts about the
borrower’s ability to comply with present
repayment terms.
This definition is believed to be substantially consistent with the standards
established by the Federal
Reserve, the Company’s primary regulator,
for loans classified as substandard, excluding nonaccrual loans.
Potential
problem loans, which are not included in nonperforming assets, amounted to $2.4
million, or 0.5% of total loans at
December 31, 2021, compared to $2.9 million, or 1.0% of total loans at December 31, 2020.
The table below provides information concerning the composition of potential problem
loans at December 31, 2021 and
2020, respectively.
December 31
(In thousands)
Potential problem loans:
Commercial and industrial
$
Construction and land development
Commercial real estate
Residential real estate
1,748
2,229
Consumer installment
Total potential problem loans
$
2,360
2,912
At December 31, 2021, approximately $0.3
million or 14.2% of total potential problem loans were past due at least 30 but
less than 90 days.
The following table is a summary of the Company’s
performing loans that were past due at least 30 days but less than
90 days as of December 31, 2021 and 2020, respectively.
December 31
(In thousands)
Performing loans past due 30 to 89 days:
Commercial and industrial
$
Construction and land development
Commercial real estate
-
Residential real estate
1,509
Consumer installment
Total performing loans past due
30 to 89 days
$
1,858
Deposits
December 31
(In thousands)
Noninterest bearing demand
$
316,132
245,398
NOW
183,021
155,870
Money market
244,195
199,937
Savings
91,245
78,187
Certificates of deposit under $250,000
101,660
105,357
Certificates of deposit and other time deposits of $250,000 or more
57,990
55,044
Total deposits
$
994,243
839,793
Total deposits increased
$154.5 million, or 18%, to $994.2 million at December 31, 2021,
compared to $839.8 million at
December 31, 2020. Noninterest-bearing deposits were $316.1
million, or 32% of total deposits, at December 31, 2021,
compared to $245.4 million, or 29% of total deposits at December 31, 2020. These
increases reflect deposits from
customers who received PPP loans, the impact of government stimulus checks, and
reduced customer spending during the
COVID-19 pandemic.
Estimated uninsured deposits totaled $420.8 million and $315.2 million at December 31,
2021 and 2020, respectively.
Uninsured amounts are estimated based on the portion of account balances in excess of FDIC
insurance limits.
The average rates paid on total interest-bearing deposits were 0.39%
in 2021 and 0.68% in 2020.
Other Borrowings
Other borrowings generally consist of short-term borrowings and long-term debt.
Short-term borrowings generally consist
of federal funds purchased and securities sold under agreements to repurchase
with an original maturity of one year or less.
The Bank had available federal fund lines totaling $41.0 million with none outstanding
at December 31, 2021 and 2020,
respectively. Securities sold under
agreements to repurchase totaled $3.4 million and $2.4 million at December 31,
and 2020, respectively.
The average rates paid on short-term borrowings were 0.51% and 0.48%
in 2021 and 2020, respectively.
The Company had no long-term debt outstanding at December 31, 2021 and 2020, respectively.
CAPITAL ADEQUACY
The Company's consolidated stockholders' equity was $103.7 million and $107.7
million as of December 31, 2021 and
2020,
respectively.
The decrease from December 31, 2020 was primarily driven by an other comprehensive
loss due to the
change in unrealized gains on securities available-for-sale, net of tax, of $6.7
million, cash dividends paid of $3.7
million
and stock repurchases of $1.6 million, representing 45,946 shares,
which was partially offset by net earnings of $8.0
million.
On January 1, 2015, the Company and Bank became subject to the rules of the Basel III regulatory
capital framework and
related Dodd-Frank Wall
Street Reform and Consumer Protection Act changes. The rules included
the implementation of a
capital conservation buffer that is added to the minimum requirements
for capital adequacy purposes. The capital
conservation buffer was subject to a three year phase-in period
that began on January 1, 2016 and was fully phased-in on
January 1, 2019 at 2.5%. A banking organization with a conservation buffer
of less than the required amount will be subject
to limitations on capital distributions, including dividend payments and certain discretionary
bonus payments to executive
officers. At December 31, 2021, the Bank’s
ratio was sufficient to meet the fully phased-in conservation
buffer.
Effective March 20, 2020, the Federal Reserve and the other federal
banking regulators adopted an interim final rule that
amended the capital conservation buffer.
The interim final rule was adopted as a final rule on August 26, 2020. The
new
rule revises the definition of “eligible retained income” for purposes of the maximum payout
ratio to allow banking
organizations to more freely use their capital buffers to promote
lending and other financial intermediation activities, by
making the limitations on capital distributions more gradual. The
eligible retained income is now the greater of (i) net
income for the four preceding quarters, net of distributions and associated tax effects
not reflected in net income; and (ii)
the average of all net income over the preceding four quarters. The interim
final rule only affects the capital buffers, and
banking organizations were encouraged to make prudent capital
distribution decisions.
The Federal Reserve has treated us as a “small bank holding company’ under the Federal
Reserve’s policy.
Accordingly,
our capital adequacy is evaluated at the Bank level, and not for the Company and its consolidated
subsidiaries. The Bank’s
tier 1 leverage ratio was 9.35%, CET1 risk-based capital ratio was 16.23%, tier 1 risk-based
capital ratio was 16.23%, and
total risk-based capital ratio was 17.06%
at December 31, 2021. These ratios exceed the minimum regulatory capital
percentages of 5.0% for tier 1 leverage ratio, 6.5% for CET1 risk-based capital ratio,
8.0% for tier 1 risk-based capital ratio,
and 10.0% for total risk-based capital ratio to be considered “well capitalized.”
The Bank’s capital conservation buffer
was
9.06%
at December 31, 2021.
MARKET AND LIQUIDITY RISK MANAGEMENT
Management’s objective is to manage assets and
liabilities to provide a satisfactory,
consistent level of profitability within
the framework of established liquidity,
loan, investment, borrowing, and capital policies. The Bank’s
Asset Liability
Management Committee (“ALCO”) is charged with the responsibility
of monitoring these policies, which are designed to
ensure an acceptable asset/liability composition. Two
critical areas of focus for ALCO are interest rate risk and liquidity
risk management.
Interest Rate Risk Management
In the normal course of business, the Company is exposed to market risk arising from
fluctuations in interest rates because
assets and liabilities may mature or reprice at different times. For example,
if liabilities reprice faster than assets, and
interest rates are generally rising, earnings will initially decline. In addition, assets
and liabilities may reprice at the same
time but by different amounts. For example, when the general level of interest rates is rising,
the Company may increase
rates paid on interest bearing demand deposit accounts and savings deposit
accounts by an amount that is less than the
general increase in market interest rates. Also, short-term and long-term
market interest rates may change by different
amounts. For example, a flattening yield curve may reduce the interest spread
between new loan yields and funding costs.
Further, the remaining maturity of various assets and
liabilities may shorten or lengthen as interest rates change. For
example, if long-term mortgage interest rates decline sharply,
mortgage-backed securities in the securities portfolio may
prepay earlier than anticipated, which could reduce earnings. Interest rates may also
have a direct or indirect effect on loan
demand, loan losses, mortgage origination volume, the fair value of MSRs and other
items affecting earnings.
ALCO measures and evaluates the interest rate risk so that we can meet customer demands
for various types of loans and
deposits. ALCO determines the most appropriate amounts of on-balance sheet and
off-balance sheet items. Measurements
used to help manage interest rate sensitivity include an earnings simulation and an economic
value of equity model.
Earnings simulation
. Management believes that interest rate risk is best estimated by our earnings simulation
modeling.
On at least a quarterly basis, the following 12 month time period is simulated to determine a
baseline net interest income
forecast and the sensitivity of this forecast to changes in interest rates. The baseline forecast
assumes an unchanged or flat
interest rate environment. Forecasted levels of earning assets, interest-bearing liabilities,
and off-balance sheet financial
instruments are combined with ALCO forecasts of market interest rates for
the next 12 months and other factors in order to
produce various earnings simulations and estimates.
To help limit interest rate risk,
we have guidelines for earnings at risk which seek to limit the variance of net interest
income from gradual changes in interest rates.
For changes up or down in rates from management’s
flat interest rate
forecast over the next 12 months, policy limits for net interest income variances are as follows:
+/- 20% for a gradual change of 400 basis points
+/- 15% for a gradual change of 300 basis points
+/- 10% for a gradual change of 200 basis points
+/- 5% for a gradual change of 100 basis points
The following table reports the variance of net interest income over the next 12
months assuming a gradual change in
interest rates up or down when compared to the baseline net interest income
forecast at December 31, 2021.
Changes in Interest Rates
Net Interest Income % Variance
400 basis points
7.92
%
300 basis points
5.61
200 basis points
3.59
100 basis points
1.54
(100) basis points
(0.44)
(200) basis points
NM
(300) basis points
NM
(400) basis points
NM
NM=not meaningful
At December 31, 2021, our earnings simulation model indicated that
we were in compliance with the policy guidelines
noted above.
Economic Value
of Equity
Economic value of equity (“EVE”) measures the extent that estimated econom
ic values of our assets, liabilities and off-
balance sheet items will change as a result of interest rate changes. Economic values are
estimated by discounting expected
cash flows from assets, liabilities and off-balance sheet items,
which establishes a base case EVE. In contrast with our
earnings simulation model which evaluates interest rate risk over a 12
month timeframe, EVE uses a terminal horizon
which allows for the re-pricing of all assets, liabilities, and off-balance sheet items.
Further, EVE is measured using values
as of a point in time and does not reflect any actions that ALCO might take in responding to
or anticipating changes in
interest rates, or market and competitive conditions.
To help limit interest rate risk,
we have stated policy guidelines for an instantaneous basis point change in interest rates,
such that our EVE should not decrease from our base case by more than the following:
45% for an instantaneous change of +/- 400 basis points
35% for an instantaneous change of +/- 300 basis points
25% for an instantaneous change of +/- 200 basis points
15% for an instantaneous change of +/- 100 basis points
The following table reports the variance of EVE assuming an immediate change in
interest rates up or down when
compared to the baseline EVE at December 31, 2021.
Changes in Interest Rates
EVE % Variance
400 basis points
(20.53)
%
300 basis points
(14.14)
200 basis points
(8.35)
100 basis points
(3.23)
(100) basis points
0.91
(200) basis points
NM
(300) basis points
NM
(400) basis points
NM
NM=not meaningful
At December 31, 2021, our EVE model indicated that we were in compliance
with the policy guidelines noted above.
Each of the above analyses may not, on its own, be an accurate indicator of how our net interest
income will be affected by
changes in interest rates. Income associated with interest-earning assets and costs associated
with interest-bearing liabilities
may not be affected uniformly by changes in interest rates. In addition,
the magnitude and duration of changes in interest
rates may have a significant impact on net interest income. For example, although certain
assets and liabilities may have
similar maturities or periods of repricing, they may react in different
degrees to changes in market interest rates, and other
economic and market factors, including market perceptions.
Interest rates on certain types of assets and liabilities fluctuate
in advance of changes in general market rates, while interest rates on other types of assets
and liabilities may lag behind
changes in general market rates. In addition, certain assets, such as adjustable rate
mortgage loans, have features (generally
referred to as “interest rate caps and floors”) which limit changes in interest rates.
Prepayment and early withdrawal levels
also could deviate significantly from those assumed in calculating the maturity of certain instruments.
The ability of many
borrowers to service their debts also may decrease during periods of rising interest rates or
economic stress, which may
differ across industries and economic sectors. ALCO reviews each of the
above interest rate sensitivity analyses along with
several different interest rate scenarios in seeking satisfactory,
consistent levels of profitability within the framework of the
Company’s established liquidity,
loan, investment, borrowing, and capital policies.
The Company may also use derivative financial instruments to improve the balance between
interest-sensitive assets and
interest-sensitive liabilities and as one tool to manage interest rate sensitivity
while continuing to meet the credit and
deposit needs of our customers. From time to time, the Company may enter into
interest rate swaps (“swaps”) to facilitate
customer transactions and meet their financing needs. These swaps qualify as derivatives,
but are not designated as hedging
instruments. At December 31, 2021 and 2020, the Company had no derivative
contracts to assist in managing interest rate
sensitivity.
Liquidity Risk Management
Liquidity is the Company’s ability to convert
assets into cash equivalents in order to meet daily cash flow requirements,
primarily for deposit withdrawals, loan demand and maturing obligations. Without
proper management of its liquidity,
the
Company could experience higher costs of obtaining funds due to insufficient liquidity,
while excessive liquidity can lead
to a decline in earnings due to the cost of foregoing alternative higher-yielding
investment opportunities.
Liquidity is managed at two levels. The first is the liquidity of the Company.
The second is the liquidity of the Bank. The
management of liquidity at both levels is essential, because the Company and the Bank are
separate and distinct legal
entities with different funding needs and sources, and each are subject
to regulatory guidelines and requirements. The
Company depends upon dividends from the Bank for liquidity to pay its operating expenses,
debt obligations and
dividends. The Bank’s payment of dividends depends
on its earnings, liquidity,
capital and the absence of any regulatory
restrictions.
The primary source of funding and liquidity for the Company has been dividends received
from the Bank. If needed, the
Company could also issue common stock or other securities. Primary uses of funds by the
Company include dividends paid
to stockholders and stock repurchases.
Primary sources of funding for the Bank include customer deposits, other borrowings,
repayment and maturity of securities,
and sale and repayment of loans.
The Bank has access to federal funds lines from various banks and borrowings
from the
Federal Reserve discount window.
In addition to these sources, the Bank has participated in the FHLB's advance program
to obtain funding for its growth. Advances include both fixed and variable terms and
are taken out with varying maturities.
As of December 31, 2021, the Bank had a remaining available line of credit with the FHLB
totaling $319.6 million.
As of
December 31, 2021, the Bank also had $41.0 million of federal funds lines, with none outstanding.
Primary uses of funds
include repayment of maturing obligations and growing the loan portfolio.
The following table presents additional information about our contractual obligations
as of December 31, 2021, which by
their terms had contractual maturity and termination dates subsequent to December
31, 2021:
Payments due by period
1 year
1 to 3
3 to 5
More than
(Dollars in thousands)
Total
or less
years
years
5 years
Contractual obligations:
Deposit maturities (1)
$
994,243
948,364
37,905
7,785
Operating lease obligations
Total
$
994,853
948,484
38,144
7,926
(1) Deposits with no stated maturity (demand, NOW, money market, and savings deposits) are
presented in the "1 year or less" column
Management believes that the Company and the Bank have adequate sources of liquidity to
meet all known contractual
obligations and unfunded commitments, including loan commitments and reasonable borrower,
depositor, and creditor
requirements over the next 12 months.
Off-Balance Sheet Arrangements
At December 31, 2021, the Bank had outstanding standby letters of credit of $1.
million and unfunded loan commitments
outstanding of $71.0 million. Because these commitments generally
have fixed expiration dates and many will expire
without being drawn upon, the total commitment level does not necessarily represent future
cash requirements. If needed to
fund these outstanding commitments, the Bank has the ability to liquidate federal funds
sold or securities available-for-sale,
or on a short-term basis to borrow and purchase federal funds from other financial
institutions.
Residential mortgage lending and servicing activities
We primarily sell conforming
residential mortgage loans in the secondary market to Fannie Mae
while retaining the
servicing of these loans. The sale agreements for these residential mortgage loans with
Fannie Mae and other investors
include various representations and warranties regarding the origination and characteristics
of the residential mortgage
loans. Although the representations and warranties vary among investors, they typically
cover ownership of the loan,
validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing
the loan,
compliance with loan criteria set forth in the applicable agreement, compliance with applicable
federal, state, and local
laws, among other matters.
As of December 31, 2021, the unpaid principal balance of residential mortgage loans,
which we have originated and sold,
but retained the servicing rights was $252.7 million. Although these loans are
generally sold on a non-recourse basis,
except for breaches of customary seller representations and warranties,
we may have to repurchase residential mortgage
loans in cases where we breach such representations or warranties or the other terms of
the sale, such as where we fail to
deliver required documents or the documents we deliver are defective. Investors also
may require the repurchase of a
mortgage loan when an early payment default underwriting review reveals significant
underwriting deficiencies, even if the
mortgage loan has subsequently been brought current. Repurchase demands are typically
reviewed on an individual loan by
loan basis to validate the claims made by the investor and to determine if a contractually
required repurchase event has
occurred. We
seek to reduce and manage the risks of potential repurchases or other claims by mortgage loan investors
through our underwriting, quality assurance and servicing practices, including
good communications with our residential
mortgage investors.
The Company was not required to repurchase any loans during 2021 and 2020
as a result of representation and warranty
provisions contained in the Company’s sale agreements
with Fannie Mae, and had no pending repurchase or make-whole
requests at December 31, 2021.
We service all residential
mortgage loans originated and sold by us to Fannie Mae. As servicer,
our primary duties are to:
(1) collect payments due from borrowers; (2) advance certain delinquent payments
of principal and interest; (3) maintain
and administer any hazard, title, or primary mortgage insurance policies relating to
the mortgage loans; (4) maintain any
required escrow accounts for payment of taxes and insurance and administer escrow payments;
and (5) foreclose on
defaulted mortgage loans or take other actions to mitigate the potential losses to investors
consistent with the agreements
governing our rights and duties as servicer.
The agreement under which we act as servicer generally specifies a
standard of responsibility for actions taken by us in
such capacity and provides protection against expenses and liabilities incurred by us
when acting in compliance with the
respective servicing agreements. However, if
we commit a material breach of our obligations as servicer,
we may be subject
to termination if the breach is not cured within a specified period following notice. The
standards governing servicing and
the possible remedies for violations of such standards are determined by servicing
guides issued by Fannie Mae as well as
the contract provisions established between Fannie Mae and the Bank.
Remedies could include repurchase of an affected
loan.
Although to date repurchase requests related to representation and warranty provisions,
and servicing activities have been
limited, it is possible that requests to repurchase mortgage loans may increase in frequency
if investors more aggressively
pursue all means of recovering losses on their purchased loans. As of December
31, 2021, we believe that this exposure is
not material due to the historical level of repurchase requests and loss trends, the results of
our quality control reviews, and
the fact that 99% of our residential mortgage loans serviced for Fannie Mae
were current as of such date. We
maintain
ongoing communications with our investors and will continue to evaluate this exposure
by monitoring the level and number
of repurchase requests as well as the delinquency rates in our investor portfolios.
Section 4021 of the CARES Act allows borrowers under 1-to-4 family residential
mortgage loans sold to Fannie Mae to
request forbearance to the servicer after affirming that such borrower
is experiencing financial hardships during the
COVID-19 emergency.
Except for vacant or abandoned properties, Fannie Mae servicers may not initiate
foreclosures on
similar procedures or related evictions or sales until December 31, 2020.
The forbearance period was extended, generally,
to March 31, 2021.
The Bank sells mortgage loans to Fannie Mae and services these on an actual/actual
basis. As a result,
the Bank is not obligated to make any advances to Fannie Mae on principal and interest on
such mortgage loans where the
borrower is entitled to forbearance.
Effects of Inflation and Changing Prices
The consolidated financial statements and related consolidated financial data
presented herein have been prepared in
accordance with GAAP and practices within the banking industry which require
the measurement of financial position and
operating results in terms of historical dollars without considering the changes in
the relative purchasing power of money
over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities
of a financial institution
are monetary in nature. As a result, interest rates have a more significant impact on a
financial institution’s performance
than the effects of general levels of inflation.
CURRENT ACCOUNTING DEVELOPMENTS
The following ASU has been issued by the FASB
but is not yet effective.
●
ASU 2016-13,
Financial Instruments - Credit Losses (Topic
326):
Measurement of Credit Losses on Financial
Instruments;
Information about this pronouncement is described in more detail below.
ASU 2016-13,
Financial Instruments - Credit Losses (Topic
326): - Measurement of Credit
Losses on Financial
Instruments
, amends guidance on reporting credit losses for assets held at amortized cost basis and
available for sale debt
securities. For assets held at amortized cost basis, the new standard eliminates the probable
initial recognition threshold in
current GAAP and, instead, requires an entity to reflect its current estimate of all expected
credit losses using a broader
range of information regarding past events, current conditions and forecasts assessing the
collectability of cash flows. The
allowance for credit losses is a valuation account that is deducted from the amortized
cost basis of the financial assets to
present the net amount expected to be collected. For available for sale debt securities, credit
losses should be measured in a
manner similar to current GAAP,
however the new standard will require that credit losses be presented as an allowance
rather than as a write-down. The new guidance affects entities holding
financial assets and net investment in leases that are
not accounted for at fair value through net income. The amendments affect
loans, debt securities, trade receivables, net
investments in leases, off-balance sheet credit exposures, reinsurance receivables,
and any other financial assets not
excluded from the scope that have the contractual right to receive cash. For public
business entities, the new guidance was
originally effective for annual and interim periods in fiscal years
beginning after December 15, 2019. The Company has
developed an implementation team that is following a general timeline. The
team has been working with an advisory
consultant, with whom a third-party software license has been purchased.
The Company’s preliminary evaluation
indicates
the provisions of ASU No. 2016-13 are expected to impact the Company’s
consolidated financial statements, in particular
the level of the reserve for credit losses. The Company is continuing to evaluate the
extent of the potential impact and
expects that portfolio composition and economic conditions at the time of adoption
will be a factor. On October 16, 2019,
the FASB approved
a previously issued proposal granting smaller reporting companies a postponement of the required
implementation date for ASU 2016-13. The Company will now be required
to implement the new standard in January 2023,
with early adoption permitted in any period prior to that date.
Table 1
- Explanation of Non-GAAP Financial Measures
In addition to results presented in accordance with GAAP,
this annual report on Form 10-K includes certain designated net
interest income amounts presented on a tax-equivalent basis, a non-GAAP financial
measure, including the presentation of
total revenue and the calculation of the efficiency ratio.
The Company believes the presentation of net interest income on a tax-equivalent
basis provides comparability of net
interest income from both taxable and tax-exempt sources and facilitates comparability
within the industry. Although the
Company believes these non-GAAP financial measures enhance investors’
understanding of its business and performance,
these non-GAAP financial measures should not be considered an alternative to
GAAP.
The reconciliation of these non-
GAAP financial measures from GAAP to non-GAAP is presented below.
Year ended December 31
(In thousands)
Net interest income (GAAP)
$
23,990
24,338
26,064
25,570
24,526
Tax-equivalent adjustment
1,205
Net interest income (Tax-equivalent)
$
24,460
24,830
26,621
26,183
25,731
Table 2
- Selected Financial Data
Year ended December 31
(Dollars in thousands, except per share amounts)
Income statement
Tax-equivalent interest income (a)
$
26,977
28,686
30,804
29,859
29,325
Total interest expense
2,517
3,856
4,183
3,676
3,594
Tax equivalent net interest income (a)
24,460
24,830
26,621
26,183
25,731
Provision for loan losses
(600)
1,100
(250)
-
(300)
Total noninterest income
4,288
5,375
5,494
3,325
3,441
Total noninterest expense
19,433
19,554
19,697
17,874
16,784
Net earnings before income taxes and
tax-equivalent adjustment
9,915
9,551
12,668
11,634
12,688
Tax-equivalent adjustment
1,205
Income tax expense
1,406
1,605
2,370
2,187
3,637
Net earnings
$
8,039
7,454
9,741
8,834
7,846
Per share data:
Basic and diluted net earnings
$
2.27
2.09
2.72
2.42
2.15
Cash dividends declared
$
1.04
1.02
1.00
0.96
0.92
Weighted average shares outstanding
Basic and diluted
3,545,310
3,566,207
3,581,476
3,643,780
3,643,616
Shares outstanding
3,520,485
3,566,276
3,566,146
3,643,868
3,643,668
Book value
$
29.46
30.20
27.57
24.44
23.85
Common stock price
High
$
48.00
63.40
53.90
53.50
40.25
Low
31.32
24.11
30.61
28.88
30.75
Period-end
$
32.30
42.29
53.00
31.66
38.90
To earnings ratio
14.23
x
20.23
19.49
13.08
18.09
To book value
%
Performance ratios:
Return on average equity
7.54
%
7.12
10.35
10.14
9.17
Return on average assets
0.78
%
0.83
1.18
1.08
0.94
Dividend payout ratio
45.81
%
48.80
36.76
39.67
42.79
Average equity to average assets
10.39
%
11.63
11.39
10.63
10.30
Asset Quality:
Allowance for loan losses as a % of:
Loans
1.08
%
1.22
0.95
1.00
1.05
Nonperforming loans
1,112
%
1,052
2,345
2,691
Nonperforming assets as a % of:
Loans and other real estate owned
0.18
%
0.12
0.04
0.07
0.66
Total assets
0.07
%
0.06
0.02
0.04
0.35
Nonperforming loans as % of loans
0.10
%
0.12
0.04
0.04
0.66
Net charge-offs (recoveries) as a % of average loans
0.02
%
(0.03)
0.03
(0.01)
(0.09)
Capital Adequacy (c):
CET 1 risk-based capital ratio
16.23
%
17.27
17.28
16.49
16.42
Tier 1 risk-based capital ratio
16.23
%
17.27
17.28
16.49
16.98
Total risk-based capital ratio
17.06
%
18.31
18.12
17.38
17.91
Tier 1 leverage ratio
9.35
%
10.32
11.23
11.33
10.95
Other financial data:
Net interest margin (a)
2.55
%
2.92
3.43
3.40
3.29
Effective income tax rate
14.89
%
17.72
19.57
19.84
31.67
Efficiency ratio (b)
67.60
%
64.74
61.33
60.57
57.53
Selected period end balances:
Securities
$
421,891
335,177
235,902
239,801
257,697
Loans, net of unearned income
458,364
461,700
460,901
476,908
453,651
Allowance for loan losses
4,939
5,618
4,386
4,790
4,757
Total assets
1,105,150
956,597
828,570
818,077
853,381
Total deposits
994,243
839,792
724,152
724,193
757,659
Long-term debt
-
-
-
-
3,217
Total stockholders’ equity
103,726
107,689
98,328
89,055
86,906
(a) Tax-equivalent.
See "Table 1 - Explanation of Non-GAAP Financial Measures".
(b) Efficiency ratio is the result of noninterest expense divided
by the sum of noninterest income and tax-equivalent net interest
income.
(c) Regulatory capital ratios presented are for the Company's
wholly-owned subsidiary, AuburnBank.
Table 3
- Average Balance
and Net Interest Income Analysis
Year ended December 31
Interest
Interest
Average
Income/
Yield/
Average
Income/
Yield/
(Dollars in thousands)
Balance
Expense
Rate
Balance
Expense
Rate
Interest-earning assets:
Loans and loans held for sale (1)
$
459,712
$
20,473
4.45%
$
465,378
$
22,055
4.74%
Securities - taxable
320,766
4,107
1.28%
234,420
3,932
1.68%
Securities - tax-exempt (2)
62,736
2,242
3.57%
63,029
2,343
3.72%
Total securities
383,502
6,349
1.66%
297,449
6,275
2.11%
Federal funds sold
38,659
0.15%
30,977
0.41%
Interest bearing bank deposits
77,220
0.13%
56,104
0.41%
Total interest-earning assets
959,093
26,977
2.81%
849,908
28,686
3.38%
Cash and due from banks
14,591
13,727
Other assets
51,664
37,010
Total assets
$
1,025,348
$
900,645
Interest-bearing liabilities:
Deposits:
NOW
$
178,197
0.12%
$
154,431
0.34%
Savings and money market
296,708
0.22%
242,485
1,071
0.44%
Certificates of deposits
159,111
1,633
1.03%
165,120
2,253
1.36%
Total interest-bearing deposits
634,016
2,500
0.39%
562,036
3,847
0.68%
Short-term borrowings
3,349
0.51%
1,864
0.48%
Total interest-bearing liabilities
637,365
2,517
0.39%
563,900
3,856
0.68%
Noninterest-bearing deposits
278,013
227,127
Other liabilities
3,392
4,884
Stockholders' equity
106,578
104,734
Total liabilities and
and stockholders' equity
$
1,025,348
$
900,645
Net interest income and margin
$
24,460
2.55%
$
24,830
2.92%
(1) Average loan balances are
shown net of unearned income and loans on nonaccrual status have been included
in the computation of average balances.
(2) Yields on tax-exempt securities have been
computed on a tax-equivalent basis using an income tax rate
of 21%.
Table 4
- Volume and
Rate Variance
Analysis
Years ended December 31, 2021 vs. 2020
Years ended December 31, 2020 vs. 2019
Net
Due to change in
Net
Due to change in
(Dollars in thousands)
Change
Rate (2)
Volume (2)
Change
Rate (2)
Volume (2)
Interest income:
Loans and loans held for sale
$
(1,582)
(1,333)
(249)
$
(875)
(455)
(420)
Securities - taxable
(933)
1,108
(68)
(1,010)
Securities - tax-exempt (1)
(101)
(91)
(10)
(313)
(180)
(133)
Total securities
(1,024)
1,098
(381)
(1,190)
Federal funds sold
(70)
(81)
(298)
(342)
Interest bearing bank deposits
(131)
(159)
(564)
(645)
Total interest income
$
(1,709)
(2,597)
$
(2,118)
(2,632)
Interest expense:
Deposits:
NOW
$
(311)
(340)
$
(187)
(255)
Savings and money market
(416)
(537)
(3)
Certificates of deposits
(620)
(560)
(60)
(244)
(166)
(78)
Total interest-bearing deposits
(1,347)
(1,437)
(329)
(424)
Short-term borrowings
-
-
Total interest expense
(1,339)
(1,437)
(327)
(424)
Net interest income
$
(370)
(1,160)
$
(1,791)
(2,208)
(1) Yields on tax-exempt securities have been
computed on a tax-equivalent basis using an income
tax rate of 21%.
(2) Changes that are not solely a result of volume or rate have been allocated to volume.
Table 5
- Net Charge-Offs (Recoveries) to Average
Loans
Net
Net
Net
charge-off
Net
(recovery)
charge-offs
Average
(recovery)
(recoveries)
Average
charge-off
(Dollars in thousands)
(recoveries)
Loans (2)
ratio
charge-offs
Loans (2)
ratio
Commercial and industrial (1)
$
(140)
64,618
(0.22)
%
$
(87)
56,836
(0.15)
%
Construction and land development
-
33,945
-
-
32,721
-
Commercial real estate
253,113
0.10
-
256,444
-
Residential real estate
(52)
81,526
(0.06)
(63)
87,888
(0.07)
Consumer installment
6,975
0.24
8,096
0.22
Total
$
440,177
0.02
%
$
(132)
441,985
(0.03)
%
(1) Excludes PPP loans, which are guaranteed by the SBA.
(2) Gross loan balances.
Table 6
- Loan Maturities
December 31, 2021
1 year
1 to 5
5 to 15
After 15
(Dollars in thousands)
or less
years
years
years
Total
Commercial and industrial
$
26,593
17,474
38,125
1,785
83,977
Construction and land development
26,346
5,191
32,432
Commercial real estate
31,406
85,149
137,411
4,405
258,371
Residential real estate
3,832
21,919
31,227
20,683
77,661
Consumer installment
2,215
4,111
-
6,682
Total loans
$
90,392
133,844
207,968
26,919
459,123
Table 7
- Sensitivities to Changes in Interest Rates on Loans Maturing in More
Than One Year
December 31, 2021
Variable
Fixed
(Dollars in thousands)
Rate
Rate
Total
Commercial and industrial
$
57,116
57,384
Construction and land development
1,934
4,152
6,086
Commercial real estate
8,220
218,745
226,965
Residential real estate
24,058
49,771
73,829
Consumer installment
4,429
4,467
Total loans
$
34,518
334,213
368,731
Table 8
- Allocation of Allowance for Loan Losses
(Dollars in thousands)
Amount
%*
Amount
%*
Commercial and industrial
$
18.3%
$
17.9%
Construction and land development
7.1%
7.2%
Commercial real estate
2,739
56.2%
55.2%
Residential real estate
16.9%
18.2%
Consumer installment
1.5%
1.5%
Total allowance for loan losses
$
4,939
$
5,618
* Loan balance in each category expressed as a percentage of total loans.
Table 9
- Estimated Uninsured Time Deposits by Maturity
(Dollars in thousands)
December 31, 2021
Maturity of:
3 months or less
$
2,079
Over 3 months through 6 months
1,747
Over 6 months through 12 months
31,159
Over 12 months
6,505
Total estimated uninsured
time deposits
$
41,490

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 7A.
QUANTITATIVE
AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The information called for by ITEM 7A is set forth in ITEM 7 under the caption
“Market and Liquidity Risk Management”
and is incorporated herein by reference.

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8.
FINANCIAL STATEMENTS
AND SUPPLEMENTARY
DATA
Index
Page
Report of Independent Registered Public Accounting Firm
(PCAOB ID:
)
Consolidated Balance Sheets
Consolidated Statements of Earnings
Consolidated Statements of Comprehensive Income
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes To Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board
of Directors of
Auburn National Bancorporation, Inc. and Subsidiary
Opinion on the Financial Statements
We have audited the accompanying
consolidated balance sheets of Auburn National Bancorporation, Inc. and
Subsidiary
(the “Company”) as of December 31, 2021 and 2020, the related consolidated
statements of earnings, comprehensive
income, stockholders’ equity and cash flows for the years then ended, and the related notes
to the consolidated financial
statements (collectively, the “financial
statements”). In our opinion, the financial statements present fairly,
in all material
respects, the financial position of the Company as of December 31, 2021
and 2020, and the results of its operations and its
cash flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of
America.
Basis for Opinion
These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion
on the Company’s financial statements
based on our audits. We
are a public accounting firm registered with the Public
Company Accounting Oversight Board (United States) (PCAOB) and are
required to be independent with respect to the
Company in accordance with U.S. federal securities laws and the applicable
rules and regulations of the Securities and
Exchange Commission and the PCAOB.
We conducted
our audits in accordance with the standards of the PCAOB. Those standards require that
we plan and
perform the audits to obtain reasonable assurance about whether the financial statements are
free of material misstatement,
whether due to error or fraud. The Company is not required to have, nor were
we engaged to perform, an audit of its
internal control over financial reporting. As part of our audits we are required to
obtain an understanding of internal control
over financial reporting but not for the purpose of expressing an opinion on the effectiveness
of the Company’s internal
control over financial reporting. Accordingly,
we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the
financial statements, whether
due to error or fraud, and performing procedures that respond to those risks. Such procedures
included examining, on a test
basis, evidence regarding the amounts and disclosures in the financial statements. Our
audits also included evaluating the
accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of
the financial statements. We
believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period
audit of the financial statements
that were communicated or required to be communicated to the audit committee and that: (1)
relate to accounts or
disclosures that are material to the financial statements and (2) involved our especially challenging,
subjective or complex
judgments. The communication of critical audit matters does not alter in any way our opinion
on the financial statements,
taken as a whole, and we are not, by communicating the critical audit matter below,
providing separate opinions on the
critical audit matter or on the accounts or disclosures to which they relate.
Allowance for Loan Losses
As described in Note 5 to the Company’s consolidated
financial statements, the Company has a gross loan portfolio of
$460.5 million and related allowance for loan losses of $4.9 million as of December
31, 2021. As described by the
Company in Note 1, the evaluation of the allowance for loan losses is inherently subjective
as it requires estimates that are
susceptible to significant revision as more information becomes available. The allowance
for loan losses is evaluated on a
regular basis and is based upon the Company’s
review of the collectability of the loans in light of historical experience, the
nature and volume of the loan portfolio, adverse situations that may affect the
borrower’s ability to repay,
estimated value
of any underlying collateral, and prevailing economic conditions.
We identified the Company’s
estimate of the allowance for loan losses as a critical audit matter.
The principal
considerations for our determination of the allowance for loan losses as a critical audit
matter related to the high degree of
subjectivity in the Company’s judgments in
determining the qualitative factors. Auditing these complex judgments
and
assumptions by the Company involves especially challenging auditor judgment due to
the nature and extent of audit
evidence and effort required to address these matters, including the extent
of specialized skill or knowledge needed.
The primary procedures we performed to address this critical audit matter included
the following:
●
We evaluated the relevance and
the reasonableness of assumptions related to evaluation of the loan portfolio,
current economic conditions, and other risk factors used in development of the qualitative
factors for collectively
evaluated loans.
●
We evaluated the reasonableness
of assumptions and data used by the Company in developing the qualitative
factors by comparing these data points to internally developed and third-party sources,
and other audit evidence
gathered.
/s/
Elliott Davis, LLC
We have served as the Company's
auditor since 2015.
Greenville, South Carolina
March 8, 2022
AUBURN NATIONAL
BANCORPORATION,
INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31
(Dollars in thousands, except share data)
Assets:
Cash and due from banks
$
11,210
$
14,868
Federal funds sold
77,420
28,557
Interest bearing bank deposits
67,629
69,150
Cash and cash equivalents
156,259
112,575
Securities available-for-sale
421,891
335,177
Loans held for sale
1,376
3,418
Loans, net of unearned income
458,364
461,700
Allowance for loan losses
(4,939)
(5,618)
Loans, net
453,425
456,082
Premises and equipment, net
41,724
22,193
Bank-owned life insurance
19,635
19,232
Other assets
10,840
7,920
Total assets
$
1,105,150
$
956,597
Liabilities:
Deposits:
Noninterest-bearing
$
316,132
$
245,398
Interest-bearing
678,111
594,394
Total deposits
994,243
839,792
Federal funds purchased and securities sold under agreements to repurchase
3,448
2,392
Accrued expenses and other liabilities
3,733
6,723
Total liabilities
1,001,424
848,907
Stockholders' equity:
Preferred stock of $
0.01
par value; authorized
200,000
shares;
issued shares - none
-
-
Common stock of $
0.01
par value; authorized
8,500,000
shares;
issued
3,957,135
shares
Additional paid-in capital
3,794
3,789
Retained earnings
109,974
105,617
Accumulated other comprehensive income, net
7,599
Less treasury stock, at cost -
436,650
shares and
390,859
shares
at December 31, 2021 and 2020, respectively
(10,972)
(9,354)
Total stockholders’ equity
103,726
107,690
Total liabilities and stockholders’
equity
$
1,105,150
$
956,597
See accompanying notes to consolidated financial statements
AUBURN NATIONAL
BANCORPORATION,
INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
Year ended December 31
(Dollars in thousands, except share and per share data)
Interest income:
Loans, including fees
$
20,473
$
22,055
Securities:
Taxable
4,107
3,932
Tax-exempt
1,772
1,851
Federal funds sold and interest bearing bank deposits
Total interest income
26,507
28,194
Interest expense:
Deposits
2,500
3,847
Short-term borrowings
Total interest expense
2,517
3,856
Net interest income
23,990
24,338
Provision for loan losses
(600)
1,100
Net interest income after provision for loan
losses
24,590
23,238
Noninterest income:
Service charges on deposit accounts
Mortgage lending
1,547
2,319
Bank-owned life insurance
Other
1,757
1,644
Securities gains, net
Total noninterest income
4,288
5,375
Noninterest expense:
Salaries and benefits
11,710
11,316
Net occupancy and equipment
1,743
2,511
Professional fees
1,052
FDIC and other regulatory assessments
Other
4,559
4,419
Total noninterest expense
19,433
19,554
Earnings before income taxes
9,445
9,059
Income tax expense
1,406
1,605
Net earnings
$
8,039
$
7,454
Net earnings per share:
Basic and diluted
$
2.27
$
2.09
Weighted average shares
outstanding:
Basic and diluted
3,545,310
3,566,207
See accompanying notes to consolidated financial statements
AUBURN NATIONAL
BANCORPORATION,
INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Year ended December 31
(Dollars in thousands)
Net earnings
$
8,039
$
7,454
Other comprehensive (loss) income, net of tax:
Unrealized net holding (loss) gain on securities
(6,697)
5,617
Reclassification adjustment for net gain on securities
recognized in net earnings
(11)
(77)
Other comprehensive (loss) income
(6,708)
5,540
Comprehensive income
$
1,331
$
12,994
See accompanying notes to consolidated financial statements
AUBURN NATIONAL
BANCORPORATION,
INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
Accumulated
Common
Additional
other
Shares
Common
paid-in
Retained
comprehensive
Treasury
(Dollars in thousands, except share data)
Outstanding
Stock
capital
earnings
(loss) income
stock
Total
Balance, December 31, 2019
3,566,146
$
3,784
101,801
2,059
(9,355)
$
98,328
Net earnings
-
-
-
7,454
-
-
7,454
Other comprehensive income
-
-
-
-
5,540
-
5,540
Cash dividends paid ($
1.02
per share)
-
-
-
(3,638)
-
-
(3,638)
Sale of treasury stock
-
-
-
Balance, December 31, 2020
3,566,276
$
$
3,789
$
105,617
$
7,599
$
(9,354)
$
107,690
Net earnings
-
-
-
8,039
-
-
8,039
Other comprehensive loss
-
-
-
-
(6,708)
-
(6,708)
Cash dividends paid ($
1.04
per share)
-
-
-
(3,682)
-
-
(3,682)
Stock repurchases
(45,946)
-
-
-
-
(1,619)
(1,619)
Sale of treasury stock
-
-
-
Balance, December 31, 2021
3,520,485
$
$
3,794
$
109,974
$
$
(10,972)
$
103,726
See accompanying notes to consolidated financial statements
AUBURN NATIONAL
BANCORPORATION,
INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year ended December 31
(In thousands)
Cash flows from operating activities:
Net earnings
$
8,039
$
7,454
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Provision for loan losses
(600)
1,100
Depreciation and amortization
1,244
1,666
Premium amortization and discount accretion, net
3,979
2,862
Deferred tax expense (benefit)
(330)
Net gain on securities available for sale
(15)
(103)
Net gain on sale of loans held for sale
(1,417)
(2,300)
Net gain on other real estate owned
-
(52)
Loans originated for sale
(47,937)
(82,726)
Proceeds from sale of loans
50,901
83,138
Increase in cash surrender value of bank owned life insurance
(403)
(442)
Income recognized from death benefit on bank-owned life insurance
-
(282)
Net decrease (increase) in other assets
1,235
(2,656)
Net (decrease) increase in accrued expenses and other liabilities
(2,984)
2,399
Net cash provided by operating activities
$
12,320
$
9,728
Cash flows from investing activities:
Proceeds from sales of securities available-for-sale
-
21,029
Proceeds from maturities of securities available-for-sale
73,607
62,021
Purchase of securities available-for-sale
(173,243)
(177,686)
Decrease (increase) in loans, net
2,883
(766)
Net purchases of premises and equipment
(20,175)
(8,355)
Decrease (increase) in FHLB stock
(9)
Purchase of New Markets Tax
Credit investment
(2,181)
-
Proceeds from bank-owned life insurance death benefit
-
Proceeds from sale of other real estate owned
-
Net cash used in investing activities
$
(118,842)
$
(102,921)
Cash flows from financing activities:
Net increase in noninterest-bearing deposits
70,734
49,180
Net increase in interest-bearing deposits
83,717
66,460
Net increase in federal funds purchased and securities sold
under agreements to repurchase
1,056
1,323
Stock repurchases
(1,619)
-
Dividends paid
(3,682)
(3,638)
Net cash provided by financing activities
$
150,206
$
113,325
Net change in cash and cash equivalents
$
43,684
$
20,132
Cash and cash equivalents at beginning of period
112,575
92,443
Cash and cash equivalents at end of period
$
156,259
$
112,575
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest
$
2,560
$
4,055
Income taxes
2,760
1,956
Supplemental disclosure of non-cash transactions:
Real estate acquired through foreclosure
See accompanying notes to consolidated financial statements
AUBURN NATIONAL
BANCORPORATION,
INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Nature of Business
Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company
whose primary business is conducted
by its wholly-owned subsidiary,
AuburnBank (the “Bank”). AuburnBank is a commercial bank located in Auburn,
Alabama. The Bank provides a full range of banking services in its primary market area,
Lee County, which includes the
Auburn-Opelika Metropolitan Statistical Area.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. Significant
intercompany transactions and accounts are eliminated in consolidation.
COVID-19 Uncertainty
COVID-19 has adversely affected, and may continue to adversely affect
economic activity globally,
nationally and locally.
Following the COVID-19 outbreak in December 2019 and January 2020,
market interest rates declined significantly. The
federal banking agencies encouraged financial institutions to prudently
work with borrowers and passed legislation to
provide relief from reporting loan classifications due to modifications related to the COVID
-19 outbreak. The spread of
COVID-19 has caused us to modify our business practices, including employee travel,
employee work locations, and
cancellation of physical participation in meetings, events and conferences. The rapid
development and fluidity of this
situation precludes any predication as to the ultimate impact of the COVID-19 outbreak.
Nevertheless, the outbreak
presents uncertainty and risk with respect to the Company,
its performance, and its financial results.
Revenue Recognition
On January 1, 2018, the Company implemented ASU 2014-09,
Revenue from Contracts with Customers
, codified
at
ASC
606. The Company adopted ASC 606 using the modified retrospective transition
method. The majority of the
Company’s revenue stream is generated from
interest income on loans and deposits which are outside the scope of ASC
606.
The Company’s sources of income that fall
within the scope of ASC 606 include service charges on deposits, investment
services, interchange fees and gains and losses on sales of other real estate, all of which are
presented as components of
noninterest income. The following is a summary of the revenue streams that fall within the
scope of ASC 606:
Service charges on deposits, investment services, ATM
and interchange fees - Fees from these services are either
transaction-based, for which the performance obligations are satisfied
when the individual transaction is processed, or set
periodic service charges, for which the performance obligations
are satisfied over the period the service is provided.
Transaction-based fees are recognized at the time the transaction
is processed, and periodic service charges are recognized
over the service period.
Gains on sales of other real estate
-
A gain on sale should be recognized when a contract for sale exists and control of the
asset has been transferred to the buyer. ASC 606
lists several criteria required to conclude that a contract for sale exists,
including a determination that the institution will collect substantially all of the consideration
to which it is entitled. In
addition to the loan-to-value, the analysis is based on various other factors, including the credit
quality of the borrower, the
structure of the loan, and any other factors that may affect collectability.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted
accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure
of contingent assets and liabilities as of the balance sheet date and the reported
amounts of income and expense during the
reporting period. Actual results could differ from those estimates. Material estimates
that are particularly susceptible to
significant change in the near term include the determination of the allowance
for loan losses, fair value measurements,
valuation of other real estate owned, and valuation of deferred tax assets.
Change in Accounting Estimate
During the fourth quarter of 2019, the Company reassessed its estimate of the useful lives
of certain fixed assets. The
Company revised its original useful life estimate for certain land improvements, buildings
and improvements and furniture,
fixtures and equipment, with a carrying value of $
0.5
million at December 31, 2019, to correspond with estimated
demolition dates planned as part of the redevelopment project for its
main campus.
This is considered a change in
accounting estimate, per ASC 250-10, where adjustments should be made prospectively.
The effects of this change in
accounting estimate on the 2021 and 2020 consolidated financial statements, respectively,
was a decrease in net earnings of
$
thousand, or $
0.01
per share and $
thousand, or $
0.10
per share.
Reclassifications
Certain amounts reported in the prior period have been reclassified to conform to the
current-period presentation. These
reclassifications had no impact on the Company’s
previously reported net earnings or total stockholders’ equity.
Subsequent Events
The Company has evaluated the effects of events or transactions through
the date of this filing that have occurred
subsequent to December 31, 2021. The Company does not believe there are
any material subsequent events that would
require further recognition or disclosure.
Accounting Standards Adopted in 2021
In 2021, the Company did not adopt any new accounting guidance.
Cash Equivalents
Cash equivalents include cash on hand, cash items in process of collection, amounts due
from banks, including interest
bearing deposits with other banks, and federal funds sold.
Securities
Securities are classified based on management’s
intention at the date of purchase. At December 31, 2021, all
of the
Company’s securities were classified
as available-for-sale. Securities available-for-sale are
used as part of the Company’s
interest rate risk management strategy,
and they may be sold in response to changes in interest rates, changes in prepayment
risks or other factors. All securities classified as available-for-sale are recorded
at fair value with any unrealized gains and
losses reported in accumulated other comprehensive income (loss), net of the deferred
income tax effects. Interest and
dividends on securities, including the amortization of premiums and accretion of discounts
are recognized in interest
income using the effective interest method.
Premiums are amortized to the earliest call date while discounts are accreted
over the estimated life of the security.
Realized gains and losses from the sale of securities are determined using the
specific identification method.
On a quarterly basis, management makes an assessment to determine
whether there have been events or economic
circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily
impaired.
For debt securities with an unrealized loss, an other-than-temporary
impairment write-down is triggered when (1) the
Company has the intent to sell a debt security,
(2) it is more likely than not that the Company will be required to sell the
debt security before recovery of its amortized cost basis, or (3) the Company does
not expect to recover the entire amortized
cost basis of the debt security.
If the Company has the intent to sell a debt security or if it is more likely than not that it
will
be required to sell the debt security before recovery,
the other-than-temporary write-down is equal to the entire difference
between the debt security’s amortized cost
and its fair value.
If the Company does not intend to sell the security or it is not
more likely than not that it will be required to sell the security before recovery,
the other-than-temporary impairment write-
down is separated into the amount that is credit related (credit loss component) and the amount due to all other
factors.
The
credit loss component is recognized in earnings, as a realized loss in securities gains (losses),
and is the difference between
the security’s amortized cost basis and the present
value of its expected future cash flows.
The remaining difference
between the security’s fair value and the present
value of future expected cash flows is due to factors that are not credit
related and is recognized in other comprehensive income, net of applicable taxes.
Loans held for sale
Loans originated and intended for sale in the secondary market are carried at the lower of
cost or estimated fair value in the
aggregate.
Loan sales are recognized when the transaction closes, the proceeds
are collected, and ownership is transferred.
Continuing involvement, through the sales agreement, consists of the right to service the loan
for a fee for the life of the
loan, if applicable.
Gains on the sale of loans held for sale are recorded net of related costs, such as commissions,
and
reflected as a component of mortgage lending income in the consolidated statements
of earnings.
In the course of conducting the Bank’s
mortgage lending activities of originating mortgage loans and selling those loans in
the secondary market, the Bank makes various representations and
warranties to the purchaser of the mortgage loans.
Every loan closed by the Bank’s mortgage
center is run through a government agency automated underwriting system.
Any exceptions noted during this process are remedied prior to sale.
These representations and warranties also apply to
underwriting the real estate appraisal opinion of value for the collateral securing these
loans.
Failure by the Company to
comply with the underwriting and/or appraisal standards could result in the Company
being required to repurchase the
mortgage loan or to reimburse the investor for losses incurred (make whole requests)
if such failure cannot be cured by the
Company within the specified period following discovery.
Loans
Loans are reported at their outstanding principal balances, net of any unearned
income, charge-offs, and any deferred fees
or costs on originated loans.
Interest income is accrued based on the principal balance outstanding.
Loan origination fees,
net of certain loan origination costs, are deferred and recognized in interest income over the
contractual life of the loan
using the effective interest method. Loan commitment fees are
generally deferred and amortized on a straight-line basis
over the commitment period, which results in a recorded amount that approximates fair
value.
The accrual of interest on loans is discontinued when there is a significant deterioration
in the financial condition of the
borrower and full repayment of principal and interest is not expected or the principal or
interest is more than 90 days past
due, unless the loan is both well-collateralized and in the process of collection. Generally,
all interest accrued but not
collected for loans that are placed on nonaccrual status is reversed against current
interest income. Interest collections on
nonaccrual loans are generally applied as principal reductions. The Company determines
past due or delinquency status of a
loan based on contractual payment terms.
A loan is considered impaired when it is probable the Company will be unable to collect all
principal and interest payments
due according to the contractual terms of the loan agreement. Individually identified impaired
loans are measured based on
the present value of expected payments using the loan’s
original effective rate as the discount rate, the loan’s
observable
market price, or the fair value of the collateral if the loan is collateral dependent. If the recorded
investment in the impaired
loan exceeds the measure of fair value, a valuation allowance may be established as part of
the allowance for loan losses.
Changes to the valuation allowance are recorded as a component of the provision for loan
losses.
Impaired loans also include troubled debt restructurings (“TDRs”). In the normal
course of business, management may
grant concessions to borrowers who are experiencing financial difficulty.
The concessions granted most frequently for
TDRs involve reductions or delays in required payments of principal and interest
for a specified time, the rescheduling of
payments in accordance with a bankruptcy plan or the charge-off
of a portion of the loan. In most cases, the conditions of
the credit also warrant nonaccrual status, even after the restructuring occurs.
As part of the credit approval process, the
restructured loans are evaluated for adequate collateral protection in determining
the appropriate accrual status at the time
of restructuring. TDR loans may be returned to accrual status if there has been at least a six-month
sustained period of
repayment performance by the borrower.
The Company began offering short-term loan modifications to assist borrowers
during the COVID-19 pandemic.
If the
modification meets certain conditions, the modification does not need to be
accounted for as a TDR.
For more information,
please refer to Note 5, Loans and Allowance for Loan Losses.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level that management believes
is adequate to absorb probable losses
inherent in the loan portfolio. Loan losses are charged against the allowance
when they are known. Subsequent recoveries
are credited to the allowance. Management’s
determination of the adequacy of the allowance is based on an evaluation
of
the portfolio, current economic conditions, growth, composition of the loan portfolio,
homogeneous pools of loans, risk
ratings of specific loans, historical loan loss factors, identified impaired loans and
other factors related to the portfolio. This
evaluation is performed quarterly and is inherently subjective, as it requires various
material estimates that are susceptible
to significant change, including the amounts and timing of future cash flows expected
to be received on any impaired loans.
In addition, regulatory agencies, as an integral part of their examination process,
will periodically review the Company’s
allowance for loan losses, and may require the Company to record additions to the allowance
based on their judgment about
information available to them at the time of their examinations.
Premises and Equipment
Land is carried at cost. Land improvements, buildings and improvements, and furniture,
fixtures, and equipment are carried
at cost, less accumulated depreciation computed on a straight-line method over the
useful lives of the assets or the expected
terms of the leases, if shorter. Expected
terms include lease option periods to the extent that the exercise of such options is
reasonably assured.
Nonmarketable equity investments
Nonmarketable equity investments include equity securities that are not publicly traded
and securities acquired for various
purposes. The Bank is required to maintain certain minimum levels of equity investments
with certain regulatory and other
entities in which the Bank has an ongoing business relationship based on the Bank’s
common stock and surplus (with
regard to the relationship with the Federal Reserve Bank) or outstanding borrowings (with
regard to the relationship with
the Federal Home Loan Bank of Atlanta). These nonmarketable equity securities
are accounted for at cost which equals par
or redemption value. These securities do not have a readily determinable fair value as their
ownership is restricted and there
is no market for these securities. These securities can only be redeemed or sold
at their par value and only to the respective
issuing government supported institution or to another member
institution. The Company records these nonmarketable
equity securities as a component of other assets, which are periodically evaluated for
impairment. Management considers
these nonmarketable equity securities to be long-term investments.
Accordingly, when evaluating these
securities for
impairment, management considers the ultimate recoverability of the par
value rather than by recognizing temporary
declines in value.
Mortgage Servicing Rights
The Company recognizes as assets the rights to service mortgage loans for others, known as
MSRs. The Company
determines the fair value of MSRs at the date the loan is transferred.
An estimate of the Company’s MSRs is determined
using assumptions that market participants would use in estimating future
net servicing income, including estimates of
prepayment speeds, discount rate, default rates, cost to service, escrow account earnings,
contractual servicing fee income,
ancillary income, and late fees.
Subsequent to the date of transfer, the Company
has elected to measure its MSRs under the amortization method.
Under
the amortization method, MSRs are amortized in proportion to, and over the period
of, estimated net servicing income.
The
amortization of MSRs is analyzed monthly and is adjusted to reflect changes in prepayment
speeds, as well as other factors.
MSRs are evaluated for impairment based on the fair value of those assets.
Impairment is determined by stratifying MSRs
into groupings based on predominant risk characteristics, such as interest rate and loan type.
If, by individual stratum, the
carrying amount of the MSRs exceeds fair value, a valuation allowance is established
through a charge to earnings.
The
valuation allowance is adjusted as the fair value changes.
MSRs are included in the other assets category in the
accompanying consolidated balance sheets.
Transfers of Financial
Assets
Transfers of an entire financial asset (i.e. loan sales), a group
of entire financial assets, or a participating interest in an entire
financial asset (i.e. loan participations sold) are accounted for as sales when control
over the assets have been surrendered.
Control over transferred assets is deemed to be surrendered when (1)
the assets have been isolated from the Company,
(2) the transferee obtains the right (free of conditions that constrain it from taking that right)
to pledge or exchange the
transferred assets, and (3) the Company does not maintain effective
control over the transferred assets through an
agreement to repurchase them before their maturity.
Subsequent to the date of transfer, the Company
has elected to measure its MSRs under the amortization method.
Under
the amortization method, MSRs are amortized in proportion to, and over
the period of, estimated net servicing income.
The
amortization of MSRs is analyzed monthly and is adjusted to reflect changes in prepayment
speeds, as well as other factors.
MSRs are evaluated for impairment based on the fair value of those assets.
Impairment is determined by stratifying MSRs
into groupings based on predominant risk characteristics, such as interest rate and loan type.
If, by individual stratum, the
carrying amount of the MSRs exceeds fair value, a valuation allowance is established
through a charge to earnings.
The
valuation allowance is adjusted as the fair value changes.
MSRs are included in the other assets category in the
accompanying consolidated balance sheets.
Securities sold under agreements to repurchase
Securities sold under agreements to repurchase generally mature less than one
year from the transaction date. Securities
sold under agreements to repurchase are reflected as a secured borrowing in the accompanying consolidated
balance sheets
at the amount of cash received in connection with each transaction.
Income Taxes
Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences
between carrying
amounts and tax bases of assets and liabilities, computed using enacted tax rates. A
valuation allowance, if needed, reduces
deferred tax assets to the amount expected to be realized.
The net deferred tax asset is reflected as a component of other
assets in the accompanying consolidated balance sheets.
Income tax expense or benefit for the year is allocated among continuing operations and other
comprehensive income
(loss), as applicable. The amount allocated to continuing operations is the income tax effect
of the pretax income or loss
from continuing operations that occurred during the year,
plus or minus income tax effects of (1) changes in certain
circumstances that cause a change in judgment about the realization of deferred tax assets in future
years, (2) changes in
income tax laws or rates, and (3) changes in income tax status, subject to certain exceptions.
The amount allocated to other
comprehensive income (loss) is related solely to changes in the valuation allowance on items
that are normally accounted
for in other comprehensive income (loss) such as unrealized gains or losses on available
-for-sale securities.
In accordance with ASC 740,
Income Taxes
, a tax position is recognized as a benefit only if it is “more likely than not” that
the tax position would be sustained in a tax examination, with a tax examination being presumed
to occur. The amount
recognized is the largest amount of tax benefit that is greater than 50% likely of
being realized on examination. For tax
positions not meeting the “more likely than not” test, no tax benefit is recorded.
It is the Company’s policy to recognize
interest and penalties related to income tax matters in income tax expense. The Company and
its wholly-owned subsidiaries
file a consolidated income tax return
.
Fair Value Measureme
nts
ASC 820,
Fair Value
Measurements,
which defines fair value, establishes a framework for measuring fair value in U.S.
generally accepted accounting principles and expands disclosures about fair value
measurements. ASC 820 applies only to
fair-value measurements that are already required or
permitted by other accounting standards.
The definition of fair value
focuses on the exit price, i.e., the price that would be received to sell an asset or paid to transfer a liability
in an orderly
transaction between market participants at the measurement
date, not the entry price, i.e., the price that would be paid to
acquire the asset or received to assume the liability at the measurement date. The statement
emphasizes that fair value is a
market-based measurement; not an entity-specific measurement. Therefore,
the fair value measurement should be
determined based on the assumptions that market participants would use in pricing
the asset or liability.
For more
information related to fair value measurements, please refer to Note 14, Fair
Value.
NOTE 2: BASIC AND DILUTED NET EARNINGS PER SHARE
Basic net earnings per share is computed by dividing net earnings by the weighted average
common shares outstanding for
the year.
Diluted net earnings per share reflect the potential dilution that could occur upon
exercise of securities or other
rights for, or convertible into, shares of the Company’s
common stock.
As of December 31, 2021 and 2020, respectively,
the Company had no such securities or other rights issued or outstanding, and therefore,
no dilutive effect to consider for
the diluted net earnings per share calculation.
The basic and diluted net earnings per share computations for the respective years are
presented below.
Year ended December 31
(Dollars in thousands, except share and per share data)
Basic and diluted:
Net earnings
$
8,039
$
7,454
Weighted average common
shares outstanding
3,545,310
3,566,207
Net earnings per share
$
2.27
$
2.09
NOTE 3: VARIABLE
INTEREST ENTITIES
Generally, a variable interest entity (“VIE”)
is a corporation, partnership, trust or other legal structure that does not have
equity investors with substantive or proportional voting rights or has equity investors
that do not provide sufficient financial
resources for the entity to support its activities.
At December 31, 2021, the Company did not have any consolidated VIEs to
disclose but did have one nonconsolidated
VIE, discussed below.
New Markets Tax
Credit Investment
The New Markets Tax Credit
(“NMTC”) program provides federal tax incentives to investors to make investments in
distressed communities and promotes economic improvement through the development
of successful businesses in these
communities.
The NMTC is available to investors over seven years and is subject to recapture if certain events occur
during such period.
At December 31, 2021, the Company had one such investment in the amount of $2.2 million,
which
was included in other assets in the consolidated balance sheets, compared
to none at December 31, 2020.
The Company’s
equity investment meets the definition of a VIE. While the Company’s
investment exceeds 50% of the outstanding equity
interests, the Company does not consolidate the VIE because it does not
meet the characteristics of a primary beneficiary
since the Company lacks the power to direct the activities of the VIE.
(Dollars in thousands)
Maximum
Loss Exposure
Asset Recognized
Classification
Type:
New Markets Tax Credit investment
$
2,176
$
2,176
Other assets
NOTE 4: SECURITIES
At December 31, 2021 and 2020, respectively,
all securities within the scope of ASC 320,
Investments - Debt and Equity
Securities
were classified as available-for-sale.
The fair value and amortized cost for securities available-for-sale by
contractual maturity at December 31, 2021 and 2020, respectively,
are presented below.
1 year
1 to 5
5 to 10
After 10
Fair
Gross Unrealized
Amortized
(Dollars in thousands)
or less
years
years
years
Value
Gains
Losses
Cost
December 31, 2021
Agency obligations (a)
$
5,007
49,604
69,802
-
124,413
1,080
2,079
$
125,412
Agency MBS (a)
-
35,855
186,836
223,371
1,527
2,680
224,524
State and political subdivisions
15,743
57,547
74,107
3,611
70,766
Total available-for-sale
$
5,177
50,931
121,400
244,383
421,891
6,218
5,029
$
420,702
December 31, 2020
Agency obligations (a)
$
5,048
24,834
55,367
12,199
97,448
3,156
$
94,390
Agency MBS (a)
-
1,154
20,502
141,814
163,470
3,245
160,358
State and political subdivisions
8,405
64,745
74,259
3,988
70,282
Total available-for-sale
$
5,525
26,620
84,274
218,758
335,177
10,389
$
325,030
(a) Includes securities issued by U.S. government agencies or government sponsored
entities.
Expected maturities of
these securities may differ from contractual maturities because issues
may have the right to call or repay obligations
with or without prepayment penalties.
Securities with aggregate fair values of $
172.3
million and $
166.9
million at December 31, 2021 and 2020, respectively,
were pledged to secure public deposits, securities sold under agreements to repurchase,
Federal Home Loan Bank
(“FHLB”) advances, and for other purposes required or permitted by law.
Included in other assets on the accompanying consolidated balance sheets are nonmarketable
equity investments.
The
carrying amounts of nonmarketable equity investments were $
1.2
million and $
1.4
million at December 31, 2021 and 2020,
respectively.
Nonmarketable equity investments include FHLB of Atlanta stock,
Federal Reserve Bank (“FRB”) stock, and
stock in a privately held financial institution.
Gross Unrealized Losses and Fair Value
The fair values and gross unrealized losses on securities at December 31,
2021 and 2020, respectively, segregated
by those
securities that have been in an unrealized loss position for less than 12 months and 12
months or more are presented below.
Less than 12 Months
12 Months or Longer
Total
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
(Dollars in thousands)
Value
Losses
Value
Losses
Value
Losses
December 31, 2021:
Agency obligations
$
49,799
1,025
26,412
1,054
76,211
$
2,079
Agency MBS
130,110
1,555
38,611
1,125
168,721
2,680
State and political subdivisions
7,960
3,114
11,074
Total
$
187,869
2,689
68,137
2,340
256,006
$
5,029
December 31, 2020:
Agency obligations
$
15,416
-
-
15,416
$
Agency MBS
41,488
-
-
41,488
State and political subdivisions
2,945
-
-
2,945
Total
$
59,849
-
-
59,849
$
For the securities in the previous table, the Company does not have the intent to sell and has determined it is
not more likely
than not that the Company will be required to sell the security before recovery of the
amortized cost basis, which may be
maturity. On a quarterly basis,
the Company assesses each security for credit impairment. For debt securities, the
Company
evaluates, where necessary,
whether credit impairment exists by comparing the present value of the expected cash
flows to
the securities’ amortized cost basis.
In determining whether a loss is temporary,
the Company considers all relevant information including:
●
the length of time and the extent to which the fair value has been less than the amortized
cost basis;
●
adverse conditions specifically related to the security,
an industry, or a geographic area
(for example, changes in
the financial condition of the issuer of the security,
or in the case of an asset-backed debt security,
in the financial
condition of the underlying loan obligors, including changes in technology or the discontinuance of
a segment of
the business that may affect the future earnings potential of the issuer or
underlying loan obligors of the security or
changes in the quality of the credit enhancement);
●
the historical and implied volatility of the fair value of the security;
●
the payment structure of the debt security and the likelihood of the issuer being able to make payments
that
increase in the future;
●
failure of the issuer of the security to make scheduled interest or principal payments;
●
any changes to the rating of the security by a rating agency; and
●
recoveries or additional declines in fair value subsequent to the balance sheet date.
Agency obligations
The unrealized losses associated with agency obligations were primarily driven by changes
in interest rates and not due to
the credit quality of the securities. These securities were issued by U.S. government
agencies or government-sponsored
entities and did not have any credit losses given the explicit government guarantee
or other government support.
Agency mortgage-backed securities (“MBS”)
The unrealized losses associated with agency MBS were primarily driven by changes
in interest rates and not due to the
credit quality of the securities. These securities were issued by U.S. government agencies
or government-sponsored entities
and did not have any credit losses given the explicit government guarantee or other government
support.
Securities of U.S. states and political subdivisions
The unrealized losses associated with securities of U.S. states and political subdivisions
were primarily driven by changes
in interest rates and were not due to the credit quality of the securities. Some of these securities
are guaranteed by a bond
insurer, but management did not rely on the guarantee
in making its investment decision. These securities will continue
to
be monitored as part of the Company’s quarterly
impairment analysis, but are expected to perform even if the rating
agencies reduce the credit rating of the bond insurers. As a result, the Company expects to
recover the entire amortized cost
basis of these securities.
The carrying values of the Company’s investment
securities could decline in the future if the financial condition of an
issuer deteriorates and the Company determines it is probable that it will not recover the entire
amortized cost basis for the
security. As a result, there is a risk that other-than-temporary
impairment charges may occur in the future.
Other-Than-Temporarily
Impaired Securities
Credit-impaired debt securities are debt securities where the Company
has written down the amortized cost basis of a
security for other-than-temporary impairment and the credit
component of the loss is recognized in earnings. At
December 31, 2021 and 2020, respectively,
the Company had no credit-impaired debt securities and there were no additions
or reductions in the credit loss component of credit-impaired debt securities during the
years ended December 31, 2021 and
2020, respectively.
Realized Gains and Losses
The following table presents the gross realized gains and losses on sales related to securities.
Year ended December 31
(Dollars in thousands)
Gross realized gains
$
Gross realized losses
-
(81)
Realized gains, net
$
NOTE 5: LOANS AND ALLOWANCE
FOR LOAN LOSSES
December 31
(In thousands)
Commercial and industrial
$
83,977
$
82,585
Construction and land development
32,432
33,514
Commercial real estate:
Owner occupied
63,375
54,033
Hotel/motel
43,856
42,900
Multifamily
42,587
40,203
Other
108,553
118,000
Total commercial real estate
258,371
255,136
Residential real estate:
Consumer mortgage
29,781
35,027
Investment property
47,880
49,127
Total residential real estate
77,661
84,154
Consumer installment
6,682
7,099
Total loans
459,123
462,488
Less: unearned income
(759)
(788)
Loans, net of unearned income
$
458,364
$
461,700
Loans secured by real estate were approximately
80.3
% of the total loan portfolio at December 31, 2021.
At December 31,
2021, the Company’s geographic loan
distribution was concentrated primarily in Lee County,
Alabama and surrounding
areas.
In accordance with ASC 310,
Receivables
, a portfolio segment is defined as the level at which an entity develops and
documents a systematic method for determining its allowance for loan losses.
As part of the Company’s quarterly
assessment of the allowance, the loan portfolio is disaggregated into the
following portfolio segments:
commercial and
industrial, construction and land development, commercial real estate, residential real
estate and consumer installment.
Where appropriate, the Company’s loan portfolio
segments are further disaggregated into classes. A class is generally
determined based on the initial measurement attribute, risk characteristics of the loan,
and an entity’s method for
monitoring and determining credit risk.
The following describe the risk characteristics relevant to each of the portfolio segments
and classes.
Commercial and industrial (“C&I”) -
includes loans to finance business operations, equipment purchases, or
other needs
for small and medium-sized commercial customers. Also included
in this category are loans to finance agricultural
production.
Generally, the primary source of repayment
is the cash flow from business operations and activities of the
borrower.
We are a participating lender
in the PPP.
PPP loans are forgivable in whole or in part, if the proceeds are used
for payroll and other permitted purposes in accordance with the requirements of the PPP.
As of December 31, 2021, the
Company has
PPP loans with an aggregate outstanding principal balance of $
8.1
million included in this category.
The
Company had
PPP loans with an aggregate outstanding principal balance of $
19.0
million included in this category at
December 31, 2020.
Construction and land development (“C&D”) -
includes both loans and credit lines for the purpose of purchasing,
carrying and developing land into commercial developments or residential subdivisions.
Also included are loans and lines
for construction of residential, multi-family and commercial buildings. Generally the primary
source of repayment is
dependent upon the sale or refinance of the real estate collateral.
Commercial real estate
(“CRE”) -
includes loans disaggregated into three classes: (1) owner occupied (2)
multi-family
and (3) other.
Owner occupied
- includes loans secured by business facilities to finance business operations, equipment and
owner-occupied facilities primarily for small and medium-sized commercial customers.
Generally the primary source
of repayment is the cash flow from business operations and activities of the borrower,
who owns the property.
Hotel/motel
- includes loans for hotels and motels.
Generally, the primary source
of repayment is dependent upon
income generated from the real estate collateral.
The underwriting of these loans takes into consideration the
occupancy and rental rates, as well as the financial health of the borrower.
Multifamily
- primarily includes loans to finance income-producing multi-family properties. Loans in this
class include
loans for 5 or more unit residential property and apartments leased to residents. Generally,
the primary source of
repayment is dependent upon income generated from the real estate collateral.
The underwriting of these loans takes
into consideration the occupancy and rental rates, as well as the financial health of the
borrower.
Other
- primarily includes loans to finance income-producing commercial properties. Loans in this class include
loans
for neighborhood retail centers, hotels, medical and professional offices, single
retail stores, industrial buildings, and
warehouses leased generally to local businesses and residents. Generally,
the primary source of repayment is dependent
upon income generated from the real estate collateral. The underwriting of these loans takes into consideration
the
occupancy and rental rates as well as the financial health of the borrower.
Residential real estate (“RRE”) -
includes loans disaggregated into two classes: (1) consumer mortgage and (2)
investment property.
Consumer mortgage
- primarily includes first or second lien mortgages and home equity lines to consumers
that are
secured by a primary residence or second home. These loans are underwritten in accordance
with the Bank’s general
loan policies and procedures which require, among other things, proper documentation of each borrower’s
financial
condition, satisfactory credit history and property value.
Investment property
- primarily includes loans to finance income-producing 1-4 family residential properties.
Generally,
the primary source of repayment is dependent upon income generated from leasing the property
securing the
loan. The underwriting of these loans takes into consideration the rental rates as
well as the financial health of the
borrower.
Consumer installment -
includes loans to individuals both secured by personal property and unsecured.
Loans include
personal lines of credit, automobile loans, and other retail loans.
These loans are underwritten in accordance with the
Bank’s general loan policies and procedures
which require, among other things, proper documentation of each borrower’s
financial condition, satisfactory credit history,
and if applicable, property value.
The following is a summary of current, accruing past due and nonaccrual loans by portfolio
class as of December 31, 2021
and 2020.
Accruing
Accruing
Total
30-89 Days
Greater than
Accruing
Non-
Total
(In thousands)
Current
Past Due
90 days
Loans
Accrual
Loans
December 31, 2021:
Commercial and industrial
$
83,974
-
83,977
-
$
83,977
Construction and land development
32,228
-
32,432
-
32,432
Commercial real estate:
Owner occupied
63,375
-
-
63,375
-
63,375
Hotel/motel
43,856
-
-
43,856
-
43,856
Multifamily
42,587
-
-
42,587
-
42,587
Other
108,366
-
-
108,366
108,553
Total commercial real estate
258,184
-
-
258,184
258,371
Residential real estate:
Consumer mortgage
29,070
-
29,586
29,781
Investment property
47,818
-
-
47,818
47,880
Total residential real estate
76,888
-
77,404
77,661
Consumer installment
6,657
-
6,682
-
6,682
Total
$
457,931
-
458,679
$
459,123
December 31, 2020:
Commercial and industrial
$
82,355
-
82,585
-
$
82,585
Construction and land development
33,453
-
33,514
-
33,514
Commercial real estate:
Owner occupied
54,033
-
-
54,033
-
54,033
Hotel/motel
42,900
-
-
42,900
-
42,900
Multifamily
40,203
-
-
40,203
-
40,203
Other
117,759
-
117,788
118,000
Total commercial real estate
254,895
-
254,924
255,136
Residential real estate:
Consumer mortgage
33,169
1,503
34,812
35,027
Investment property
49,014
-
49,020
49,127
Total residential real estate
82,183
1,509
83,832
84,154
Consumer installment
7,069
7,099
-
7,099
Total
$
459,955
1,858
461,954
$
462,488
The gross interest income which would have been recorded under the original terms of those
nonaccrual loans had they
been accruing interest, amounted to approximately $
thousand and $
thousand for the years ended December 31, 2021
and 2020, respectively.
Allowance for Loan Losses
The allowance for loan losses as of and for the years ended December 31,
2021 and 2020, is presented below.
Year ended December 31
(In thousands)
Beginning balance
$
5,618
$
4,386
Charged-off loans
(294)
(45)
Recovery of previously charged-off loans
Net (charge-offs) recoveries
(79)
Provision for loan losses
(600)
1,100
Ending balance
$
4,939
$
5,618
The Company assesses the adequacy of its allowance for loan losses prior
to the end of each calendar quarter. The level of
the allowance is based upon management’s
evaluation of the loan portfolio, past loan loss experience, current asset quality
trends, known and inherent risks in the portfolio, adverse situations that may affect
a borrower’s ability to repay (including
the timing of future payment), the estimated value of any underlying collateral,
composition of the loan portfolio, economic
conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory
recommendations. This
evaluation is inherently subjective as it requires material estimates including the amounts
and timing of future cash flows
expected to be received on impaired loans that may be susceptible to significant change. Loans are
charged off, in whole or
in part, when management believes that the full collectability of the loan is unlikely.
A loan may be partially charged-off
after a “confirming event” has occurred which serves to validate that full repayment pursuant
to the terms of the loan is
unlikely.
The Company deems loans impaired when, based on current information and events,
it is probable that the Company will
be unable to collect all amounts due according to the contractual terms of the loan agreement.
Collection of all amounts due
according to the contractual terms means that both the interest and principal payments of
a loan will be collected as
scheduled in the loan agreement.
An impairment allowance is recognized if the fair value of the loan is less than the recorded
investment in the loan. The
impairment is recognized through the allowance. Loans that are impaired are
recorded at the present value of expected
future cash flows discounted at the loan’s effective
interest rate, or if the loan is collateral dependent, impairment
measurement is based on the fair value of the collateral, less estimated disposal costs.
The level of allowance maintained is believed by management to be adequate
to absorb probable losses inherent in the
portfolio at the balance sheet date. The allowance is increased by provisions charged
to expense and decreased by charge-
offs, net of recoveries of amounts previously charged-off.
In assessing the adequacy of the allowance, the Company also considers the results of its
ongoing internal, independent
loan review process. The Company’s loan
review process assists in determining whether there are loans in the portfolio
whose credit quality has weakened over time and evaluating the risk characteristics of the
entire loan portfolio. The
Company’s loan review process includes the judgment
of management, the input from our independent loan reviewers, and
reviews that may have been conducted by bank regulatory agencies as part of their examination
process. The Company
incorporates loan review results in the determination of whether or not it is probable
that it will be able to collect all
amounts due
according to the contractual terms of a loan.
As part of the Company’s quarterly assessment
of the allowance, management divides the loan portfolio into five segments:
commercial and industrial, construction and land development, commercial real estate, residential
real estate, and consumer
installment loans. The Company analyzes each segment and estimates an allowance allocation
for each loan segment.
The allocation of the allowance for loan losses begins with a process of estimating the
probable losses inherent for these
types of loans. The estimates for these loans are established by category and based
on the Company’s internal system of
credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s
internal system of
credit risk grades is based on its experience with similarly graded loans. For
loan segments where the Company believes it
does not have sufficient historical loss data, the Company may
make adjustments based, in part, on loss rates of peer bank
groups. At December 31, 2021 and 2020, and for the years then ended, the Company adjusted
its historical loss rates for the
commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.
The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s
estimate of
probable losses for several “qualitative and environmental” factors. The allocation
for qualitative and environmental factors
is particularly subjective and does not lend itself to exact mathematical calculation. This
amount represents estimated
probable inherent credit losses which exist, but have not yet been identified,
as of the balance sheet date, and are based
upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration
changes, prevailing economic
conditions, changes in lending personnel experience, changes in lending policies or
procedures and other influencing
factors. These qualitative and environmental factors are considered
for each of the five loan segments and the allowance
allocation, as determined by the processes noted above, is increased or decreased
based on the incremental assessment of
these factors.
The Company regularly re-evaluates its practices in determining the allowance
for loan losses. Since the fourth quarter of
2016, the Company has increased its look-back period each quarter to incorporate
the effects of at least one economic
downturn in its loss history. The Company
believes the extension of its look-back period is appropriate due to the risks
inherent in the loan portfolio. Absent this extension, the early cycle periods in
which the Company experienced significant
losses would be excluded from the determination of the allowance for loan losses and its balance
would decrease. For the
year ended December 31, 2021, the Company increased its look-back period
to 51 quarters to continue to include losses
incurred by the Company beginning with the first quarter of 2009. The
Company will likely continue to increase its look-
back period to incorporate the effects of at least one economic
downturn in its loss history.
During 2020, the Company
adjusted certain qualitative and economic factors related to changes in economic conditions
driven by the impact of the
COVID-19 pandemic and resulting adverse economic conditions, including
higher unemployment in our primary market
area.
During 2021, the Company adjusted certain qualitative and economic factors to reflect
improvements in economic
conditions in our primary market area.
Further adjustments may be made in the future as a result of the ongoing COVID-19
pandemic.
The following table details the changes in the allowance for loan losses by portfolio segment
for the years ended December
31, 2021 and 2020.
(in thousands)
Commercial
and industrial
Construction
and land
Development
Commercial
Real Estate
Residential
Real Estate
Consumer
Installment
Total
Balance, December 31, 2019
$
2,289
$
4,386
Charge-offs
(7)
-
-
-
(38)
(45)
Recoveries
-
-
Net (charge-offs) recoveries
-
-
(18)
Provision
(16)
1,100
Balance, December 31, 2020
$
3,169
$
5,618
Charge-offs
-
-
(254)
(3)
(37)
(294)
Recoveries
-
-
Net recoveries (charge-offs)
-
(254)
(17)
(79)
Provision
(90)
(76)
(176)
(257)
(1)
(600)
Balance, December 31, 2021
$
2,739
$
4,939
The following table presents an analysis of the allowance for loan losses and recorded
investment in loans by portfolio
segment and impairment methodology as of December 31, 2021 and 2020.
Collectively evaluated (1)
Individually evaluated (2)
Total
Allowance
Recorded
Allowance
Recorded
Allowance
Recorded
for loan
investment
for loan
investment
for loan
investment
(In thousands)
losses
in loans
losses
in loans
losses
in loans
December 31, 2021:
Commercial and industrial
$
83,977
-
-
83,977
Construction and land development
32,432
-
-
32,432
Commercial real estate
2,739
258,184
-
2,739
258,371
Residential real estate
77,599
-
77,661
Consumer installment
6,682
-
-
6,682
Total
$
4,939
458,874
-
4,939
459,123
December 31, 2020:
Commercial and industrial
$
82,585
-
-
82,585
Construction and land development
33,514
-
-
33,514
Commercial real estate
3,169
254,924
-
3,169
255,136
Residential real estate
84,047
-
84,154
Consumer installment
7,099
-
-
7,099
Total
$
5,618
462,169
-
5,618
462,488
(1) Represents loans collectively evaluated for impairment
in accordance with ASC 450-20,
Loss Contingencies
(formerly FAS 5), and pursuant to amendments by ASU 2010-20 regarding allowance for
unimpaired loans.
(2) Represents loans individually evaluated for impairment
in accordance with ASC 310-30,
Receivables
(formerly
FAS 114), and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.
Credit Quality Indicators
The credit quality of the loan portfolio is summarized no less frequently than quarterly using categories
similar to the
standard asset classification system used by the federal banking agencies.
The following table presents credit quality
indicators for the loan portfolio segments and classes. These categories are utilized to develop
the associated allowance for
loan losses using historical losses adjusted for qualitative and environmental factors
and are defined as follows:
●
Pass - loans which are well protected by the current net worth and paying capacity of the
obligor (or guarantors, if
any) or by the fair value, less cost to acquire and sell, of any underlying collateral.
●
Special Mention - loans with potential weakness that may,
if not reversed or corrected, weaken the credit or
inadequately protect the Company’s position
at some future date. These loans are not adversely classified and do
not expose an institution to sufficient risk to warrant an adverse classification.
●
Substandard Accruing - loans that exhibit a well-defined weakness which presently jeopardizes
debt repayment,
even though they are currently performing. These loans are characterized by the distinct possibility
that the
Company may incur a loss in the future if these weaknesses are not corrected.
●
Nonaccrual - includes loans where management has determined that full payment
of principal and interest is in
doubt.
(In thousands)
Pass
Special
Mention
Substandard
Accruing
Nonaccrual
Total loans
December 31, 2021
Commercial and industrial
$
83,725
-
$
83,977
Construction and land development
32,212
-
32,432
Commercial real estate:
Owner occupied
61,573
1,675
-
63,375
Hotel/motel
36,162
7,694
-
-
43,856
Multifamily
39,093
3,494
-
-
42,587
Other
107,426
108,553
Total commercial real estate
244,254
13,774
258,371
Residential real estate:
Consumer mortgage
27,647
1,487
29,781
Investment property
47,459
47,880
Total residential real estate
75,106
1,748
77,661
Consumer installment
6,650
-
6,682
Total
$
441,947
14,372
2,360
$
459,123
December 31, 2020
Commercial and industrial
$
79,984
2,383
-
$
82,585
Construction and land development
33,260
-
-
33,514
Commercial real estate:
Owner occupied
51,265
2,627
-
54,033
Hotel/motel
35,084
7,816
-
-
42,900
Multifamily
36,673
3,530
-
-
40,203
Other
116,498
1,243
118,000
Total commercial real estate
239,520
15,216
255,136
Residential real estate:
Consumer mortgage
32,518
1,897
35,027
Investment property
48,501
49,127
Total residential real estate
81,019
2,229
84,154
Consumer installment
7,069
-
7,099
Total
$
440,852
18,190
2,912
$
462,488
Impaired loans
The following table presents details related to the Company’s
impaired loans. Loans which have been fully charged-off do
not appear in the following table. The related allowance generally represents the
following components which correspond
to impaired loans:
●
Individually evaluated impaired loans equal to or greater than $500 thousand secured
by real estate (nonaccrual
construction and land development, commercial real estate, and residential real estate).
●
Individually evaluated impaired loans equal to or greater than $250 thousand not secured
by real estate
(nonaccrual commercial and industrial and consumer loans).
The following table sets forth certain information regarding the Company’s
impaired loans that were individually evaluated
for impairment at December 31, 2021 and 2020.
December 31, 2021
(In thousands)
Unpaid
principal
balance (1)
Charge-offs
and payments
applied (2)
Recorded
investment (3)
Related
allowance
With no allowance recorded:
Commercial real estate:
Other
$
(18)
$
-
Total commercial real estate
(18)
-
Residential real estate:
Investment property
(6)
-
Total residential real estate
(6)
-
Total
impaired loans
$
(24)
$
-
(1) Unpaid principal balance represents the contractual obligation
due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well
as interest payments that have been
applied against the outstanding principal balance.
(3) Recorded investment represents the unpaid principal balance
less charge-offs and payments applied; it is shown before
any related allowance for loan losses.
December 31, 2020
(In thousands)
Unpaid
principal
balance (1)
Charge-offs
and payments
applied (2)
Recorded
investment (3)
Related
allowance
With no allowance recorded:
Other
$
(4)
$
-
Total commercial real estate
(4)
-
Investment property
(2)
-
Total residential real estate
(2)
-
Total
impaired loans
$
(6)
$
-
(1) Unpaid principal balance represents the contractual obligation
due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well
as interest payments that have been
applied against the outstanding principal balance.
(3) Recorded investment represents the unpaid principal balance
less charge-offs and payments applied; it is shown before
any related allowance for loan losses.
The following table provides the average recorded investment in impaired loans and
the amount of interest income
recognized on impaired loans after impairment by portfolio segment and class.
Year ended December 31, 2021
Year ended December 31, 2020
Average
Total interest
Average
Total interest
recorded
income
recorded
income
(In thousands)
investment
recognized
investment
recognized
Impaired loans:
Commercial real estate:
Other
$
-
$
-
Total commercial real estate
-
-
Residential real estate:
Investment property
-
-
Total residential real estate
-
-
Total
$
-
$
-
Troubled Debt
Restructurings
Impaired loans also include troubled debt restructurings (“TDRs”).
Section 4013 of the CARES Act, “Temporary
Relief
From Troubled Debt Restructurings,” provides banks the option
to temporarily suspend certain requirements under ASC
340-10 TDR classifications for a limited period of time to account for the effects
of COVID-19. In addition, the Interagency
Statement on COVID-19 Loan Modifications, encourages banks to
work prudently with borrowers and describes the
agencies’ interpretation of how accounting rules under ASC 310
-40, “Troubled Debt Restructurings by Creditors,” apply
to
certain COVID-19-related modifications. The Interagency Statement on
COVID-19 Loan Modifications was supplemented
on June 23, 2020 by the Interagency Examiner Guidance for Assessing Safety and
Soundness Considering the Effect of the
COVID-19 Pandemic on Institutions.
If a loan modification is eligible, a bank may elect to account for the loan under
section 4013 of the CARES Act. If a loan modification is not eligible under section 4013,
or if the bank elects not to
account for the loan modification under section 4013, the Revised Statement includes
criteria when a bank may presume a
loan modification is not a TDR in accordance with ASC 310-40.
The Company evaluates loan extensions or modifications not qualified under
Section 4013 of the CARES Act or under the
Interagency Statement on COVID-19 Loan Modifications in accordance
with FASB ASC 340-10 with respect to the
classification of the loan as a TDR.
In the normal course of business, management may grant concessions to borrowers
that
are experiencing financial difficulty.
A concession may include, but is not limited to, delays in required payments of
principal and interest for a specified period, reduction of the stated interest rate of the loan,
reduction of accrued interest,
extension of the maturity date, or reduction of the face amount or maturity amount of the debt.
A concession has been
granted when, as a result of the restructuring, the Bank does not expect to collect,
when due, all amounts owed, including
interest at the original stated rate.
A concession may have also been granted if the debtor is not able to access funds
elsewhere at a market rate for debt with similar risk characteristics as the restructured
debt.
In making the determination of
whether a loan modification is a TDR, the Company considers the individual facts
and circumstances surrounding each
modification.
As part of the credit approval process, the restructured loans are evaluated for
adequate collateral protection
in determining the appropriate accrual status at the time of restructure.
Similar to other impaired loans, TDRs are measured for impairment based on the present value of expected
payments using
the loan’s original effective
interest rate as the discount rate, or the fair value of the collateral, less selling costs if the
loan is
collateral dependent. If the recorded investment in the loan exceeds the measure of
fair value, impairment is recognized by
establishing a valuation allowance as part of the allowance for loan losses or a charge
-off to the allowance for loan losses.
In periods subsequent to the modification, all TDRs are evaluated individually,
including those that have payment defaults,
for possible impairment.
The following is a summary of accruing and nonaccrual TDRs and the related loan losses, by portfolio
segment and class at
December 31, 2021 and 2020.
TDRs
Related
(In thousands)
Accruing
Nonaccrual
Total
Allowance
December 31, 2021
Commercial real estate:
Other
$
-
$
-
Total commercial real estate
-
-
Investment property
-
-
Total residential real estate
-
-
Total
$
-
$
-
TDRs
Related
(In thousands)
Accruing
Nonaccrual
Total
Allowance
December 31, 2020
Commercial real estate:
Other
$
-
$
-
Total commercial real estate
-
-
Investment property
-
-
Total residential real estate
-
-
Total
$
-
$
-
At December 31, 2021 there were no significant outstanding commitments to advance
additional funds to customers whose
loans had been restructured.
The following table summarizes loans modified in a TDR during the respective periods
both
before and after modification.
Pre-
Post-
modification
modification
outstanding
outstanding
Number of
recorded
recorded
($ in thousands)
contracts
investment
investment
December 31, 2020
Commercial real estate:
Other
$
Total commercial real estate
Investment property
Total residential real estate
Total
$
There were no loans modified in a TDR in 2021.
Four loans were modified in a TDR during the year ended December 31,
2020 the only concession granted by the Company was related to a delay in the required
payment of principal and/or
interest.
During the years ended December 31, 2021 and 2020, respectively,
the Company had no loans modified in a TDR within
the previous 12 months for which there was a payment default (defined as 90 days or
more past due).
NOTE 6: PREMISES AND EQUIPMENT
Premises and equipment at December 31, 2021 and 2020 is presented below
.
December 31
(Dollars in thousands)
Land and improvements
$
9,830
9,829
Buildings and improvements
16,124
7,436
Furniture, fixtures, and equipment
3,096
2,715
Construction in progress
19,277
8,171
Total premises and equipment
48,327
28,151
Less:
accumulated depreciation
(6,603)
(5,958)
Premises and equipment, net
$
41,724
22,193
Depreciation expense was approximately $
thousand and $
thousand for the years ended December 31, 2021 and
2020, respectively, and is a component
of net occupancy and equipment expense in the consolidated statements of earnings.
For more information related to depreciation expense, please refer to “Change in
Accounting Estimate” in Note 1,
Summary of Significant Accounting Policies.
NOTE 7: MORTGAGE SERVICING
RIGHTS, NET
MSRs are recognized
based on the
fair value of
the servicing rights
on the date
the corresponding mortgage
loans are sold.
An
estimate
of
the
Company’s
MSRs
is
determined
using
assumptions
that
market
participants
would
use
in
estimating
future net
servicing income,
including estimates
of prepayment
speeds, discount
rate, default
rates, cost
to service,
escrow
account earnings,
contractual servicing
fee income,
ancillary income,
and late
fees.
Subsequent to
the date
of transfer,
the
Company
has
elected
to
measure
its
MSRs
under
the
amortization
method.
Under
the
amortization
method,
MSRs
are
amortized in proportion
to, and over
the period of,
estimated net servicing
income. Servicing
fee income is
recorded net
of
related amortization expense and recognized in earnings as part of mortgage lending
income.
The Company has recorded MSRs related to loans sold without recourse to
Fannie Mae.
The Company generally sells
conforming, fixed-rate, closed-end, residential mortgages to Fannie Mae.
MSRs are included in other assets on the
accompanying consolidated balance sheets.
The Company evaluates MSRs for impairment on a quarterly basis.
Impairment is determined by stratifying MSRs into
groupings based on predominant risk characteristics, such as interest rate and loan type.
If, by individual stratum, the
carrying amount of the MSRs exceeds fair value, a valuation allowance is established.
The valuation allowance is adjusted
as the fair value changes.
Changes in the valuation allowance are recognized in earnings as a component
of mortgage
lending income.
The following table details the changes in amortized MSRs and the related valuation allowance for
the years ended
December 31, 2021 and 2020.
Year ended December 31
(Dollars in thousands)
Beginning balance
$
1,330
1,299
Additions, net
Amortization expense
(516)
(640)
Ending balance
$
1,309
1,330
Valuation
allowance included in MSRs, net:
Beginning of period
$
-
-
End of period
-
-
Fair value of amortized MSRs:
Beginning of period
$
1,489
2,111
End of period
1,908
1,489
Data and assumptions used in the fair value calculation related to MSRs at December
31, 2021 and 2020, respectively,
are
presented below.
December 31
(Dollars in thousands)
Unpaid principal balance
$
255,310
265,964
Weighted average prepayment
speed (CPR)
13.3
%
20.7
Discount rate (annual percentage)
9.5
%
10.0
Weighted average coupon
interest rate
3.4
%
3.6
Weighted average remaining
maturity (months)
Weighted average servicing
fee (basis points)
25.0
25.0
At December 31, 2021, the weighted average amortization period
for MSRs was
5.1
years.
Estimated amortization expense
for each of the next five years is presented below.
(Dollars in thousands)
December 31, 2021
$
NOTE 8:
DEPOSITS
At December 31, 2021, the scheduled maturities of certificates of deposit and other time
deposits are presented below.
(Dollars in thousands)
December 31, 2021
$
113,771
26,196
11,709
3,377
4,408
Thereafter
Total certificates of deposit and
other time deposits
$
159,650
Additionally, at December 31,
2021 and 2020, approximately $
58.0
million and $
55.0
million, respectively, of certificates
of deposit and other time deposits were issued in denominations greater than $250
thousand.
At December 31, 2021 and 2020, the amount of deposit accounts in overdraft status that
were reclassified to loans on the
accompanying consolidated balance sheets was not material.
NOTE 9: LEASE COMMITMENTS
We lease certain office
facilities and equipment under operating leases. Rent expense for all
operating leases totaled $
0.2
million for both years ended December 31, 2021 and 2020.
On January 1, 2019, we adopted a new accounting standard
which required the recognition of certain operating leases on our balance sheet as lease right of
use assets (reported as
component of other assets) and related lease liabilities (reported as a component of accrued
expenses and other liabilities).
Aggregate lease right of use assets were $
thousand and $
thousand at December 31, 2021 and 2020, respectively.
Aggregate lease liabilities were $
thousand and $
thousand at December 31, 2021 and 2020, respectively.
Rent
expense includes amounts related to items that are not included in the determination of lease
right of use assets including
expenses related to short-term leases totaling $
0.1
million for the year ended December 31, 2021.
Lease payments under operating leases that were applied to our operating lease liability totaled
$
thousand during the
year ended December 31, 2021. The following table reconciles future undiscounted
lease payments due under non-
cancelable operating leases (those amounts subject to recognition) to the aggregate operating lease
liability as of December
31, 2021.
(Dollars in thousands)
Future lease
payments
$
Thereafter
Total undiscounted operating
lease liabilities
$
Imputed interest
Total operating lease liabilities
included in the accompanying consolidated balance sheets
$
Weighted-average lease terms
in years
6.79
Weighted-average discount rate
3.06
%
NOTE 10:
OTHER COMPREHENSIVE (LOSS) INCOME
Comprehensive income
is defined
as the
change in
equity from
all transactions
other than
those with
stockholders,
and
it
includes
net
earnings
and
other
comprehensive
(loss)
income.
Other
comprehensive
(loss)
income
for
the
years
ended
December 31, 2021 and 2020, is presented below.
Pre-tax
Tax benefit
Net of
(Dollars in thousands)
amount
(expense)
tax amount
2021:
Unrealized net holding loss on securities
$
(8,943)
2,246
(6,697)
Reclassification adjustment for net gain on securities recognized in net earnings
(15)
(11)
Other comprehensive loss
$
(8,958)
2,250
(6,708)
2020:
Unrealized net holding gain on securities
$
7,501
(1,884)
5,617
Reclassification adjustment for net gain on securities recognized in net earnings
(103)
(77)
Other comprehensive income
$
7,398
(1,858)
5,540
NOTE 11:
INCOME TAXES
For the years ended December 31, 2021 and 2020 the components of income tax expense
from continuing operations are
presented below.
Year ended December 31
(Dollars in thousands)
Current income tax expense:
Federal
$
1,459
State
Total current income tax expense
1,128
1,935
Deferred income tax benefit:
Federal
(262)
State
(68)
Total deferred
income tax expense (benefit)
(330)
Total income tax expense
$
1,406
1,605
Total income tax expense differs
from the amounts computed by applying the statutory federal income tax rate of 21%
to
earnings before income taxes.
A reconciliation of the differences for the years ended December 31,
2021 and 2020, is
presented below.
Percent of
Percent of
pre-tax
pre-tax
(Dollars in thousands)
Amount
earnings
Amount
earnings
Earnings before income taxes
$
9,445
9,059
Income taxes at statutory rate
1,983
21.0
%
1,902
21.0
%
Tax-exempt interest
(514)
(5.4)
(489)
(5.4)
State income taxes, net of
federal tax effect
3.7
3.8
New Markets Tax Credit
(356)
(3.8)
-
-
Bank-owned life insurance
(85)
(0.9)
(152)
(1.7)
Other
0.3
(1)
-
Total income tax expense
$
1,406
14.9
%
1,605
17.7
%
At December 31, 2021, the Company had a net deferred tax asset of $0.4
million included in other assets on the
consolidated balance sheet and at December 31, 2020, a deferred tax liability of $1.5
million included in other liabilities on
the consolidated balance sheet.
The tax effects of temporary differences that give rise to significant
portions of the deferred
tax assets and deferred tax liabilities at December 31, 2021 and 2020 are presented
below.
December 31
(Dollars in thousands)
Deferred tax assets:
Allowance for loan losses
$
1,240
1,411
Accrued bonus
Right of use liability
Other
Total deferred
tax assets
1,687
1,889
Deferred tax liabilities:
Premises and equipment
Unrealized gain on securities
2,548
Originated mortgage servicing rights
Right of use asset
New Markets Tax Credit investment
-
Other
Total deferred
tax liabilities
1,252
3,426
Net deferred tax asset (liability)
$
(1,537)
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available
evidence, it is more-likely-
than-not that some portion of the entire deferred tax asset will not be realized.
The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the periods
in which those temporary differences
become deductible.
Management considers the scheduled reversal of deferred tax liabilities,
projected future taxable
income and tax planning strategies in making this assessment. Based upon the level of historical
taxable income and
projection for future taxable income over the periods which the temporary differences
resulting in the remaining deferred
tax assets are deductible, management believes it is more-likely-than
-not that the Company will realize the benefits of these
deductible differences at December 31, 2021.
The amount of the deferred tax assets considered realizable, however,
could
be reduced in the near term if estimates of future taxable income are reduced.
The change in the net deferred tax asset for the years ended December 31, 2021
and 2020, is presented
below.
Year ended December 31
(Dollars in thousands)
Net deferred tax asset (liability):
Balance, beginning of year
$
(1,537)
(9)
Deferred tax (expense) benefit related to continuing operations
(278)
Stockholders' equity, for accumulated
other comprehensive loss (income)
2,250
(1,858)
Balance, end of year
$
(1,537)
ASC 740,
Income Taxes,
defines the threshold for recognizing the benefits of tax return positions in the financial statements
as “more-likely-than-not” to be sustained by the taxing authority.
This section also provides guidance on the de-
recognition, measurement, and classification of income tax uncertainties in interim
periods.
As of December 31, 2021, the
Company had no unrecognized tax benefits related to federal or state income tax matters.
The Company does not anticipate
any material increase or decrease in unrecognized tax benefits during 2022
relative to any tax positions taken prior to
December 31, 2021.
As of December 31, 2021, the Company has accrued no interest and no penalties related to uncertain
tax positions.
It is the Company’s policy to recognize interest
and penalties related to income tax matters in income tax
expense.
The Company and its subsidiaries file consolidated U.S. federal and State of Alabama income
tax returns.
The Company is
currently open to audit under the statute of limitations by the Internal Revenue Service and the State of
Alabama for the
years ended December 31, 2018 through 2021.
NOTE 12:
EMPLOYEE BENEFIT PLAN
The Company sponsors a qualified defined contribution retirement plan, the Auburn National
Bancorporation, Inc. 401(k)
Plan (the "Plan").
Eligible employees may contribute up to 100% of eligible compensation, subject to statutory limits
upon
completion of 2 months of service.
Furthermore, the Company allows employer Safe Harbor contributions. Participants
are
immediately vested in employer Safe Harbor contributions. The
Company's matching contributions on behalf of
participants were equal to $1.00 for each $1.00 contributed by participants, up to 3% of the
participants' eligible
compensation, and $0.50 for every $1.00 contributed by participants, above 3% up to 5%
of the participants' eligible
compensation, for a maximum matching contribution of 4% of the participants' eligible
compensation. Company matching
contributions to the Plan were approximately $
0.3
million for the years ended December 31, 2021 and 2020, respectively,
and are included in salaries and benefits expense.
NOTE 13:
COMMITMENTS AND CONTINGENT LIABILITIES
Credit-Related Financial Instruments
The Company is party to credit related financial instruments with off
-balance sheet risk in the normal course of business to
meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit.
Such commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the
amount recognized in the consolidated balance sheets.
The Company’s exposure to credit
loss is represented by the contractual amount of these commitments.
The Company
follows the same credit policies in making commitments as it does for on-balance sheet
instruments.
At December 31, 2021 and 2020, the following financial instruments were outstanding
whose contract amount represents
credit risk.
December 31
(Dollars in thousands)
Commitments to extend credit
$
70,993
$
74,970
Standby letters of credit
1,455
1,237
Commitments to extend credit are agreements to lend to a customer as long as there is no violation
of any condition
established in the agreement.
Commitments generally have fixed expiration dates or other termination clauses
and may
require payment of a fee.
The commitments for lines of credit may expire without being
drawn upon.
Therefore, total
commitment amounts do not necessarily represent future cash requirements.
The amount of collateral obtained, if it is
deemed necessary by the Company,
is based on management’s credit
evaluation of the customer.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer
to a third party.
The credit risk involved in issuing letters of credit is essentially the same
as that involved in extending loan
facilities to customers.
The Company holds various assets as collateral, including accounts receivable,
inventory,
equipment, marketable securities, and property to support those commitments
for which collateral is deemed necessary.
The Company has recorded a liability for the estimated fair value of these standby letters
of credit in the amount of $
thousand and $
thousand at December 31, 2021 and 2020, respectively.
Other Commitments
At December 31, 2021, the Company has contracts with construction companies
for an aggregate of $
30.5
million to
construct a new headquarters in Auburn, Alabama.
As of December 31, 2021, the Company has paid $
24.1
million under
these contracts with a balance to finish, including retainage, of $
6.4
million.
Contingent Liabilities
The Company and the Bank are involved in various legal proceedings, arising in connection
with their business.
In the
opinion of management, based upon consultation with legal counsel, the ultimate resolution
of these proceeding will not
have a material adverse effect upon the consolidated financial
condition or results of operations of the Company and the
Bank.
NOTE 14: FAIR VALUE
Fair Value
Hierarchy
“Fair value” is defined by ASC 820,
Fair Value
Measurements and Disclosures
, as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction occurring in the principal market
(or most advantageous
market in the absence of a principal market) for an asset or liability at the measurement date.
GAAP establishes a fair
value hierarchy for valuation inputs that gives the highest priority to quoted prices
in active markets for identical assets or
liabilities and the lowest priority to unobservable inputs.
The fair value hierarchy is as follows:
Level 1-inputs to the valuation methodology are quoted prices, unadjusted, for identical
assets or liabilities in active
markets.
Level 2-inputs to the valuation methodology include quoted prices for similar assets and
liabilities in active markets,
quoted prices for identical or similar assets or liabilities in markets that are not active, or
inputs that are observable for the
asset or liability, either directly or
indirectly.
Level 3-inputs to the valuation methodology are unobservable and reflect the
Company’s own assumptions about the
inputs market participants would use in pricing the asset or liability.
Level changes in fair value measurements
Transfers between levels of the fair value hierarchy are generally
recognized at the end of the reporting period.
The
Company monitors the valuation techniques utilized for each category of
financial assets and liabilities to ascertain when
transfers between levels have been affected.
The nature of the Company’s financial assets
and liabilities generally is such
that transfers in and out of any level are expected to be infrequent. For the years ended December
31, 2021 and 2020, there
were no transfers between levels and no changes in valuation techniques for the Company’s
financial assets and liabilities.
Assets and liabilities measured at fair value on a recurring
basis
Securities available-for-sale
Fair values of securities available for sale were primarily measured using
Level 2 inputs.
For these securities, the Company
obtains pricing from third party pricing services.
These third party pricing services consider observable data that may
include broker/dealer quotes, market spreads, cash flows, market consensus prepayment
speeds, benchmark yields, reported
trades for similar securities, credit information and the securities’ terms and conditions.
On a quarterly basis, management
reviews the pricing received from the third party pricing services for reasonableness
given current market conditions.
As
part of its review, management
may obtain non-binding third party broker quotes to validate the fair value measurements.
In addition, management will periodically submit pricing provided by the third party
pricing services to another
independent valuation firm on a sample basis.
This independent valuation firm will compare the price provided
by the
third-party pricing service with its own price and will review the significant assumptions
and valuation methodologies used
with management.
The following table presents the balances of the assets and liabilities measured at fair value
on a recurring as of December
31, 2021 and 2020, respectively,
by caption, on the accompanying consolidated balance sheets by ASC 820
valuation
hierarchy (as described above).
Quoted Prices in
Significant
Active Markets
Other
Significant
for
Observable
Unobservable
Identical Assets
Inputs
Inputs
(Dollars in thousands)
Amount
(Level 1)
(Level 2)
(Level 3)
December 31, 2021:
Securities available-for-sale:
Agency obligations
$
124,413
-
124,413
-
Agency MBS
223,371
-
223,371
-
State and political subdivisions
74,107
-
74,107
-
Total securities available-for-sale
421,891
-
421,891
-
Total
assets at fair value
$
421,891
-
421,891
-
December 31, 2020:
Securities available-for-sale:
Agency obligations
$
97,448
-
97,448
-
Agency MBS
163,470
-
163,470
-
State and political subdivisions
74,259
-
74,259
-
Total securities available-for-sale
335,177
-
335,177
-
Total
assets at fair value
$
335,177
-
335,177
-
Assets and liabilities measured at fair value on a nonrecurring
basis
Loans held for sale
Loans held for sale are carried at the lower of cost or fair value. Fair values of loans held for
sale are determined using
quoted market secondary market prices for similar loans.
Loans held for sale are classified within Level 2 of the fair value
hierarchy.
Impaired Loans
Loans considered impaired under ASC 310-10-35,
Receivables
, are loans for which, based on current information and
events, it is probable that the Company will be unable to collect all principal and interest
payments due in accordance with
the contractual terms of the loan agreement.
Impaired loans can be measured based on the present value of expected
payments using the loan’s original effective
rate as the discount rate, the loan’s observable
market price, or the fair value of
the collateral less selling costs if the loan is collateral dependent.
The fair value of impaired loans were primarily measured based on the value of the collateral
securing these loans.
Impaired loans are classified within Level 3 of the fair value hierarchy.
Collateral may be real estate and/or business assets
including equipment, inventory,
and/or accounts receivable.
The Company determines the value of the collateral based on
independent appraisals performed by qualified licensed appraisers.
These appraisals may utilize a single valuation
approach or a combination of approaches including comparable sales and the income
approach.
Appraised values are
discounted for costs to sell and may be discounted further based on management’s
historical knowledge, changes in market
conditions from the date of the most recent appraisal, and/or management’s
expertise and knowledge of the customer and
the customer’s business.
Such discounts by management are subjective and are typically significant unobservable
inputs
for determining fair value.
Impaired loans are reviewed and evaluated on at least a quarterly basis
for additional
impairment and adjusted accordingly,
based on the same factors discussed above.
Other real estate owned
Other real estate
owned, consisting of properties obtained through foreclosure or in satisfaction
of loans, are initially
recorded at the lower of the loan’s carrying amount or
the fair value less costs to sell upon transfer of the loans to other real
estate. Subsequently, other real
estate is carried at the lower of carrying value or fair value less costs to sell. Fair values are
generally based on third party appraisals of the property and are classified within
Level 3 of the fair value hierarchy.
The
appraisals are sometimes further discounted based on management’s
historical knowledge, and/or changes in market
conditions from the date of the most recent appraisal, and/or management’s
expertise and knowledge of the customer and
the customer’s business. Such discounts are typically significant
unobservable inputs for determining fair value. In cases
where the carrying amount exceeds the fair value, less costs to sell, a loss is recognized
in noninterest expense.
Mortgage servicing rights, net
Mortgage servicing rights, net, included in other assets on the accompanying consolidated
balance sheets, are carried at the
lower of cost or estimated fair value.
MSRs do not trade in an active market with readily observable prices.
To determine
the fair value of MSRs, the Company engages an independent third party.
The independent third party’s
valuation model
calculates the present value of estimated future net servicing income using assumptions
that market participants would use
in estimating future net servicing income, including estimates of prepayment speeds, discount
rate, default rates, cost to
service, escrow account earnings, contractual servicing fee income, ancillary
income, and late fees.
Periodically, the
Company will review broker surveys and other market research to validate significant
assumptions used in the model.
The
significant unobservable inputs include prepayment speeds or the constant prepayment rate
(“CPR”) and the weighted
average discount rate.
Because the valuation of MSRs requires the use of significant unobservable inputs, all of the
Company’s MSRs are classified
within Level 3 of the valuation hierarchy.
The following table presents the balances of the assets and liabilities measured
at fair value on a nonrecurring basis as of
December 31, 2021 and
2020, respectively, by caption, on the accompanying
consolidated balance sheets and by ASC 820
valuation hierarchy (as described above):
Quoted Prices in
Active Markets
Other
Significant
for
Observable
Unobservable
Identical Assets
Inputs
Inputs
(Dollars in thousands)
Amount
(Level 1)
(Level 2)
(Level 3)
December 31, 2021:
Loans held for sale
$
1,376
-
1,376
-
Loans, net
(1)
-
-
Other assets
(2)
1,683
-
-
1,683
Total assets at fair value
$
3,308
-
1,376
1,932
December 31, 2020:
Loans held for sale
$
3,418
-
3,418
-
Loans, net
(1)
-
-
Other assets
(2)
1,330
-
-
1,330
Total assets at fair value
$
5,067
-
3,418
1,649
(1)
Loans considered impaired under ASC 310-10-35 Receivables. This amount reflects the recorded
investment in
impaired loans, net of any related allowance for loan losses.
(2)
Represents other real estate owned and MSRs, net both of which are carried at lower of cost or
estimated fair value.
At December 31, 2021 and 2020 and for the years then ended, the Company had no Level
3 assets measured at fair value on
a recurring basis.
For Level 3 assets measured at fair value on a non-recurring basis as of December
31, 2021 and 2020, the
significant unobservable inputs used in the fair value measurements are presented
below.
Weighted
Carrying
Significant
Average
(Dollars in thousands)
Amount
Valuation Technique
Unobservable Input
Range
of Input
December 31, 2021:
Impaired loans
$
Appraisal
Appraisal discounts
10.0
-
10.0
%
10.0
%
Other real estate owned
Appraisal
Appraisal discounts
55.0
-
55.0
%
55.0
%
Mortgage servicing rights, net
1,309
Discounted cash flow
Prepayment speed or CPR
6.8
-
16.5
%
13.3
%
Discount rate
9.5
-
11.5
%
9.5
%
December 31, 2020:
Impaired loans
$
Appraisal
Appraisal discounts
10.0
-
10.0
%
10.0
%
Mortgage servicing rights, net
1,330
Discounted cash flow
Prepayment speed or CPR
18.2
-
36.4
%
20.7
%
Discount rate
10.0
-
12.0
%
10.0
%
Fair Value
of Financial Instruments
ASC 825,
Financial Instruments
, requires disclosure of fair value information about financial instruments,
whether or not
recognized on the face of the balance sheet, for which it is practicable to estimate that
value. The assumptions used in the
estimation of the fair value of the Company’s
financial instruments are explained below.
Where quoted market prices are
not available, fair values are based on estimates using discounted cash flow analyses. Discounted
cash flows can be
significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. The
following fair value estimates cannot be substantiated by comparison to independent
markets and should not be considered
representative of the liquidation value of the Company’s
financial instruments, but rather are a good-faith estimate of the
fair value of financial instruments held by the Company.
ASC 825 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements.
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:
Loans, net
Fair values for loans were calculated using discounted cash flows. The discount rates reflected
current rates at which similar
loans would be made for the same remaining maturities. Expected
future cash flows were projected based on contractual
cash flows, adjusted for estimated prepayments.
The fair value of loans was measured using an exit price
notion.
Loans held for sale
Fair values of loans held for sale are determined using quoted market secondary
market prices for similar loans.
Time Deposits
Fair values for time deposits were estimated using discounted
cash flows. The discount rates were based on rates currently
offered for deposits with similar remaining maturities.
Fair Value Hierarchy
Carrying
Estimated
Level 1
Level 2
Level 3
(Dollars in thousands)
amount
fair value
inputs
inputs
Inputs
December 31, 2021:
Financial Assets:
Loans, net (1)
$
453,425
$
449,105
$
-
$
-
$
449,105
Loans held for sale
1,376
1,410
-
1,410
-
Financial Liabilities:
Time Deposits
$
159,650
$
160,581
$
-
$
160,581
$
-
December 31, 2020:
Financial Assets:
Loans, net (1)
$
456,082
$
451,816
$
-
$
-
$
451,816
Loans held for sale
3,418
3,509
-
3,509
-
Financial Liabilities:
Time Deposits
$
160,401
$
162,025
$
-
$
162,025
$
-
(1) Represents loans, net of unearned income and the allowance
for loan losses.
The fair value of loans was measured using an exit
price notion.
NOTE 15: RELATED PARTY
TRANSACTIONS
The Bank has made, and expects in the future to continue to make in the ordinary course
of business, loans to directors and
executive officers of the Company,
the Bank, and their affiliates. In management’s
opinion, these loans were made in the
ordinary course of business at normal credit terms, including interest rate and collateral
requirements, and do not represent
more than normal credit risk.
An analysis of such outstanding loans is presented below.
(Dollars in thousands)
Amount
Loans outstanding at December 31, 2021
$
1,236
New loans/advances
Repayments
(516)
Loans outstanding at December 31, 2021
$
1,564
During 2021 and 2020, certain executive officers and directors
of the Company and the Bank, including companies with
which they are affiliated, were deposit customers of the bank.
Total deposits for these persons
at December 31, 2021 and
2020 amounted to $
19.3
million and $
18.7
million, respectively.
NOTE 16: REGULATORY
RESTRICTIONS AND CAPITAL
RATIOS
As required by the Economic Growth, Regulatory Relief, and Consumer Protection
Act in August 2018, the Federal
Reserve Board issued an interim final rule that expanded applicability of the Board’s
small bank holding company policy
statement. The interim final rule raised the policy statement’s
asset threshold from $1 billion to $3 billion in total
consolidated assets for a bank holding company or savings and loan holding company that:
(1) is not engaged in significant
nonbanking activities; (2) does not conduct significant off-balance sheet
activities; and (3) does not have a material amount
of debt or equity securities, other than trust-preferred securities, outstanding. The
interim final rule provides that, if
warranted for supervisory purposes, the Federal Reserve may exclude a company from
the threshold increase. Management
believes the Company meets the conditions of the Federal Reserve’s
small bank holding company policy statement and is
therefore excluded from consolidated capital requirements at December 31,
2021.
The Bank remains subject to regulatory capital requirements administered by the
federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators
that, if undertaken, could have a direct material effect on the Company’s
financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that
involve quantitative measures of their assets, liabilities and certain off
-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are also subject
to qualitative judgments by the regulators
about components, risk weightings and other factors.
As of December 31, 2021, the Bank is “well capitalized” under the regulatory framework
for prompt corrective action. To
be categorized as “well capitalized,” the Bank must maintain minimum common equit
y
Tier 1, total risk-based, Tier
1 risk-
based, and Tier 1 leverage ratios as set forth in the table. Management
has not received any notification from the Bank's
regulators that changes the Bank’s regulatory capital
status.
The actual capital amounts and ratios for the Bank and the aforementioned minimums as
of December 31, 2021 and 2020
are presented below.
Minimum for capital
Minimum to be
Actual
adequacy purposes
well capitalized
(Dollars in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
At December 31, 2021:
Tier 1 Leverage Capital
$
100,059
9.35
%
$
42,808
4.00
%
$
53,509
5.00
%
Common Equity Tier 1 Capital
100,059
16.23
27,742
4.50
40,072
6.50
Tier 1 Risk-Based Capital
100,059
16.23
36,990
6.00
49,320
8.00
Total Risk-Based Capital
105,163
17.06
49,320
8.00
61,649
10.00
At December 31, 2020:
Tier 1 Leverage Capital
$
96,096
10.32
%
$
37,263
4.00
%
$
46,579
5.00
%
Common Equity Tier 1 Capital
96,096
17.27
25,042
4.50
36,171
6.50
Tier 1 Risk-Based Capital
96,096
17.27
33,389
6.00
44,519
8.00
Total Risk-Based Capital
101,906
18.31
44,519
8.00
55,648
10.00
Dividends paid by the Bank are a principal source of funds available to the Company for
payment of dividends to its
stockholders and for other needs. Applicable federal and state statutes and regulations impose
restrictions on the amounts of
dividends that may be declared by the subsidiary bank. State law and Federal Reserve policy
restrict the Bank from
declaring dividends in excess of the sum of the current year’s earnings
plus the retained net earnings from the preceding
two years without prior approval. In addition to the formal statutes and regulations,
regulatory authorities also consider the
adequacy of the Bank’s total capital in relation to its assets,
deposits, and other such items. Capital adequacy considerations
could further limit the availability of dividends from the Bank. At December 31,
2021, the Bank could have declared
additional dividends of approximately $
8.3
million without prior approval of regulatory authorities. As a result of this
limitation, approximately $
92.6
million of the Company’s investment in the Bank
was restricted from transfer in the form
of dividends.
NOTE 17: AUBURN NATIONAL
BANCORPORATION
(PARENT COMPANY)
The Parent Company’s condensed balance sheets
and related condensed statements of earnings and cash flows are as
follows.
CONDENSED BALANCE SHEETS
December 31
(Dollars in thousands)
Assets:
Cash and due from banks
$
2,705
4,049
Investment in bank subsidiary
100,951
103,695
Other assets
Total assets
$
104,286
108,375
Liabilities:
Accrued expenses and other liabilities
$
Total liabilities
Stockholders' equity
103,726
107,690
Total liabilities and stockholders'
equity
$
104,286
108,375
CONDENSED STATEMENTS
OF EARNINGS
Year ended December 31
(Dollars in thousands)
Income:
Dividends from bank subsidiary
$
3,682
3,638
Noninterest income
Total income
4,347
4,500
Expense:
Noninterest expense
Total expense
Earnings before income tax expense and equity
in undistributed earnings of bank subsidiary
4,158
4,245
Income tax expense
Earnings before equity in undistributed earnings
of bank subsidiary
4,076
4,135
Equity in undistributed earnings of bank subsidiary
3,963
3,319
Net earnings
$
8,039
7,454
CONDENSED STATEMENTS
OF CASH FLOWS
Year ended December 31
(Dollars in thousands)
Cash flows from operating activities:
Net earnings
$
8,039
7,454
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Net decrease (increase) in other assets
(6)
Net decrease in other liabilities
(120)
(561)
Equity in undistributed earnings of bank subsidiary
(3,963)
(3,319)
Net cash provided by operating activities
3,957
3,568
Cash flows from financing activities:
Dividends paid
(3,682)
(3,638)
Stock repurchases
(1,619)
-
Net cash used in financing activities
(5,301)
(3,638)
Net change in cash and cash equivalents
(1,344)
(70)
Cash and cash equivalents at beginning of period
4,049
4,119
Cash and cash equivalents at end of period
$
2,705
4,049

---

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.

---

ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange
Act”), the Company’s
management, under the supervision and with the participation of its principal executive
and principal financial officer,
conducted an evaluation as of the end of the period covered by this report, of the effectiveness
of the Company’s disclosure
controls and procedures as defined in Rule 13a-15(e) under the Exchange
Act. Based on that evaluation, and the results of
the audit process described below,
the Chief Executive Officer and Chief Financial Officer
concluded that the Company’s
disclosure controls and procedures were effective to ensure that information
required to be disclosed in the Company’s
reports under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the
SEC’s rules and regulations, and that such information
is accumulated and communicated to the Company’s
management,
including the Chief Executive Officer and the Chief Financial Officer,
as appropriate, to allow timely decisions regarding
disclosure.
Management’s Report on Internal Control
Over Financial Reporting
The Company’s management is responsible
for establishing and maintaining adequate internal control over financial
reporting. The Company’s internal
control system was designed to provide reasonable assurance to the Company’s
management and board of directors regarding the preparation and fair presentation of published
financial statements. All
internal control systems, no matter how well designed, have inherent limitations.
Therefore, even those systems determined
to be effective can provide only reasonable assurance with respect
to financial statement preparation and presentation.
Under the direction of the Company’s Chief Executive
Officer and Chief Financial Officer,
management has assessed the
effectiveness of the Company’s
internal control over financial reporting as of December 31, 2021 in accordance
with the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”) in Internal
Control - Integrated Framework (2013). Based on this assessment, management
has concluded that such internal control
over financial reporting was effective as of December 31,
2021.
This annual report does not include an attestation report of the Company’s
independent registered public accounting firm
regarding internal control over financial reporting. Management’s
report was not subject to attestation by the Company’s
registered public accounting firm pursuant to the final rules of the Securities and Exchange
Commission that permit the
Company to provide only a management’s
report in this annual report.
Changes in Internal Control Over Financial Reporting
During the period covered by this report, there has not been any change in the Company’s
internal controls over financial
reporting that has materially affected, or is reasonably likely to
materially affect, the Company’s
internal controls over
financial reporting.

---

ITEM 9B. OTHER INFORMATION
ITEM 9B.
OTHER INFORMATION
None.

---

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is set forth under the headings “Proposal
One: Election of Directors - Information about
Nominees for Directors,” and “Executive Officers,”
“Additional Information Concerning the Company’s
Board of
Directors and Committees,” “Executive Compensation,” “Audit Committee
Report” and “Compliance with Section 16(a) of
the Securities Exchange Act of 1934” in the Proxy Statement, and is incorporated herein by reference.
The Board of Directors has adopted a Code of Conduct and Ethics applicable to the Company’s
directors, officers and
employees, including the Company’s principal
executive officer,
principal financial and principal accounting officer,
controller and other senior financial officers. The Code of Conduct and Ethics,
as well as the charters for the Audit
Committee, Compensation Committee, and the Nominating and Corporate
Governance Committee, can be found by
hovering over the heading “About Us” on the Company’s
website,
www.auburnbank.com
, and then clicking on “Investor
Relations”, and then clicking on “Governance Documents”.
In addition, this information is available in print to any
shareholder who requests it. Written requests
for a copy of the Company’s Code of Conduct
and Ethics or the Audit
Committee, Compensation Committee, or Nominating and Corporate
Governance Committee Charters may be sent to
Auburn National Bancorporation, Inc., 132 N. Gay Street, Auburn, Alabama 36830,
Attention: Marla Kickliter, Senior Vice
President of Compliance and Internal Audit. Requests may also be made
via telephone by contacting Marla Kickliter,
Senior Vice President of Compliance
and Internal Audit, or Laura Carrington, Vice
President of Human Resources, at
(334) 821-9200.

---

ITEM 11. EXECUTIVE COMPENSATION
ITEM 11.
EXECUTIVE COMPENSATION
Information required by this item is set forth under the headings “Additional Information
Concerning the Company’s Board
of Directors and Committees - Board Compensation,” and “Executive Officers”
in the Proxy Statement, and is incorporated
herein by reference.

---

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDE
R
MATTERS
Information required by this item is set forth under the headings “Proposal
One: Election of Directors - Information about
Nominees for Directors and Executive Officers” and “Stock
Ownership by Certain Persons” in the Proxy Statement, and is
incorporated herein by reference.

---

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13. CERTAIN
RELATIONSHIPS
AND RELATED
TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information required by this item is set forth under the headings “Additional Information
Concerning the Company’s Board
of Directors and Committees - Committees of the Board of Directors - Independent
Directors Committee” and “Certain
Transactions and Business Relationships” in the Proxy Statement,
and is incorporated herein by reference.

---

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 14.
PRINCIPAL ACCOUNTING FEES
AND SERVICES
Information required by this item is set forth under the heading “Independent Public
Accountants” in the Proxy Statement,
and is incorporated herein by reference.
PART
IV

---

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES
(a)
List of all Financial Statements
The following consolidated financial statements and report of independent registered
public accounting firm of the
Company are included in this Annual Report on Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2021 and 2020
Consolidated Statements of Earnings for the years ended December 31,
2021 and 2020
Consolidated Statements of Comprehensive Income for the years ended December
31, 2021 and 2020
Consolidated Statements of Stockholders’ Equity for the years ended December
31, 2021 and 2020
Consolidated Statements of Cash Flows for the years ended December 31,
2021 and
Notes to the Consolidated Financial Statements
(b)
Exhibits
3.1.
Certificate of Incorporation of Auburn National Bancorporation, Inc. (incorporated by reference from
Registrant's Form 10-Q dated June 30, 2002 (File No. 000-26486)).
3.2.
Amended and Restated Bylaws of Auburn National Bancorporation, Inc., adopted as of November 13, 2007
(incorporated by reference from Registrant’s Form 10-K dated March 31, 2008 (File No. 000-26486)).
4.1.
Description of the Registrant’s Securities
21.1
Subsidiaries of Registrant
31.1
Certification signed by the Chief Executive Officer pursuant to SEC Rule 13a-14(a).
31.2
Certification signed by the Chief Financial Officer pursuant to SEC Rule 13a-14(a).
32.1
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley
Act of 2002 by Robert W. Dumas, Chairman, President and Chief Executive Officer *
32.2
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley
Act of 2002 by David A. Hedges, EVP, Chief Financial Officer.*
101.INS
Inline XBRL Instance Document
101.SCH
Inline XBRL Taxonomy Extension
Schema Document
101.CAL
Inline XBRL Taxonomy Extension
Calculation Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension
Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension
Presentation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension
Definition Linkbase Document
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101
*
The certifications attached as exhibits 32.1 and 32.2 to this annual report on Form 10-K are
“furnished” to the Securities
and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and shall not be deemed “filed”
by the Company for purposes of Section 18 of the Securities Exchange Act of 1934,
as amended.
(c)
Financial Statement Schedules
All financial statement schedules required pursuant to this item were either included
in the financial information set
forth in (a) above or are inapplicable and therefore have been omitted.