株探米国株
英語
エドガーで原本を確認する
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
 
20549
 
FORM
10-K
For the quarterly period ended
December 31, 2022
OR
 
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period __________ to __________
Commission File Number:
0-26486
Auburn National Bancorporation, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
 
63-0885779
(State or other jurisdiction
of incorporation)
 
(I.R.S. Employer
Identification No.)
100 N. Gay Street
,
Auburn,
Alabama
 
36830
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (
334
)
821-9200
 
Securities registered pursuant to Section 12 (b) of the Act:
 
Title of Each Class
 
Trading Symbol
 
Name of Exchange on which Registered
Common Stock
, par value $0.01
 
AUBN
 
NASDAQ
 
Global Market
Securities registered to Section 12(g) of the Act:
 
None
Indicate by check mark if the registrant
 
is a well-known seasoned issuer, as defined in Rule 405
 
of the Securities Act. Yes
No
 
Indicate by check mark if the registrant
 
is not required to file reports pursuant
 
to Section 13 or Section 15(d) of the Act.
 
Yes
No
 
Indicate by check mark whether the registrant
 
(1) has filed all reports required to be
 
filed by Section 13 or 15(d) of
 
the Securities Exchange Act of 1934 during
 
the
preceding 12 months (or for such shorter
 
period that the registrant was required
 
to file such reports), and (2) has been subject
 
to such filing requirements for the past
90 days.
Yes
 
No
 
Indicate by check mark whether the registrant
 
has submitted electronically every Interactive
 
Data File required to be submitted pursuant
 
to Rule 405 of Regulation S-
T (§ 232.405 of this chapter) during
 
the preceding 12 months (or for such
 
shorter period that the registrant was required
 
to submit such files).
Yes
 
No
Indicate by check mark whether the registrant
 
is a large accelerated filer, an accelerated filer, a non-accelerated
 
filer, or a smaller reporting company. See the
definitions of “large accelerated filer,” “accelerated filer”
 
and “smaller reporting company” in
 
Rule 12b-2 of the Exchange Act. (Check
 
one):
 
Large Accelerated filer
 
 
Accelerated filer
 
Non-accelerated filer
 
 
Smaller reporting company
Emerging Growth
 
Company
If an emerging growth company, indicate by check mark if the registrant
 
has selected not to use the extended
 
transition period for complying with any
 
new or revised
financial accounting standards provided pursuant
 
to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant
 
has filed a report on and attestation
 
to its management’s assessment of the effectiveness of its internal
 
control over
financial reporting under Section 404(b)
 
of the Sarbanes-Oxley Act (15 U.S.C.
 
7262(b)) by the registered public accounting
 
firm that prepared or issued its audit
report.
 
If securities are registered pursuant to Section
 
12(b) of the Act, indicate by check
 
mark whether the financial statements of
 
the registrant included in the filing reflect
the correction of an error to previously
 
issued financial statements.
 
Indicate by check mark whether any
 
of those error corrections are restatements
 
that required a recovery analysis of
 
incentive-based compensation received by any
 
of
the registrant’s executive officers during the relevant recovery
 
period pursuant to §240.10D-1(b).
 
Indicate by check mark if the registrant
 
is a shell company (as defined in Rule
 
12b-2 of the Act). Yes
 
No
 
State the aggregate market value of the voting
 
and non-voting common equity held by
 
non-affiliates computed by reference to the price
 
at which the common equity
was last sold, or the average bid and
 
asked price of such common equity
 
as of the last business day of the registrant’s most recently
 
completed second fiscal quarter:
$
61,228,105
 
as of June 30, 2022.
 
APPLICABLE ONLY TO CORPORATE REGISTRANTS
 
Indicate the number of shares outstanding
 
of each of the registrant’s classes of common stock,
 
as of the latest practicable date:
3,500,879
 
shares of common stock as
of March 16, 2023.
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Proxy Statement for the
 
Annual Meeting of Shareholders, scheduled
 
to be held May 9, 2023, are incorporated by
 
reference into Part II, Item 5 and
Part III of this Form 10-K.
 
3
PART
 
I
 
SPECIAL CAUTIONARY NOTE REGARDING
 
FORWARD
 
-LOOKING STATEMENTS
Various
 
of the statements made herein under the captions “Management’s
 
Discussion and Analysis of Financial Condition
and Results of Operations”, “Quantitative and Qualitative Disclosures about Market
 
Risk”, “Risk Factors” “Description of
Property” and elsewhere, are “forward-looking statements” within the
 
meaning and protections of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
 
as amended (the “Exchange Act”).
Forward-looking statements include statements with respect to our beliefs, plans, objectives,
 
goals, expectations,
anticipations, assumptions, estimates, intentions and future performance, and involve
 
known and unknown risks,
uncertainties and other factors, which may be beyond our control, and
 
which may cause the actual results, performance,
achievements or financial condition of the Company to be materially different
 
from future results, performance,
achievements or financial condition expressed or implied by such forward-looking
 
statements.
 
You
 
should not expect us to
update any forward-looking statements.
All statements other than statements of historical fact are statements that could be forward-looking
 
statements.
 
You
 
can
identify these forward-looking statements through our use of words such as “may,”
 
“will,” “anticipate,” “assume,”
“should,” “indicate,” “would,” “believe,” “contemplate,” “expect,”
 
“estimate,” “continue,” “designed”, “plan,” “point to,”
“project,” “could,” “intend,” “target” and other similar words and
 
expressions of the future.
 
These forward-looking
statements may not be realized due to a variety of factors, including, without limitation:
the effects of future economic, business and market conditions and
 
changes, foreign, domestic and locally,
including inflation, seasonality,
 
natural disasters or climate change, such as rising sea and water levels,
 
hurricanes
and tornados, COVID-19 or other epidemics or pandemics including supply chain disruptions,
 
inventory volatility,
and changes in consumer behaviors;
the effects of war or other conflicts, acts of terrorism, trade restrictions, sanctions
 
or other events that may affect
general economic conditions;
governmental monetary and fiscal policies, including the continuing effects
 
of COVID-19 fiscal and monetary
stimuli, and changes in monetary policies in response to inflations including increases
 
in the Federal Reserve’s
target federal funds rate and reductions in the Federal Reserve’s
 
holdings of securities;
legislative and regulatory changes, including changes in banking, securities and tax laws,
 
regulations and rules and
their application by our regulators, including capital and liquidity requirements, and
 
changes in the scope and cost
of FDIC insurance;
changes in accounting pronouncements and interpretations, including the required
 
implementation of Financial
Accounting Standards Board’s (“FASB”)
 
Accounting Standards Update (ASU) 2016-13, “Financial Instruments –
Credit Losses (Topic
 
326): Measurement of Credit Losses on Financial Instruments,” as well as the
 
updates issued
since June 2016 (collectively, FASB
 
ASC Topic 326)
 
on Current Expected Credit Losses (“CECL”), and ASU
2022-02, Troubled Debt Restructurings and Vintage
 
Disclosures, which eliminates troubled debt restructurings
(“TDRs”) and related guidance;
the failure of assumptions and estimates, as well as differences in, and changes to, economic,
 
market and credit
conditions, including changes in borrowers’ credit risks and payment behaviors from
 
those used in our loan
portfolio reviews;
the risks of changes in market interest rates and the shape of the yield curve on the levels, composition
 
and costs of
deposits, loan demand and mortgage loan originations, and the values and liquidity of loan
 
collateral, securities,
and interest-sensitive assets and liabilities, and the risks and uncertainty of the amounts
 
realizable on collateral;
the risks of increases in market interest rates creating unrealized losses on our securities available
 
for sale, which
adversely affect our stockholders’ equity for financial reporting purposes;
changes in borrower liquidity and credit risks, and savings, deposit and payment behaviors; changes in the availability and cost of credit and capital in the financial markets, and the types of instruments that
4
may be included as capital for regulatory purposes;
changes in the prices, values and sales volumes of residential and commercial real estate;
the effects of competition from a wide variety of local, regional, national
 
and other providers of financial,
investment and insurance services, including the disruptive effects
 
of financial technology and other competitors
who are not subject to the same regulations as the Company and the Bank and credit
 
unions, which are not subject
to federal income taxation;
the failure of assumptions and estimates underlying the establishment of allowances
 
for possible loan losses and
other asset impairments, losses valuations of assets and liabilities and other estimates, and
 
the allowance of credit
losses for CECL beginning January 1, 2023;
the timing and amount of rental income from third parties following the June 2022
 
opening of our new
headquarters;
the risks of mergers, acquisitions and divestitures, including,
 
without limitation, the related time and costs of
implementing such transactions, integrating operations as part of these transactions and
 
possible failures to achieve
expected gains, revenue growth and/or expense savings from such transactions;
changes in technology or products that may be more difficult, costly,
 
or less effective than anticipated;
cyber-attacks and data breaches that may compromise our systems, our
 
vendors’ systems or customers’
information;
the risks that our deferred tax assets (“DTAs”)
 
included in “other assets” on our consolidated balance sheets, if
any, could be reduced if estimates of future
 
taxable income from our operations and tax planning strategies are less
than currently estimated, and sales of our capital stock could trigger a reduction in the amount of
 
net operating loss
carry-forwards that we may be able to utilize for income tax purposes; and
other factors and risks described under “Risk Factors” herein and in any of our subsequent
 
reports that we make
with the Securities and Exchange Commission (the “Commission” or “SEC”)
 
under the Exchange Act.
All written or oral forward-looking statements that are we make or are
 
attributable to us are expressly qualified in their
entirety by this cautionary notice.
 
We have no obligation and
 
do not undertake to update, revise or correct any of the
forward-looking statements after the date of this report, or after the respective dates on
 
which such statements otherwise are
made.
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 Bank of Atlanta (the
 
“Federal
Reserve Bank”) 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 The Company’s business is conducted primarily through the Bank and its subsidiaries.
“FHLB”) since 1991.
 
5
General
Although it has no immediate plans
to conduct any other business, the Company may engage directly or indirectly in a number
 
of activities closely related to
banking permitted by the Federal Reserve.
The Company’s principal executive offices
 
are located at 100 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 machine (“ATM”)
 
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 and can be used anywhere Visa
 
is accepted, including ATMs.
 
The Bank’s Visa
 
Checkcards can be used
internationally through the Plus
®
 
network.
 
The Bank offers online banking, bill payment and other electronic banking
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.”
 
The Bank does not offer any services related to any Bitcoin or other digital or crypto instruments
 
or stablecoins or
businesses.
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, including CDs and
savings accounts.
 
Certain of these competitors are not subject to the same regulatory restrictions as the Bank.
 
6
Selected Economic Data
The Auburn-Opelika Metropolitan Statistical Area is Lee County,
 
Alabama, including Auburn, Opelika and part of Phenix
City, Alabama.
 
The U.S. Census Bureau estimates Lee County’s
 
population was 181,881 in 2022, and has increased
approximately 29.7% from 2010 to 2022.
 
The largest employers in the area are Auburn University,
 
East Alabama Medical
Center, Lee County School System, Wal
 
-Mart Distribution Center, Baxter Healthcare, Thermo
 
Fisher Scientific, Mando
America Corporation (automobile brakes and steering), 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.
 
Various
 
suppliers to the automotive industry have facilities in Lee County.
 
The unemployment rate in Lee County was
2.0% at year end 2022 according to the U.S. Bureau of Labor Statistics.
Between 2010 and 2022, the Auburn-Opelika MSA was the second fastest
 
growing MSA in Alabama.
 
The Auburn-
Opelika MSA population is estimated to grow 6.6% from 2023 to 2028.
 
During the same time, household income is
estimated to increase 14.25%, to $69,213.
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
 
sales 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 remaining economic effects of the
 
COVID-19 pandemic, including continuing supply
chain disruptions and a tight labor market,
 
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 our markets, 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.
 
We also may make
loans to other borrowers outside these areas, especially where we have a relationship with the borrower, or its business or At December 31, 2022, the Company and its subsidiaries had 150 full-time equivalent employees, including 37 officers.
owners.
7
Human Capital
Our average term of service is approximately 10 years.
 
We successfully implemented
 
plans to protect our employees’
health consistent with CDC and State of Alabama guidelines during the COVID-19 pandemic,
 
while maintaining critical
banking services to our communities.
 
In addition, we developed our remote and electronic banking services, and
 
established remote work access to help employees stay at home where job
 
duties permitted.
 
This promoted employee
retention, and these efforts will provide us proven experience and flexibility
 
to meet other disruptive events and conditions,
and still provide our customers and communities continuity of service.
We experienced
 
little turnover as a result of the COVID-19 pandemic and made no staff
 
reductions.
 
As a result, we
received a federal employee retention tax credit of approximately $1.6
 
million in 2022.
We have a talented group
 
of employees,
 
many of which, have a college or associate degree.
 
We believe the Auburn-
Opelika MSA is a desirable place to live and work with excellent schools and quality of life.
 
Our MSA was the second
fastest growing MSA in Alabama from 2010 to 2022.
 
Auburn University is a major employer that attracts talented students
and employee families.
 
Various
 
of our
 
employees have a family member that is employed by or is attending the University.
We
 
were an active PPP lender in our communities during 2020-2021, which required our employees to quickly
 
learn and
apply a new SBA loan program with frequent overnight changes.
 
All our PPP loans were forgiven by the SBA, except one
where the borrower is repaying its PPP loan without government assistance.
We had a successful
 
management transition in 2022 where our CEO became Chairman, and
 
was succeeded by our CFO,
whose role was then filled by our Chief Accounting Officer.
 
Our Chairman has served the Bank his entire 39-year career,
our President and CEO has been with us 16 years and our Chief Accounting Officer
 
has been with us for 7 years.
 
Our new
President and CFO had careers with major national and regional accounting
 
firms and focused on financial services before
joining the Bank.
We seek to provide
 
competitive compensation and benefits.
 
We provide
 
employer matches for employee contributions to
our 401(k) retirement plan.
 
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.
 
Our Chairman is the current President Pro Tempore
 
of the Auburn University Board of Trustees.
Statistical Information
Certain statistical information is included in responses to Items 6, 7, 7A and 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.
8
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 subsidiar
 
ies.
 
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”.
 
Bank mergers are also subject to the approval of the acquiring bank’s
primary federal regulator and the Bank Merger Act.
 
The BHC Act and the Bank Merger Act provide various generally
similar statutory factors.
 
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.
Bank mergers are also subject to the approval of the acquiring bank’s
 
primary federal regulator.
 
On March 19, 2022, the
FDIC published a “Request for Information and Comment on Rules, Regulations,
 
Guidance, and Statements of Policy
Regarding Bank Merger Transactions” (the
 
“FDIC Notice”).
 
The FDIC solicited comments from interested parties
regarding the application of the laws, practices, rules, regulations, guidance, and statements
 
of policy (together, regulatory
framework) that apply to merger transactions involving one
 
or more insured depository institution, including the merger
between an insured depository institution and a noninsured institution. The FDIC is interested
 
in receiving comments
regarding the effectiveness of the existing framework in
 
meeting the requirements of the Bank Merger Act.
 
The Request described the consolidation of the banking industry,
 
the increase in the number of large and systemically
important banking organizations and the need to evaluate large
 
mergers’ financial stability and resolution of failing bank
risks consistent with the Dodd-Frank Act changes to the BHC Act and the Bank Merger
 
Act, and the effects of banking
mergers on competition.
 
The FDIC Notice also stated that Executive Order Promoting Competition in the
 
American
Economy (July 9, 2021) (the “Executive Order”), among other things, “instructs U.S.
 
agencies to consider the impact that
consolidation may have on maintaining a fair, open,
 
and competitive marketplace, and on the welfare of workers, farmers,
small businesses, startups, and consumers.”
 
The FDIC requested comment on all aspects of the bank regulatory
framework, including qualitative and quantitative support for such responses.
 
The other Federal bank regulators as well as
the U.S. Department of Justice are also considering the framework for
 
mergers involving banking organizations, including
the competitive effects of such combinations.
 
The federal bank regulators have not announced any conclusions, but these
reviews could result in changes to the frameworks used to evaluate banking combinations
 
which could make such
combinations more difficult, time consuming and expensive.
9
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 the Bank is subject to various FDIC regulations applicable to FDIC-
insured banks.
 
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.
 
10
The Federal Reserve has adopted the Federal Financial Institutions Examination Council’s
 
(“FFIEC”) Uniform Financial
Institutions Rating System (“UFIRS”), 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:
 
C
apital
Adequacy,
A
sset Quality,
M
anagement,
E
arnings,
L
iquidity and
S
ensitivity 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.
In addition, and separate from the interagency UFIRS, the Federal Reserve assigns a risk
 
-management rating to all state
member banks. The summary,
 
or composite, rating, as well as each of the assessment areas, including risk management,
 
is
delineated on a numerical scale of 1 to 5, with 1 being the highest or best possible rating. Thus,
 
a bank with a composite
rating of 1 requires the lowest level of supervisory attention while a 5-rated bank has the
 
most critically deficient level of
performance and therefore requires the highest degree of supervisory attention.
 
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.
H.R. 1165, The Data Privacy Act of 2023,
 
was introduced in Congress on February 24, 2023 by Rep. McHenry,
 
the
Chairman of the House Financial Services Committee, to which the Bill was referred.
 
It amends various sections of the
GLB Act and preempts certain state privacy laws. Its preemption provisions have triggered opposition by the minority in Community Reinvestment Act and Consumer Laws
the House of Representatives.
11
The Bank is subject to the provisions
 
of the CRA and the Federal Reserve’s CRA
 
regulations.
 
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 (“LMI”) 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 and
emphasize CRA records of each subsidiary depository institution of the applicant bank
 
holding company and the target
bank in meeting the needs of their entire communities, including LMI neighborhoods,
 
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.
 
The Federal Reserve
also considers the effect of a bank acquisition proposal on the convenience
 
and need of the markets served by the
combining organizations.
 
CRA agreements with private parties must be disclosed and annual
 
CRA reports must be made to a bank’s primary
 
federal
regulator.
 
Community benefit plans have become common in banking mergers, especially
 
larger bank combinations.
 
The
National Community Resolution Coalition reported in February 2023
 
that it had executed more than 20 community benefit
plans with banking organizations.
 
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 joint CRA regulations,
 
which were proposed in
May 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 Bank had a “satisfactory” CRA rating in its latest CRA public evaluation dated February 28,
 
2022, with satisfactory
ratings on both its lending and community development tests.
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 joint CRA regulations,
 
which were proposed by
the Federal Reserve, the FDIC and the Comptroller of the Currency in May and June 2022.
Proposed Revision of CRA Regulations
The federal banking regulators jointly proposed (the “CRA Proposal”)
 
revised CRA regulations on June 3, 2022.
 
It is
currently anticipated that these revised regulations may be adopted in the first half of 2023.
12
The objectives of the proposed CRA regulations included:
Update CRA regulations to strengthen the achievement of the core purpose of the statute;
 
Adapt to changes in the banking industry,
 
including the expanded role of mobile and online banking;
 
Provide greater clarity and consistency in the application of the regulations;
 
Tailor performance standards
 
to account for differences in bank size and business models
 
and local conditions;
 
Tailor data collection
 
and reporting requirements and use existing data whenever possible;
 
Promote transparency and public engagement;
 
Confirm that CRA and fair lending
 
responsibilities are mutually reinforcing; and
 
Create a consistent regulatory approach that applies to banks regulated by all three agencies.
The proposed regulations create a new framework for evaluating CRA performance.
 
The new framework would establish
the following four tests for large banks: Retail Lending Test;
 
Retail Services and Products Test;
 
Community Development
Financing Test; and Community
 
Development Services Test.
 
Intermediate banks would be evaluated under the Retail
Lending Test and the
status quo
 
community development test, unless they choose to opt into the Community Development
Financing Test. Small banks
 
would be evaluated under the
status quo
 
small bank lending test, unless they choose to opt into
the Retail Lending Test. Wholesale
 
and limited purpose banks would be evaluated under a tailored version of the
Community Development Financing Test.
 
The bank is currently an “intermediate small bank”.
 
As currently proposed, the Bank would be an “intermediate bank”
until it reached $2.0 billion or more in assets at the date(s) of determination.
 
Intermediate banks would be evaluated
generally under the new Retail Lending Test
 
for intermediate banks and a community development test.
 
The release
proposing the new rules states that the proposed Retail Lending Test
 
represents a significant change from the lending test
applicable to intermediate small banks in the agencies' current regulations, but intermediate
 
banks would not need to
collect, maintain, or report data to facilitate the application of this test.
 
Instead, as under the current CRA regulations,
examiners would continue to use information gathered from individual loan
 
files or maintained on an intermediate bank's
internal operating systems for purposes of the Retail Lending Test.
 
The proposed intermediate bank Community
Development Test evaluates all
 
community development activities, including community development loans,
 
qualified
investments, and community development services.
 
The Retail Lending and Community Development tests will be
weighted equally in determining intermediate banks’ CRA evaluations.
The proposed Retail Lending Test
 
“is intended to make a bank's retail lending evaluation more transparent and predictable
by specifying quantitative standards for lending consistent with achieving,
 
for example, a “Low Satisfactory” or
“Outstanding” conclusion in an assessment area. The proposed rule would limit the evaluation
 
of an intermediate bank's
retail lending performance to areas outside of its facility-based assessment areas only if it
 
does more than 50 percent of its
lending outside of its facility-based assessment areas.”
 
Under the Retail Lending test, an intermediate bank’s
 
lending test
would be based on its major product lines in each assessment area.
 
A major product line would be one or more of the six
retail loan product types: closed-end home mortgage loans; open-end home
 
mortgage loans; multifamily mortgage loans;
small business loans; small farm loans; or automobile loans.
The CRA Proposal states that “the agencies believe retail lending remains a core
 
part of a bank's affirmative obligation
under the CRA to meet the credit needs of their entire communities. At the same time, the
 
agencies recognize that,
compared to large banks, intermediate banks might not offer
 
as wide a range of retail products and services, have a more
limited capacity to conduct community development activities, and
 
may focus on the local communities where their
branches are located.”
 
The CRA Proposal reflects “the agencies’ views that banks of this size should have
 
meaningful
capacity to conduct community development financing, as they do under
 
the current approach.”
 
The CRA Proposal states
that the community development criteria for intermediate banks is unchanged
 
from the current intermediate small bank
community development test.
Intermediate banks would generally be exempt from the data collection,
 
maintenance, and reporting requirements
applicable to large banks under the
 
CRA Proposal.
Banks are currently required to delineate their CRA “assessment areas.”
 
The Bank currently designates two assessment
areas – the Auburn-Opelika MSA (lee County) and the Chambers-Macon-Tallapoosa
 
assessment area – comprised of
Chambers, Macon, and Tallapoosa
 
Counties.
 
The Bank operates two branches in the Chambers, Macon and Tallapoosa
Counties.
 
The CRA Proposal seeks to recognize electronic and remote delivery services.
 
Intermediate banks’ must
designate one or more facilities based CRA assessment areas.
13
The facilities based CRA assessment area under the CRA Proposal
 
would include a bank’s main office, branches,
 
and
deposit-taking ATMs.
 
An intermediate bank could continue to adjust the boundaries of a facilities based
 
assessment area to
include whole census tracts of a county or statistically equivalent entity that the bank could
 
reasonably be expected to serve.
 
Facilities based assessment areas could not extend across a state or metropolitan
 
statistical area (MSA) boundary,
 
unless the
facilities were located in a multistate MSA or combined statistical area.
 
Retail lending activities outside an intermediate
bank’s Facilities based assessment area
 
would be considered in aggregate at the bank level if such outside retail lending was
more than 50% of the bank’s total retail lending.
 
Otherwise, outside retail lending would not be considered.
 
Community
development
 
activities outside an intermediate bank’s
 
facilities based assessment area generally would not be considered.
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.
CFPB Consumer Financial Protection Circular 2022-06 (Oct. 26, 2022)
 
concluded that overdraft fee practices must comply
with Regulation Z, Regulation E, and the prohibition against unfair,
 
deceptive, and abusive acts or practices in Section 1036
of the Consumer Financial Protection Act.
 
Further,
 
overdraft fees assessed by financial institutions on transactions that a
consumer would not reasonably anticipate are likely unfair even if these comply
 
with these other consumer laws and
regulations. 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.”
14
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.
15
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. The forbearance period
 
was extended to February 28, 2021 and then
again to March 31, 2021 after being extended earlier 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-Terrorism
 
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.
 
16
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 Corporate Transparency Act (the”CTA”)
 
was adopted as Title LXIV of the William
 
M. (Mac) Thornberry National
Defense Authorization Act for Fiscal Year
 
2021.
 
FinCEN adopted a final regulation as 31 C.F.R.
 
101.380 on September
30, 2022, which is effective on January 1, 2024 to implement the CTA.
 
These regulations require entities to report
information about their beneficial owners and the individuals who created the entity (together,
 
beneficial ownership
information or BOI).
 
FinCEN explained that the proposed rule would help protect the U.S. financial system from illicit
 
use
by making it more difficult for bad actors to conceal their financial activities
 
through entities with opaque ownership
structures.
 
FinCEN also explained that the proposed reporting obligations would provide
 
essential information to law
enforcement and others to help prevent corrupt actors, terrorists, and proliferators from hiding
 
money or other property in
the United States.”
 
The new rules expand financial institutions’ obligations under the Customer
 
Due Diligence Rule
(“CDD Rule”) to collect information and verify the beneficial ownership of legal entities.
 
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.
Russia’s February 2022 invasion
 
of Ukraine has generated a significant number of new sanctions on Russia, Russian
persons and suppliers of military or dual-purpose products to Russia,
 
The Federal bank regulators have issued alerts that
Russia and others may step up cyber attacks and data intrusions following the invasion.
 
FinCen has issued four alerts on
potential Russian illicit financial activity since February 2022.
 
On January 25, 2023 FinCEN issued an alert to financial
institutions on potential investments in the U.S. commercial real estate sector by sanctioned
 
Russian elites, oligarchs, their
family members, and the entities through which they act. The alert listed
 
potential red flags and typologies involving
attempted sanctions evasion in the commercial real estate sector,
 
and reminds financial institutions of their Bank Secrecy
Act (BSA) reporting obligations.
 
Bill H.R. 1164, the OFAC
 
Outreach and Engagement Capabilities and Enhancement
 
Act, was introduced in Congress on
February 24, 2023.
 
It would set up a review of and improve OFAC
 
outreach and communications to assist financial
institutions to better understand and comply with OFAC
 
sanctions.
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.
 
17
The Company has evaluated its controls, including compliance
 
with the SEC and FDIC 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, 2022 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 2022,
 
the Bank paid total cash dividends of
approximately $3.7 million to the Company.
 
At December 31, 2022, the Bank could have declared and paid additional
dividends of approximately $13.9 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 the capital conservation buffer
 
requirement.
 
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
 
 
18
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 subsidiaries 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.
 
Any HVCRE exposure
excludes loans made before January 1, 2015.
 
The rules define HVCRE loans as loans secured by land or improved real
property that:
primarily 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.
 
The full value of any borrower contributed land (net of any liens on the
land securing HVCRE exposure) count toward the 15% capital contribution to
 
the appraised as completed value, which is
one of the criteria for exemption form the heightened risk weight.
 
Banking institutions and their holding companies are
required to assign 150% risk weight to HVCRE loans.
Capital
The Federal Reserve has risk-based capital guidelines for bank holding companies and
 
state member banks, respectively.
 
These guidelines required, beginning December 31, 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, totaling 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.
 
19
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 activities.
 
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, 2021 or 2022.
 
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, the Company’s
 
CET1 is not adjusted for certain
accumulated other comprehensive income (“AOCI”).
20
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 for regulatory
capital purposes.
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
 
beginning January 1, 2019.
 
Thereafter, 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 -
On 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.
 
This clarifying 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, as used in the Federal Reserve’s
Regulation Q capital rule, as corrected on January 13, 2021, is 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.
 
Banking organizations were encouraged to
 
make prudent capital distribution decisions.
21
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 carrybacks 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%.
In December 2019 the federal bank regulators revised their definition of HVCRE and related
 
capital requirements
consistent with Section 214 of the 2018 Growth Act.
The Financial Accounting Standards Board’s
 
(“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 became effective for the Company beginning January 1,
 
2023.
 
22
The Company is currently finalizing controls, processes, policies and disclosures and
 
has completed full end-to-end parallel
runs.
 
Based on the Company’s portfolio composition
 
as of December 31, 2022, and current expectations of future
economic conditions, the reserve for credit losses is expected to increase from 1.14%
 
as a percentage of total loans at
December 31, 2022 to a range between 1.32% and 1.36% of total loans.
 
These effects result from changing from the
incurred loss model to CECL’s
 
expected loss model, which provides for expected credit losses over the life of the loan
portfolio.
 
The Company does not expect to record an allowance for available-for-sale
 
securities as the investment portfolio
consists primarily of debt securities explicitly or implicitly backed by the U.S. Government
 
for which credit risk is deemed
minimal.
 
ASU 2016-13 is not expected to have a material impact on the allowance for unfunded
 
commitments.
 
The
estimates described herein regarding CECL’s
 
effects are subject to change as key assumptions are refined.
 
These effects in
2023 and later will depend on the future composition, characteristics, and credit
 
quality of the loan and securities portfolios
as well as the economic conditions at future reporting periods that are included in our
 
CECL models.
Federal Reserve Capital Review
The Federal Reserve’s Vice
 
Chair for Supervision is considering a holistic review of regulatory capital requirements,
 
which
are expected to focus on banking organizations larger
 
than the Company.
 
Recently a Federal Reserve.
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 8.0% or greater,
 
a Tier 1 risk-based capital ratio
of 6.0% or greater, a Common Equity Tier
 
1 capital ratio of 4.5% or greater, and generally has a leverage
 
capital
ratio of 4.0% or greater;
“undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier
 
1 risk-based capital ratio of less
than 6.0%, a Common Equity Tier 1 capital
 
ratio of less than 4.5% or generally has a leverage capital ratio of less
than 4.0%;
“significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier
 
1 risk-based
capital ratio of less than 6.0%, a Common Equity Tier 1
 
capital ratio of less than 3%, or a leverage capital ratio of
less than 3.0%; or
“critically undercapitalized” if its tangible equity is equal to or less than 2.0% to total assets.
The federal bank regulatory agencies have authority to require additional capital
 
where they determine it is necessary,
including where a bank is unsafe or unsound condition or where the bank is determined
 
to have less than a satisfactory
rating on any of its CAMELS ratings. The regulators have confirmed 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 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.
 
23
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 prompt corrective action provisions
 
of FDICIA have had or are
expected to have any material effect on the Company and the Bank or
 
their respective operations.
 
Community Bank Leverage Ratio Framework
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 as part of the
community bank leverage ratio framework (“CBLR”).
 
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 CBLR framework which became effective January 1,
 
2020, allows qualifying CBOs to adopt a simple leverage ratio to
measure capital adequacy.
 
The CBLR may be elected by depository institutions and their holding companies
 
and is
intended to reduce regulatory burdens for qualifying community banking organizations
 
that do not use advanced
approaches capital measures, and otherwise qualify.
 
Eligible institutions
 
must 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 CBLR leverage ratio is Tier 1 capital divided
 
by average total consolidated asset for the latest quarter, taking into
account the capital simplification discussed above and the CECL related capital transitions.
A CBLR banking organization with a ratio above the requirement
 
will not be subject to other capital and leverage
requirements.
 
If elected by a banking organization, The CBLR leverage ratio
 
will be the sole capital measure, and electing
institutions will not have to calculate or use any other capital measure for regulatory purposes.
 
The Company has not
adopted the CBLR, although it believes it is eligible to make such election.
 
Management believes that current risk-based
capital measures are useful and reflect the risks of the Company’s
 
earning assets in a manner most comparable to other
banking organizations and which may be useful to investors.
 
It may consider the CBLR in the future.
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.
24
Enforcement Policies and Actions
The Federal Reserve and the Alabama Superintendent examine and regulate our compliance
 
with laws and regulations,
including the CFPB’s regulations.
 
The CFPB issues regulations, interpretations and enforcement actions under
 
the laws
 
applicable to consumer financial products and services.
 
Violations of laws and regulations,
 
including those administered by
the CFPB, or other unsafe and unsound practices, may result in the Federal Reserve and the
 
Alabama Superintendent
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.
Fiscal and Monetary Policies
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.
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. 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 and purchased large amounts of government and The CARES Act provided a $2 trillion stimulus package and various measures to provide relief from the COVID-19
mortgaged backed securities.
 
25
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 provided 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.
 
During early 2022, the Federal Reserve described inflation as “transitory,”
 
but as inflation continued at increasing rates the
Federal Reserve’s policy changed.
 
The Federal Reserve increased the target federal funds range by 25
 
basis points on
March 17, 2022, the first change since March 2020 when the target
 
was set to 0-0.25%.
 
Further increases were made: 50
basis points on May 5, 75 basis points on each of June 16, July 28, September 22, and November
 
22, and 50 basis points on
December 15, 2022.
 
The target rate was increased 25 basis points on February 2, 2023,
 
and further increases in the target
federal funds rate appear likely if inflation remains elevated.
 
The target fed funds ranges was 4.50-4.75% on March 17,
2023.
The Federal Reserve’s securities holdings in
 
its System Open Market Account (“SOMA”) increased from $4.1
 
trillion on
December 30, 2019 to $9.0 trillion at April 11, 2021,
 
largely as a result of securities purchases as the Federal Reserve
injected liquidity as a result of the COVID-19 pandemic.
 
On May 4, 2022, the Federal Reserve announced its plan to
reduce its securities holdings in an effort to reduce inflation:
Reinvestments of principal of maturing Treasury securities
 
would be reduced by $30 billion per month for three
months and thereafter would be $80 billion per month.
Reinvestments of principal of maturing agency debt and mortgage-backed securities
 
would be reduced by $17.5
billion per month for three months and thereafter would be $35 billion per month.
These declines would slow and then stop when the Federal Reserve’s
 
balance sheet was somewhat above the
balance it deemed ample.
The Federal Reserve’s SOMA
 
was $8.4 trillion on February 13, 2023.
The Federal Reserve seeks to target longer term inflation of 2% based
 
on annual changes in the personal consumption
expenditures.
 
The Federal Reserve stated on February 1, 2023 that its Federal Open Market Committee is highly attentive
to inflation risks and the war in Ukraine is contributing to elevated global uncertainty.
 
Inflation remained above that rate
through February 2023.
 
The Chairman of the Federal Reserve’s testimony
 
to the Senate Banking Committee on March 7,
2023 that inflation remains well above the target, gross domestic product
 
in 2022 was 0.9%, below the trend.
 
Higher rates
have adversely affected the housing sector and combined with slower output
 
growth, “appear to be weighing on business
fixed investment.”
 
The labor market is “extremely tight.”
 
The Chairman concluded:
“We continue to anticipate
 
that ongoing increases in the target range for the federal funds rate
 
will be appropriate in order
to attain a stance of monetary policy that is sufficiently restrictive to return inflation
 
to 2% over time. In addition, we are
continuing the process of significantly reducing the size of our balance sheet.
 
Although inflation has been moderating in
recent months, the process of getting inflation back down to 2% has a long
 
way to go and is likely to be bumpy.
 
As I
mentioned, the latest economic data have come in stronger than expected,
 
which suggests that the ultimate level of interest
rates is likely to be higher than previously anticipated. If the totality of the data
 
were to indicate that faster tightening is
warranted, we would be prepared to increase the pace of rate hikes. Restoring price
 
stability will likely require that we
maintain a restrictive stance of monetary policy for some time.”
 
 
 
 
 
 
 
 
 
 
 
 
26
The nature and timing of these ongoing changes in monetary policies and their effects
 
on the Company and the Bank cannot
be predicted.
On March 12, 2023, as a result of unrealized securities losses resulting from increased
 
market rates, liquidity issues at two
banks with over $100 billion of assets each being closed on March 10 and 12, 2023,
 
the Federal Reserve established a new
Bank Term Funding Program
 
(“BTFP”).
 
The BTFP offers loans of up to one year to banks, savings associations,
 
credit
unions, and other eligible depository institutions pledging U.S. Treasuries,
 
agency debt and mortgage-backed securities,
and other qualifying assets as collateral. These assets will be valued at par.
 
The BTFP will be an additional source of
liquidity against high-quality securities, eliminating an institution's need
 
to quickly sell those securities in times of stress.
 
Further, the Federal Reserve on March 12, 2023 stated
 
that depository institutions also may obtain liquidity against a wide
range of collateral through the Federal Reserve’s
 
discount window,
 
which remains open and available. In addition, the
discount window will apply the same margins used for the securities
 
eligible for the BTFP,
 
further increasing lendable
value at the window.
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.
 
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 Small Banks, such as the
 
Bank, for the first assessment period
of 2023 to be billed in June 2023:
Established Small Institution
CAMELS Composite
1 or 2
3
4 or 5
Initial Base Assessment Rule
5 to 32 basis points
6 to 30 basis points
16 to 30 basis points
Unsecured Debt Adjustment.
 
Cannot exceed the lesser of 5
basis points or 50% of the
bank’s initial FDIC
assessment rate
-5 to 0 basis points
-5 to 0 basis points
-5 to 0 basis points
Brokered Deposit
Adhustment
 
N/A
Total Base Assessment
 
Rate
2.5 to 32 basis points
3 to 30 basis points
11 to 30 basis points
These assessments are then adjusted based on the bank’s
 
CAMELS rating.
 
For example, Small Banks, with CAMELS
ratings of 1 or 2, have a current total assessment of 2.5 to 15 basis points for the period to
 
be billed in June 2023.
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%.
27
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
 
received 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.
 
Because of the extraordinary growth in deposits in the first six months of 2020 due to the pandemic and
 
government
stimulus, the DIF’s 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 (the “PPPLF”) 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. This had a limited effect on the Bank since it had only one PPP
 
loan of approximately $0.1 million
outstanding on December 31, 2022, and because the Bank never participated in the PPPLF.
 
The Company recorded FDIC insurance premiums expenses of $0.3 million in both 2022
 
and 2021.
Lending Practices
CRE
The federal bank regulatory agencies released guidance in 2006
 
on “Concentrations in Commercial Real Estate Lending”
(the “CRE Guidance”).
 
The CRE 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 CRE
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 CRE Guidance requires that banks have 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 CRE 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 CRE Guidance was supplemented by the Interagency Statement on Prudent Risk
 
Management for Commercial Real
Estate Lending (December 18, 2015).
 
The CRE 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 CRE Guidance did not apply to the Bank’s
 
CRE lending activities during 2021 or 2022.
 
At December 31, 2022, the
Bank had outstanding $66.5 million in construction and land development loans and
 
$203.9 million in total CRE loans
(excluding owner occupied), which represent approximately 58.9% and 182.3%,
 
respectively, of the Bank’s
 
total risk-based
capital at December 31, 2022.
 
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.
 
28
The Federal Reserve joined the other depository institution regulators in issuing a Proposed
 
Policy Statement on Prudent
Commercial Real Estate Loan Accommodations and Workouts
 
on September 15, 2022.
 
The proposed statement would
build on existing guidance on the need for financial institutions to
 
work prudently and constructively with creditworthy
borrowers during times of financial stress, update existing interagency guidance on commercial
 
real estate loan workouts,
and adds a new section on short-term loan accommodations. The proposed
 
statement would also address recent accounting
changes on estimating loan losses and provide updated examples of how to classify and account
 
for loans subject to loan
accommodations or loan workout activity.
 
The proposed statement reaffirms two key principles from the 2009
 
statement:
(1) financial institutions that implement prudent CRE loan accommodation and
 
workout arrangements after performing a
comprehensive review of a borrower's financial condition will not be subject to
 
criticism for engaging in these efforts, even
if these arrangements result in modified loans that have weaknesses that result in adverse
 
credit classification; and (2)
modified loans to borrowers who have the ability to repay their debts according to reasonable
 
terms will not be subject to
adverse classification solely because the value of the underlying collateral has declined to
 
an amount that is less than the
loan balance.
 
This proposal had not been adopted as of March 1, 2023.
Leveraged Lending
 
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 2022 or 2021
 
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, etc.
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 Section 954 of the Dodd-Frank Act added section 10D to the Exchange Act.
or other advisor.
29
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.
 
On October 2022, the SEC adopted final Rule 10D-14 instructing national securities exchanges
 
to establish specific listing
standards that require each issuer to adopt and comply with a written executive compensation
 
recovery policy.
 
Under Rule
10D-1, listed companies must recover from current and former executive officers’
 
incentive-based compensation received
during the three fiscal years preceding the date on which the issuer is required to
 
prepare an accounting restatement to
correct a material error.
 
On February 23, 2023, Nasdaq proposed to adopt Listing Rule 5608 (the “Nasdaq Rule”).The
 
recovery of erroneously
awarded compensation is required on a “no fault” basis, without regard to
 
whether any misconduct occurred or an executive
officer’s responsibility for the erroneous financial statements.
 
A restatement due to material noncompliance with any
financial reporting requirement under the securities laws triggers application of the recovery
 
policy. The determination
regarding materiality of an error should be based on facts and circumstances and existing judicial and
 
administrative
interpretations. The proposed Nasdaq Rule requires recovery for restatements that
 
correct errors that are material to
previously issued financial statements (commonly referred to
 
as “Big R” restatements), as well as for restatements that
correct errors that are not material to previously issued financial statements but
 
would result in a material misstatement if
the errors were left uncorrected in the current report or the error correction
 
was recognized in the current period (commonly
referred to as “little r” restatement).
 
Under the proposed Nasdaq Rule, Nasdaq-listed companies, such as the Company,
 
will be required to recover the amount
of incentive-based compensation received by an executive officer that exceeds
 
the amount the executive officer would have
received had the incentive-based compensation been determined based on the accounting
 
restatement.
 
Nasdaq proposes to
define “incentive-based compensation” as any compensation that is granted, earned
 
or vested based wholly or in part upon
the attainment of any financial reporting measure.
 
Incentive-based compensation is deemed received in the fiscal period
during which the financial reporting measure specified in the incentive-based
 
compensation award is attained, even if the
grant or payment of the incentive-based compensation occurs after the end of that period.
The SEC adopted rules in August 2013 to implement pay ratios pursuant to Section 953
 
of the Dodd-Frank Act comparing
their CEO’s total compensation to the median compensation
 
of all other employees.
 
These rules applied beginning to fiscal
year 2017 annual reports and proxy statements.
 
Smaller reporting companies, such as the Company,
 
are exempted from
this 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 adopted changes to its Reg. S-K Item 407(i) implementing this Section.
The Company’s has had no equity-based compensation
 
plans or arrangements.
 
The Company’s insider trading policy,
which applies to all Company and Bank directors, officers, employees and
 
certain independent contractors and specified
related persons (collectively,
 
“Covered Persons”).
 
This Policy prohibits Covered Persons, from short-selling Company
securities or engaging in transactions involving Company “Derivative Securities.”
 
This prohibition includes, without
limitation, trading in Company-based put option contracts, including straddles,
 
and the like.
 
Derivative Securities include
options, warrants, restricted stock units, stock appreciation rights or similar rights
 
whose value is derived from the value of
an equity or other security, including Company
 
Securities.
30
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 stated that this Guidance is expected to generally have
 
less effect on smaller banking
organizations, which typically are less complex and
 
make less use of incentive compensation arrangements than larger
banking organizations.
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 securities, 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.
31
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, which is currently 9.0%, 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; and
“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
 
.
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.
Reciprocal deposits, such as CDARs, may expand our funding sources
 
without being subjected to FDIC limitations and
potential insurance assessments increases for brokered deposits.
 
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 establish
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,
2021 or 2022, 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.
 
This temporary relief expired December 31, 2021.
32
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.
The Alabama legislature passed the “LIBOR Discontinuance and Replacement
 
Act of 2021” which became effective on
April 29, 2021.
 
On March 15, 2022, Congress enacted the Adjustable Interest Rate (LIBOR) Act (the “LIBOR
 
Act”) as
part of the Consolidated Appropriations Act, 2022.
 
One purpose of the LIBOR Act was to establish a clear and uniform
process, on a nationwide basis, for replacing LIBOR in existing contracts the terms of which
 
do not provide for the use of a
clearly defined or practicable replacement benchmark rate, without affecting
 
the ability of parties to use any appropriate
benchmark rate in new contracts.
 
The LIBOR Act directed the Federal Reserve to issue regulations implementing
 
the
LIBOR Act.
 
The Federal Reserve adopted final Regulation ZZ on January 26, 2023.
 
These together with Internal Revenue
Service regulation facilitate the conversion of existing LIBOR-based loans
 
when most popular LIBOR rates cease to be
quoted on June 30, 2023.
 
The Bank generally prices its variable rate loans based on the prime rate or the five-year Treasury
note rate and had no loans bearing LIBOR or other IBOR-based rates
 
at December 31, 2022.
 
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
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 2023:
The COVID-19 pandemic disrupted the economy beginning late in the first quarter of 2020.
 
Auburn University,
government agencies and businesses were limited to remote work and gatherings
 
were limited.
 
Supply chains
continue to be disrupted and labor markets remain tight.
 
Hotels, motels, restaurants, retail and shopping centers
were especially affected.
 
COVID-19 continues, but with diminishing direct economic effects
 
due to population
health, generally.
 
President Biden has terminated the COVID-19 national emergencies
 
effective May 11, 2023.
Extraordinary monetary and fiscal stimulus in 2020 and in early 2021
 
offset certain of the pandemic’s adverse
economic effects, but together with supply chain disruptions,
 
continued consumer demand, Russia’s invasion
 
of
Ukraine and its effects on energy and food prices, and tight labor
 
markets, have resulted in inflation.
 
Inflation is
running at levels unseen in decades and well above the Federal Reserve’s
 
long term inflation goal of 2.0%
annually.
 
Beginning in March 2022, the Federal Reserve has been raising target
 
federal funds interest rates and
reducing its securities holdings in an effort to reduce inflation.
 
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 Russia’s invasion
 
of Ukraine affect consumer confidence levels, economic activity
and inflation.
 
Increases in market interest rates, inflation and consumer and business confidence
 
may cause
changes in savings and payment behaviors, including potential increases in loan delinquencies
 
and default rates.
 
These could affect our earnings and credit quality.
33
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 inflation and higher market
interest rates
 
We adopted
 
CECL on January 1, 2023 as required by generally accepted accounting principles
(“GAAP”).
 
CECL changed the loss model to take into account current expected credit losses in
 
place of the
incurred loss method used historically under GAAP.
 
This changes the process we use to estimate losses inherent
in our credit exposures.
 
The process for estimating expected losses 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.
 
Changes in economic conditions and factors
used in our CECL models may increase the variability of our provisions for loan losses and
 
our earnings.
Although we had no assets or liabilities that use LIBOR reference rates at the end
 
of 2022,
 
the end of the LIBOR
reference rate, scheduled for most tenors by June 30, 2023, could adversely affect
 
our counterparties and financial
markets.
Nonperforming and similar assets take significant time to resolve
 
and may adversely affect our results of operations
 
and
financial condition.
Our nonperforming loans were 0.54% of total loans as of December 31,
 
2022, and we had $2.7 million in other real estate
owned as result of foreclosures or otherwise in full or partial payments in respect of loans (“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 and the shift beginning in March 2022
 
from an extraordinarily expansionary
monetary policies to a tightening monetary policy to fight inflation, loan
 
modifications and deferrals, market conditions or
events adversely affecting specific customers, industries or markets,
 
including disruptions of supply chains and the war in
Ukraine, and changes in borrower behaviors.
 
Certain borrowers and their businesses and real estate and commercial
projects and businesses may be adversely affected by inflation
 
and higher interest rates, and economic slowdowns arising
from tighter monetary policies.
 
Various
 
businesses will be unable to fully pass on increased costs due to inflation, and their
profits may shrink.
 
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
expected future loan losses, is effective for the Company beginning January
 
1, 2023, and its effects upon the Company have
not yet been determined.
 
The CECL model incorporates various economic condition elements,
 
where changes in fiscal and
monetary policy, as well as
 
market interest rates, could result in more volatility in our provisions for loan losses under
CECL, which could adversely affect our net income.
34
Changes in the real estate markets, including the
 
secondary market for residential mortgage loans, may continue
 
to
adversely affect us.
 
Beginning in March 2022, inflation and the Federal monetary policies to increase interest rates
 
to fight inflation have
caused mortgage rates to increase significantly.
 
Higher interest rates and the increased level of housing costs as a result
 
of
the COVID-19 pandemic, have caused housing starts and sales to slow.
 
House prices have begun to decline in certain
markets from their earlier highs.
 
This adversely affects our mortgage loan productions and the value of residential
mortgage collateral.
 
Commercial real estate projects economic assumptions may be adversely affected,
 
and certain projects
with short term and/or unhedged variable rate debt may be especially affected
 
by increased interest rates and a slower
economy.
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.
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 Fannie Mae, a government sponsored entity (‘GSE”) and other GSEs and
 
government agencies.
 
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.
 
The effects of reduced housing starts and mortgage activity due to
 
higher market interest rates, have decreased our
generation of new mortgage loans and related MSRs.
 
This may be offset by decreases in mortgage prepayments and
refinancings, and corresponding increases in the duration of our existing MSRs and their
 
values.
 
This net effect could
reduce our aggregate 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.
 
The Basel III Rules relating to MSRs may also increase the
potential capital required as a result of MSRs, when considered with other capital rule adjustments
 
and deductions.
35
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.
 
Most
LIBOR reference interest rates used by many financial institutions to price
 
extensions of credit will no longer be quoted
beginning June 30, 2023 and their use has been strongly discouraged by regulatory agencies.
 
Most banks did not adopt
CECL until January 1, 2023.
 
These changes, together with any exposures other institutions may have
 
to crypto or digital
assets, could cause disruption and unexpected changes in the industry.
 
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 the 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
40.4%
 
of our portfolio in CRE loans at year-end 2022
 
compared to 42.6% at year-end 2021.
 
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.
 
Increases in interest rates beginning
in March 2022 may adversely affect the assumptions and performance
 
of CRE, and the ability of borrowers to refinance on
terms that CRE borrowers and their projects can support.
 
Lower demand for CRE, and reduced availability of, and higher
interest rates and costs for, CRE loans could adversely affect
 
our CRE loans and sales of our OREO, and therefore our
earnings and financial condition, including our capital and liquidity.
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.
36
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
effects of higher market interest rates and inflation, supply chain disruptions,
 
changes in customer behaviors and in the
workforce and demand for space since the COVID-19 pandemic, and the timing and
 
magnitude of future inflation and
interest rates, 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 and housing
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, including loan 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.
 
The regulatory agencies are carefully scrutinizing financial institution
 
mergers, and
the merger application process has lengthened.
 
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.
37
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 and other
potential violations of law. 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, payments,
 
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 and
 
similar situations may occur in the future.
 
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.
38
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 timely 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, including the new CECL models, are based on assumptions and
 
projections. These models may not operate
properly or our inputs and assumptions may be inaccurate, or changes in economic and
 
market conditions, customer
behaviors or regulations.
 
As a result, these methods may not fully or timely predict future exposures,
 
which can be
significantly greater and/or faster 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, for back-up and service restoration, 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 disruption through 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 and tensions
 
with mainland China.
 
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.
 
Hacking and
identity theft risks, in particular, could cause serious reputational
 
harm.
39
Despite our cybersecurity policies and procedures and our Board
 
of Director’s and Management’s efforts
 
to monitor and
ensure the integrity of the systems 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 recognized until launched and can originate from a wide variety of sources, including
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, sanctions 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 changed significantly and suddenly.
 
Federal Reserve target federal funds rates declined to 0-0.25%
 
in March
2020, where these remained until March 2022.
 
As of March 7, 2023, this had increased to 4.50-4.75% 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 and tight labor markets.
 
The continuation or worsening of these conditions may adversely affect
 
our
profitability, growth asset quality and
 
financial condition.
40
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 $13.8 million with gross deferred tax assets of $15.6 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 changes in customer
behaviors 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.
 
Beginning March 2022, as inflation became more persistent, the
Federal Reserve started increasing interest rates and reducing its holdings of U.S government,
 
agency and agency
mortgage-backed securities.
 
Our costs of funds may increase as a result of general economic conditions, increasing interest
rates and competitive pressures, and inflation, and anticipated future changes by the Federal
 
Reserve to reduce inflation.
 
Traditionally,
 
we have obtained funds principally through local deposits and borrowings from other institutional
 
lenders
such as the FHLB, which we believe are a cheaper and more stable source of funds than borrowings,
 
generally.
 
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 potentially 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.
 
See “Supervision and Regulation – Fiscal and Monetary Policy.”
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.
 
Our income is primarily driven by the spread between these rates. Net interest income
 
will be adversely affected if market
interest rates and 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.
 
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.
 
The yield curve was inverted at the beginning of March 2023,
and this results in a lower spread between our costs of funds and our interest income.
 
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.
 
Higher market interest rates and sales of securities held by the Federal
 
Reserve to reduce
inflation generally reduce economic activity and may loan demand and growth.
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 promote economic growth.
 
Increases in market interest rates tend to decrease mortgage originations, increase
MSR values, decrease the value and liquidity of collateral securing loans, and potentially
 
increase net interest spread
depending upon the yield curve and the magnitude and duration of interest rate
 
increase, and constrain economic growth.
41
Increases in market interest rates have also caused unrealized losses in our securities
 
portfolio as our available for sale
investments are carried at fair value and market prices have declined as
 
market interest rates increase.
 
Although these
unrealized losses do not adversely affect our regulatory capital, these do
 
reduce our reported GAAP tangible stockholders’
equity.
 
Sales of securities with unrealized losses would result in realized losses
 
for GAAP,
 
regulatory capital and tax
purposes.
 
Increases in interest rates may also change depositor behaviors as customers
 
seek higher yielding deposits.
 
This
may adversely affect our net interest income and net income and
 
may also adversely affect our liquidity.
Liquidity risks could affect operations and jeopardize
 
our financial condition.
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
reduced returns on assets and equity.
 
Inflation and tightening monetary policies beginning in early 2022 have increased
interest spreads, but may change the mix and costs of our deposits over time.
 
The growth in deposits exceeded our loan
growth and the difference was invested in high-quality,
 
marketable U.S. government and government agency securities,
including agency mortgage-backed securities.
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 deposits (primarily core deposits), federal
 
funds purchased, securities sold under
repurchase agreements, and short-
 
and long-term debt.
 
We maintain a portfolio
 
of marketable high-quality securities that
can be used as a source of liquidity.
 
As market interest rates have risen, however,
 
we have experienced unrealized losses
on such securities, which would become realized losses upon the sale of such securities,
 
and such sales at a loss would
reduce our net income and our regulatory capital.
We are also
 
members of the FHLB and the Federal Reserve Bank, and we can obtain advances collateralized
 
with eligible
assets, and maintain uncommitted federal funds lines of credit with other banks.
 
On March 12, 2023, the Federal Reserve
established a new Bank Term
 
Funding Program (“BTFP”), which offers loans of up to one year to banks, savings
associations, credit unions, and other eligible depository institutions pledging U.S.
 
Treasuries, agency debt and mortgage-
backed securities, and other qualifying assets as collateral. These assets will be valued
 
at par. The BTFP will be an
additional source of liquidity against high-quality securities, eliminating
 
an institution's need to quickly sell those securities
in times of stress.
 
In addition, the discount window will apply the same margins used
 
for the securities eligible for the
BTFP,
 
further increasing the value of investment securities at the discount window.
Other sources of liquidity available to the Company or the Bank, if needed, include 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,
 
the economy and market interest rates and fiscal and monetary policies.
 
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.
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 the CECL models include inputs
 
based on economic and market
conditions, all of which 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 We may need to raise additional capital in the future, but that capital may not be available when it is needed or on
purposes.
42
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 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
 
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.
 
43
Legislative and regulatory changes
The Biden Administration has appointed new members to the FDIC and Federal Reserve
 
boards, and has appointed an
acting Comptroller of the Currency, and
 
a new full time CFPB director and FDIC Chairman, a new Federal Reserve Vice
Chairman for Supervision and will nominate a new Vice
 
Chair to replace Lael Brainard.
 
The 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.
 
Although not regulated or supervised by the CFPB, we are subject to the regulations and
interpretations of the CFPB and the Federal Reserve’s
 
supervision of our compliance with such regulations and
pronouncements.
 
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’s
 
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.
 
Our
regulators 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.
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 of potential
 
SBA or bank regulatory claims.
 
The Bank participated as a lender in the PPP and made a total of $56.7 million of PPP loans in 2020
 
and 2021, generally to
support existing customers in the Bank’s
 
markets.
 
All PPP loans made by the Bank have been forgiven by the SBA, except
for one credit where the borrower is voluntarily repaying the loan.
 
Since the beginning of the PPP,
 
various banks have
been subject to litigation regarding the processes 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 that we extended.
 
 
The SBA, the Department of Justice and the bank regulators are investigating
 
various PPP lenders and borrowers with
respect to potential fraud or improper activities under the PPP loan programs.
 
Although the SBA has not indicated any
issues with the Bank’s participation in the PPP
 
program and honored all PPP forgiveness requests, the Bank could have
potential liability if the SBA later 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 its forgiveness of a PPP
properly, including those related
 
to the ambiguities in the laws, rules and guidance regarding the PPP’s
 
operation.
The Bank is unaware of any such investigation or claims. If any such claims are
 
made against the Bank and are not resolved
favorably to the Bank, it may result in financial liability or adversely affect
 
our reputation.
 
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.
 
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.
44
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.
 
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 and/or maintain our liquidity 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; and
ability to make payments of principal and interest on any of our capital instruments
 
that may be then outstanding.
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 Our operations are subject to risk of loss from unfavorable fiscal, monetary and political developments in the U.S.
“Supervision and Regulation.”
45
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 regulations
 
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 or interpretations, 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.
The Federal banking regulators jointly proposed comprehensive revisions to their CRA
 
regulations on May 5, 2022, and
which may be adopted in the first half of 2023.
 
These revisions have not been finalized but could have significant effects
on our compliance costs and activities.
 
See “Supervision and Regulation -
Community Reinvestment Act and Consumer
Laws.”
COVID-19 Risks
The national emergencies related to COVID-19 have been terminated
 
by the President effective May 11, 2023.
 
The
medical and direct economic effects of COVID-19 diminished
 
over 2022 and are not directly affecting the Company’s
business.
 
COVID-19 continues to have various indirect effects and risks, the
 
most important of which are described herein,
including continuing inflation and the Federal Reserve’s
 
change from accommodative monetary policy to a tightening
monetary policy to fight inflation following significant fiscal and monetary stimuli provided
 
to reduce the effects of
COVID-19 pandemic on the economy, as
 
well significant changes resulting from the pandemic, including supply chain
disruptions, a tight labor market, remote work away from the office, population
 
and business shifts within regions of the
United States, changes in real estate utilization, and shortages of housing and increases
 
in rents and housing costs in various
areas of the country. These risks are discussed
 
in this report.
 
 
The Company’s assessment of risks related to
 
COVID-19 and its effects on the Company applicable
 
during the pandemic
are discussed in the Company‘s Annual Report on Form 10-K filed with the SEC on March
 
8, 2022 under the caption “Risk
Factors-COVID 19 Risks” and in our Quarterly Reports on Form 10-Qs though
 
September 30, 2022.
46
ITEM 1B. UNRESOLVED
 
STAFF COMMENTS
None.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank conducts its business from its main office and seven full-service
 
branches.
 
The Bank also operates a loan
production office in Phenix City,
 
Alabama.
The Bank owns its main campus in downtown Auburn, Alabama, which comprises
 
over 4 acres and includes the newly
constructed AuburnBank Center,
 
which was completed in May 2022 and held its grand opening in June 2022.
 
The
AuburnBank Center has approximately 90,000 square feet of space.
 
The AuburnBank Center includes the Bank’s
 
main
office, Auburn loan production office, and all of its back-office
 
operations.
 
The 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.
 
The Bank has approximately 46,000 square feet of office space
 
and approximately 5,000 square feet of
retail space in the new AuburnBank Center building available for lease to
 
third party tenants.
In February 2022, the Company entered into an agreement to sell a parcel of approximately
 
0.85 acres to a hotel developer.
 
As part of the agreement, the Bank negotiated a long-term lease with the hotel developer
 
for 100 to 150 parking spaces in
the Bank’s parking deck.
 
In October 2022, the Company closed the sale at the agreed upon price
 
of $4.3 million, and
recognized a $3.2 million gain.
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 2022, 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 and 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 2022, 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 had operated
 
a loan production office in Valley,
 
which 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 since August 1988. The current 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 in south Auburn, which had been opened
in 2004 to a new building, which the Bank built in 2015 at the intersection of S. Donahue
 
Avenue and E. University
 
Drive
in Auburn, Alabama.
 
The South Donahue branch has approximately 3,600 square feet of space.
 
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 In May 2017, the Bank relocated its Opelika Kroger branch to a new location the Bank purchased in August 2016 near the
for approximately 28 vehicles.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
47
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 addition to the eight ATMs
 
at various branch locations, mentioned above, the Bank also has five
 
ATMs
 
located at
various locations within our primary service area.
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.
 
This loan production office was relocated to the
newly developed AuburnBank Center in June 2022.
 
The Company has entered into a sublease agreement with a tenant for
three years with an option to renew for three additional years.
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 DISCLOSURES
Not applicable.
PART
 
II
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 16,
 
2023,
there were approximately 3,500,879 shares of the Company’s
 
Common Stock issued and outstanding, which were held by
approximately 359 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
2022
First Quarter
$
 
34.49
 
$
 
31.75
 
$
 
0.265
 
Second Quarter
 
33.57
 
 
27.04
 
 
0.265
 
Third Quarter
 
29.02
 
 
23.02
 
 
0.265
 
Fourth Quarter
 
24.71
 
 
22.07
 
 
0.265
 
2021
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
 
(1)
 
The price information represents actual transactions.
48
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 when, as and if 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, liquidity, capital and
 
regulatory requirements and other relevant factors and the
availability of dividend payable by the Bank consistent with amounts available
 
therefore, including the Bank’s earnings,
financial condition, liquidity, regulatory
 
and 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 and
liquidity in the Bank also limits dividends that may be paid to the Company.
 
 
 
 
 
 
 
 
aubn-20201231p49i0
49
Performance Graph
The following performance graph compares the cumulative, total return on the
 
Company’s Common Stock
 
from
December 31, 2017 to December 31, 2022, with that of the Nasdaq Composite Index and
 
S&P U.S. BMI Banks – Southeast
Region Index (assuming a $100 investment on December 31, 2017). 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
12/31/2017
12/31/2018
12/31/2019
12/30/2020
12/31/2021
12/31/2022
Auburn National Bancorporation, Inc.
100.00
83.35
143.34
115.20
91.76
67.91
NASDAQ Composite Index
100.00
97.16
132.81
192.47
235.15
158.65
S&P U.S. BMI Banks - Southeast Region Index Issuer Purchases of Equity Securities
100.00
82.62
116.45
104.41
149.13
121.30
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
50
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
October 1 – October 31, 2022
––
––
––
4,659,289
November 1 – November 30, 2022
 
1,903
 
 
23.28
 
 
1,903
 
4,614,989
December 1 – December 31, 2022
––
––
––
4,614,989
Total
 
1,903
 
 
23.28
 
 
1,903
 
4,614,989
On April 12, 2022, the Board of Directors of Auburn National Bancorporation, Inc. (the "Company") announced that its Board of
Directors had approved a new stock repurchase program to replace the repurchase program that expired on March 31, 2022. The new
program authorized the repurchase, from time to time, of up to $5 million of the Company’s issued and outstanding common stock
through the earliest of (i) the expenditure of $5 million on Share repurchases, (ii) the termination or replacement of the Repurchase Plan
and (iii) April 15, 2024. The stock repurchases may be open-market or private purchases, negotiated transactions, block purchases, and
otherwise.
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
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
 
OF FINANCIAL CONDITION AND RESULTS
 
OF
OPERATIONS
The following is a discussion of our financial condition at December 31,
 
2022 and 2021 and our results of operations for
the years ended December 31, 2022 and 2021. 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 a loan production office in Phenix City, Summary of Results of Operations
Alabama.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
51
Year ended December 31
(Dollars in thousands, except per share data)
2022
2021
Net interest income (a)
$
27,622
$
24,460
Less: tax-equivalent adjustment
456
470
Net interest income (GAAP)
27,166
23,990
Noninterest income
6,506
4,288
Total revenue
33,672
28,278
Provision for loan losses
1,000
(600)
Noninterest expense
19,823
19,433
Income tax expense
 
2,503
1,406
Net earnings
$
10,346
$
8,039
Basic and diluted net earnings per share
$
2.95
$
2.27
(a) Tax-equivalent.
 
See "Table 1 - Explanation of Non-GAAP Financial Measures".
Financial Summary
The Company’s net earnings were $10.3
 
million for the full year 2022, compared to $8.0 million for the full year 2021.
 
Basic and diluted net earnings per share were $2.95 per share for the full year 2022,
 
compared to $2.27 per share for the full
year 2021.
 
Net interest income (tax-equivalent) was $27.6 million in 2022, a
 
13% increase compared to $24.5 million in 2021. This
increase was primarily due to improvements in the Company’s
 
net interest margin.
 
The Company’s net interest margin
(tax-equivalent) was 2.81% in 2022, compared to 2.55% in 2021.
 
This increase was primarily due to changes in our asset
mix and higher market interest rates on interest earning assets,
 
while our cost of funds decreased 4 basis points to 0.35%.
 
At December 31, 2022, the Company’s allowance
 
for loan losses was $5.8 million, or 1.14% of total loans, compared to
$4.9 million, or 1.08% of total loans, at December 31, 2021.
 
At December 31, 2022, the Company’s recorded
 
investment
in loans considered impaired was $2.6 million with a corresponding valuation allowance
 
(included in the allowance for loan
losses) of $0.5 million, compared to a recorded investment in loans considered impaired
 
of $0.2 million with no
corresponding valuation allowance at December 31, 2021.
 
The Company recorded a charge to provision for loan losses of
$1.0 million in 2022 compared to a negative provision for loan losses of $0.6
 
million during 2021.
 
The provision for loan
losses in 2022 was primarily related to loan growth and the downgrade of one borrowing
 
relationship.
 
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 0.04%
 
in 2022 compared to
0.02% in 2021.
 
Noninterest income was $6.5 million in 2022 compared to $4.3
 
million in 2021.
 
The increase was primarily related to a
$3.2 million gain on the sale of land adjacent to the Company’s
 
headquarters.
 
Excluding the impact of this gain,
noninterest income was $3.3 million in 2022, a 24% decrease compared to 2021.
 
This decrease in noninterest income was
primarily due to a decrease in mortgage lending income
 
of $0.9 million as refinance activity slowed in our primary market
area related to higher market interest rates.
 
Noninterest expense was $19.8
 
million in 2022 compared to $19.4
 
million in 2021. Noninterest expense included a $1.6
million employee retention credit recognized in 2022.
 
Excluding the impact of this payroll tax credit, noninterest expense
was $21.4 million in 2022, a 10% increase compared to 2021.
 
The increase in noninterest expense was primarily due to
increases in net occupancy and equipment expense of $1.0 million related to the Company’s
 
new headquarters, which
opened in June 2022, an increase in salaries and benefits expense of $0.6 million, and increases in other noninterest expense Income tax expense was $2.5 million in 2022, compared to $1.4 million in 2021.
of $0.4
 
million.
 
52
The Company’s effective tax rate for
2022 was 19.48%, compared to 14.89% in 2021.
 
This increase in tax expense was primarily due to increased pre-tax
earnings in 2022 and additional income tax expense of $0.2 million related to the Company’s
 
decision to surrender certain
bank-owned life insurance contracts in 2022.
 
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 $1.06 per share in 2022, an increase of 2% from 2021.
 
At December 31, 2022, 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 16.25
 
%, a tier 1 leverage ratio of 10.01% and common equity
tier 1 (“CET1”) of 15.39%
 
at December 31, 2022.
 
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
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,
 
booster vaccines and newly
developed treatments.
 
COVID-19 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 believe that the
 
direct economic effects of COVID-19 are diminishing, but that indirect effects
 
from the
pandemic and government economic and monetary stimuli to counter the pandemic,
 
continue.
 
These indirect effects
include a tight labor market, supply chain disruptions, consumer demand and the economic
 
effects of these stimulative
government fiscal and monetary policies in response to COVID-19 beginning in early
 
2020, which have led to inflation and
to the Federal Reserve tightening its monetary policies to fight inflation beginning March
 
2022.
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 during outbreaks of
 
COVID-19 variants.
 
Bank
employees, generally, are
 
working full time in the office although we have provided scheduling
 
flexibility to our
employees.
We serviced 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 We were an active PPP lender and made an aggregate of 677 PPP loans totaling approximately $56.7 million.
request; and
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
53
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.
 
As of December 31, 2022, we
had only one outstanding PPP loan since all but one such loan had been forgiven by the
 
SBA.
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 policies,
along with shortages of certain goods and services, and rising petroleum and food
 
prices, reflecting, among other things, the
war in the Ukraine, have led to the highest inflation in decades.
 
The Federal Reserve has begun rapidly increasing its target
federal funds rate from 0 – 0.25% at the beginning of March 2022 to 4.25 – 4.50%
 
at December 31, 2022, and 4.50 – 4.75%
at January 31, 2023.
 
The Federal Reserve also has been reducing its holdings of securities in its SOMA account
 
to reduce
market liquidity and counteract 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
23
5
14,691
40
Up to $350,000
400
95
21,784
60
Total
423
100
%
$
36,475
100
%
We collected
 
approximately $1.5 million in fees from the SBA related to our PPP loans during 2020. Through
 
December
31, 2021, we had 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 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 provided 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
12
5
6,494
32
Up to $350,000
242
95
13,757
68
Total
254
100
%
$
20,251
100
%
We collected
 
approximately $1.0 million in fees from the SBA related to PPP loans under the Economic
 
Aid Act. Through
December 31, 2022, we have recognized all of these fees, net of related costs.
 
As of December 31, 2022, we have received
payments and forgiveness on all but one PPP loan, in the amount of $0.1
 
million, under the Economic Aid Act.
 
54
We believe that the COVID-19
 
pandemic stimuli and decreased economic activity increased customer liquidity and
 
tier
deposits at the Bank and decreased loan demand, while monetary stimulus reduced
 
interest rates and our costs of funds and
our interest earnings on loans.
 
As a result, our net interest margin was adversely affected.
 
A return to higher interest rates
appears underway, beginning in
 
March 2022, and has accelerated in recent months as a result of Federal Reserve efforts
 
to
curb inflation.
 
This has resulted in improved net interest margin, but at the same time
 
has reduced the market values of our
securities portfolio and resulted in unrealized securities losses.
 
As a result, we have had losses in our other comprehensive
income and our equity under generally accepted accounting principles has declined.
 
This has not adversely affected our
regulatory capital, however.
 
We continue to closely
 
monitor the pandemic’s effects,
 
and are working to continue our services and to address
developments as those occur. Our results of operations
 
for the year ended December 31, 2022, and our financial condition
at that date, which reflect only the continuing direct and indirect effects of the
 
pandemic, 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, 2022,
 
all of our capital ratios were in excess of all regulatory requirements to be well capitalized.
 
Inflation and the shift from stimulative monetary policy in response to the COVID-19
 
pandemic to tightening monetary
policy beginning in March 2022 to fight inflation could result in adverse changes to
 
credit quality and our regulatory capital
ratios, and inflation will affect our costs, interest rates and the values of our assets and
 
liabilities, changes in customer
savings and payment behaviors and economic activity.
 
Continuing supply chain disruptions and tight labor markets also
adversely affect the levels and costs of economic activities.
 
We continue to closely
 
monitor these continuing effects of the
pandemic, and are working to anticipate and
 
address developments.
The CARES Act and the 2020 Consolidated Appropriations Act provide eligible
 
employers an employee retention credit
related to COVID-19.
 
After consultation with our tax advisors, we filed amended payroll tax returns
 
with the IRS, and
received an employee retention credit of approximately $1.6 million.
The direct health issues related to COVID-19 appear to be waning as a result of vaccinations,
 
new medications and
increased resistance to the virus as a result of prior infections, although new strains continue
 
to appear.
 
The economic
effects of the pandemic and government fiscal and monetary policy responses,
 
supply chain disruptions and inflation
continue, however.
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, changes in, and expectations regarding, market interest rates and inflation,
 
industry and peer bank loan loss rates
and other pertinent factors. 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.
 
In addition, our regulators, as an integral part of their examination process,
will periodically review the Company’s loans and
 
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 The Company deems loans impaired when, based on current information and events, it is probable that the Company will
time of their examinations.
55
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 the allowance for loan losses maintained is believed by
 
management, based on its processes and estimates, 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 and by
releases from the allowance when determined to be appropriate to the levels of loans and probable
 
loan losses in such loans.
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, 2022 and 2021, 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, 2022, the Company increased its look-back period to
 
55 quarters to continue to include losses
incurred by the Company beginning with the first quarter of 2009.
 
During 2021, the Company adjusted certain qualitative
and economic factors to reflect improvements in economic conditions in our primary
 
market area that had previously been
observed as a result of the COVID-19 pandemic.
 
No changes were made to qualitative and economic factors during 2022.
56
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
 
FHLB and 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 or 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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
57
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. At December 31,
 
2022 we had total deferred tax assets of $15.6 million
included as “other assets”, including $13.7 million resulting from unrealized losses
 
in our securities portfolio.
 
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, 2022. 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
 
2022
2021
Average
Yield/
Average
Yield/
(Dollars in thousands)
Balance
Rate
Balance
Rate
Loans and loans held for sale
 
$
454,604
4.45%
$
459,712
4.45%
Securities - taxable
364,029
1.81%
320,766
1.28%
Securities - tax-exempt (a)
61,591
3.53%
62,736
3.57%
Total securities
425,620
2.06%
383,502
1.66%
Federal funds sold
43,766
1.00%
38,659
0.15%
Interest bearing bank deposits
58,141
0.99%
77,220
0.13%
Total interest-earning assets
982,131
3.05%
959,093
2.81%
Deposits:
 
 
NOW
197,177
0.19%
178,197
0.12%
Savings and money market
327,139
0.20%
296,708
0.22%
Certificates of deposits
154,273
0.84%
159,111
1.03%
Total interest-bearing deposits
678,589
0.34%
634,016
0.39%
Short-term borrowings
4,516
1.33%
3,349
0.51%
Total interest-bearing liabilities
683,105
0.35%
637,365
0.39%
Net interest income and margin (a)
$
27,622
2.81%
$
24,460
2.55%
(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 $27.6 million in 2022, compared
 
to $24.5 million in 2021.
 
This increase was due
to improvements in the Company’s net interest
 
margin (tax-equivalent).
 
Net interest margin (tax-equivalent) increased to
2.81% in 2022, compared to 2.55% in 2021 due to increases in the Federal
 
Reserve’s target federal
 
funds rates beginning
March 17, 2022, and changes in our asset mix.
 
During 2022, the Federal Reserve increased the target federal funds range
from 0 – 0.25% to 4.25 – 4.50%.
 
The
 
target rate was increased another 25 basis points on January 31, 2023,
 
and further
increases in the target federal funds rate appear likely if inflation remains elevated.
 
Net interest income (tax-equivalent)
included $0.3 million in PPP loan fees, net of related costs for 2022,
 
compared to $1.0 million for 2021.
 
See “Supervision
and Regulation – Fiscal and Monetary Policies”.
The tax-equivalent yield on total interest-earning assets increased by 24 basis points
 
to 3.05% in 2022 compared to 2.81%
in 2021. This increase was primarily due to changes in our asset mix and higher market interest rates on interest earning The cost of total interest-bearing liabilities decreased by 4 basis points to 0.35% in 2022 compared to 0.39% in 2021.
assets.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
58
The
net decrease in our funding costs was primarily due to a portion of our time deposits repricing into
 
lower prevailing market
interest rates during 2022.
 
Our deposit costs may increase as the Federal Reserve increases its target federal
 
funds rate,
market interest rates increase, and as customer savings behaviors change as a result of inflation
 
and higher market interest
rates on deposits and other alternative investments.
The Company continues to deploy various asset liability management strategies
 
to manage its risk to interest rate
fluctuations.
 
Deposit and loan pricing remains competitive in our markets.
 
We believe this
 
challenging competitive
environment will continue in 2023.
 
Our ability to hold our deposit rates low until our interest-earning assets reprice
 
will be
important to maintaining or potentially increasing our net interest
 
margin during the monetary tightening cycle that we
believe will continue in 2023.
 
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. At December 31, 2022, the Company’s
 
recorded investment in loans considered impaired was $2.6
million with a corresponding valuation allowance (included in the allowance
 
for loan losses) of $0.5 million, compared to a
recorded investment in loans considered impaired of $0.2 million with no corresponding
 
valuation allowance at December
31, 2021.
 
The Company recorded a charge to provision for loan losses of $1.0
 
million during 2022, compared to a negative
provision for loan losses of $0.6 million during 2021.
 
The provision for loan losses in 2022 was primarily related to loan
growth and the downgrade of one borrowing relationship.
 
The provision for loan losses is based upon various estimates
and judgments, 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 0.04% in 2022
 
compared to 0.02% in 2021.
 
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 1.14% at December 31, 2022, compared
 
to 1.08% at December 31, 2021.
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,
 
inflation and market interest rates, and local real estate markets and
businesses) may have a material adverse effect on our asset
 
quality and the adequacy of our allowance for loan losses under
CECL resulting in significant increases in the provision for credit losses.
Noninterest Income
 
Year ended December 31
(Dollars in thousands)
2022
2021
Service charges on deposit accounts
$
598
$
566
Mortgage lending
650
1,547
Bank-owned life insurance
317
403
Gain on sale of premises and equipment
3,234
Securities gains, net
12
15
Other
1,695
1,757
Total noninterest income
$
6,506
$
4,288
The Company’s noninterest 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
mortgage 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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
59
The Company evaluates MSRs for impairment quarterly.
 
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 2022 and 2021.
Year ended December 31
(Dollars in thousands)
2022
2021
Origination income
$
309
$
1,417
Servicing fees, net
341
130
Total mortgage lending income
$
650
$
1,547
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 as market interest rates on
mortgage loans increased.
 
The decrease in origination income was partially offset by an increase in
 
servicing fees, net of
related amortization expense as prepayment speeds slowed, resulting in decreased
 
amortization expense.
In October 2022, the Company closed the sale of approximately 0.85 acres of
 
land located next to the Company’s
headquarters in Auburn, Alabama for a purchase price of $4.3 million.
 
The sale resulted in a gain of $3.2 million, net of
prorations, closing costs and costs of demolishing the Bank’s
 
former main office building.
 
Noninterest Expense
Year ended December 31
(Dollars in thousands)
2022
2021
Salaries and benefits
$
12,307
$
11,710
Employee retention credit
(1,569)
 
Net occupancy and equipment
2,742
1,743
Professional fees
975
995
FDIC and other regulatory assessments
404
426
Other
4,964
4,559
Total noninterest expense
$
19,823
$
19,433
The increase in salaries and benefits was primarily due to a decrease in deferred costs related
 
to the PPP loan program, and
routine annual wage and benefit increases.
 
The employee retention tax credit of $1.6 million in 2022 relates to a one-time payroll tax
 
credit provided by the CARES
Act and the 2020 Consolidated Appropriations Act.
 
The increase in net occupancy and equipment expense was primarily due to increased
 
expenses related to the
redevelopment of the Company’s headquarters
 
in downtown Auburn.
 
This amount includes depreciation expense and one-
time costs associated with the opening of the Company’s
 
new headquarters.
 
The Company relocated its main office branch
and bank operations into its newly constructed headquarters during May 2022.
The increase in other noninterest expense was due to a variety of miscellaneous items including
 
increased information
technology and systems expenses, loan related expenses, losses on New Markets Tax Credits investments and other Income tax expense was $2.5 million in 2022, compared to $1.4 million in 2021.
miscellaneous operating expenses.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
60
Income Tax
 
Expense
The Company’s effective tax rate for
2022 was 19.48%, compared to 14.89% in 2021.
 
This increase in tax expense was primarily due to increased pre-tax
earnings in 2022 and additional income tax expense of $0.2 million related to the Company’s
 
decision to surrender certain
bank-owned life insurance contracts in 2022.
 
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 $405.3
 
million at December 31, 2022, compared to $421.9 million at December 31, 2021.
 
This decrease reflects an increase in the amortized cost basis of securities available-for-sale
 
of $39.2 million, offset by a
decrease of $55.8 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 increase in customer deposits.
 
The decrease in the fair value of securities was primarily due to an
increase in long-term market interest rates, which resulted in $13.7
 
million of deferred tax assets included in our other
assets.
 
The average annualized tax-equivalent yields earned on total securities
 
were 2.06%
 
in 2022 and 1.66% in 2021.
The following table shows the carrying value and weighted average
 
yield of securities available-for-sale as of December
31, 2022 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, 2022
1 year
 
1 to 5
5 to 10
 
After 10
Total
 
(Dollars in thousands)
or less
years
years
years
Fair Value
Agency obligations
$
4,935
50,746
69,936
125,617
Agency MBS
7,130
27,153
183,877
218,160
State and political subdivisions
300
642
15,130
45,455
61,527
Total available-for-sale
$
5,235
58,518
112,219
229,332
405,304
Weighted average yield (1):
Agency obligations
1.64%
1.29%
1.83%
1.61%
Agency MBS
1.35%
1.56%
2.14%
2.05%
State and political subdivisions
4.00%
1.83%
2.29%
2.77%
2.65%
Total available-for-sale
1.77%
1.30%
1.83%
2.27%
2.00%
(1) Yields are calculated based on amortized cost.
Loans
December 31
(In thousands)
2022
2021
Commercial and industrial
$
66,179
83,977
Construction and land development
66,479
32,432
Commercial real estate
 
265,181
258,371
Residential real estate
97,735
77,661
Consumer installment
9,546
6,682
Total loans
505,120
459,123
Less:
 
unearned income
(662)
(759)
Loans, net of unearned income
$
504,458
458,364
 
 
 
 
 
 
 
 
 
61
Total loans, net of unearned income,
 
were $504.5 million at December 31, 2022, and $458.4 million at December
 
31, 2021,
an increase of $46.1 million, or 10%.
 
Total loans at December
 
31, 2021 included $8.1 million in PPP loans, all but one of
these PPP loans, totaling $0.1 million, were forgiven during
 
2022.
 
Excluding PPP loans, total loans, net of unearned
income, increased $54.0 million, or 12% from December 31, 2021.
 
Four loan categories represented the majority of the
loan portfolio at December 31, 2022: commercial real estate (53%),
 
residential real estate (19%), construction and land
development (13%), and commercial and industrial (13%).
 
Approximately 23% of the Company’s commercial
 
real estate
loans were classified as owner-occupied at December 31,
 
2022.
Within the residential real estate portfolio
 
segment, the Company had junior lien mortgages of approximately $7.4
 
million,
or 1%, and $7.2 million, or 2%, of total loans, net of unearned income at December 31,
 
2022 and 2021, respectively.
 
For
residential real estate mortgage loans with a consumer purpose, the Company
 
had no loans that required interest only
payments at December 31, 2022 and 2021. The Company’s
 
residential real estate mortgage portfolio does not include any
option ARM loans, subprime loans, or any material amount of other consumer
 
mortgage products which are generally
viewed as high risk.
 
The average yield earned on loans and loans held for sale was 4.45% in 2022
 
and 2021, respectively.
 
The specific economic and credit risks associated with our loan portfolio include,
 
but are not limited to, the effects of
current economic conditions, including inflation and the continuing increases in
 
market interest rates, remaining COVID-19
pandemic effects including supply chain disruptions, commercial
 
office occupancy levels, housing supply shortages and
inflation, on our borrowers’ cash flows, real estate market sales volumes
 
and liquidity,
 
valuations used in making loans and
evaluating collateral, 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.
 
Various
 
projects financed earlier that were based on lower interest rate assumptions
 
than
currently in effect may not be as profitable or successful at higher interest rate currently
 
in effect and currently expected in
the future.
 
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 $22.6 million. Furthermore, we have an internal limit
 
for aggregate credit exposure (loans outstanding plus
unfunded commitments) to a single borrower of $20.3 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, 2022, 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, 2022 (and related balances at December 31,
 
2021).
 
December 31
(In thousands)
2022
2021
Lessors of 1-4 family residential properties In light of disruptions in economic conditions caused by COVID-19, the financial institution regulators have issued
$
52,325
$
47,880
Multi-family residential properties
41,181
42,587
Hotel/motel
33,457
43,856
62
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 recognized that a combination of the payment relief options may be prudent dependent
 
on a borrower’s business
type.
 
As of December 31, 2022, we had no COVID-19 loan deferrals, compared to
 
one COVID-19 loan deferral totaling
$0.1 million at December 31, 2021, down from $32.3 million of deferrals at the end of 2020.
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 $5.8 million at
December 31, 2022 compared to $4.9 million at December 31, 2021,
 
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.”
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
63
A summary of the changes in the allowance for loan losses and certain asset quality ratios
 
for the years ended December 31,
2022 and 2021 are presented below.
 
Year ended December 31
(Dollars in thousands)
2022
2021
Allowance for loan losses:
Balance at beginning of period
$
4,939
5,618
Charge-offs:
Commercial and industrial
(222)
Construction and land development
(254)
Residential real estate
 
(3)
Consumer installment
(70)
(37)
Total charge
 
-offs
(292)
(294)
Recoveries:
Commercial and industrial
7
140
Commercial real estate
 
23
Residential real estate
 
26
55
Consumer installment
62
20
Total recoveries
118
215
Net charge-offs
(174)
(79)
Provision for loan losses
1,000
(600)
Ending balance
$
5,765
4,939
as a % of loans
1.14
%
1.08
as a % of nonperforming loans
211
%
1,112
Net charge-offs
 
as a % of average loans
0.04
%
0.02
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 1.14% at December 31,
 
2022, compared to 1.08% at December 31,
2021.
 
In the future, the allowance for loan losses used in the allowance to total loans outstanding ratio
 
will be determined
in accordance with the CECL standard, and may increase or decrease
 
to the extent the factors that influence our quarterly
allowance assessment,
 
including changes in economic conditions that are part of our CECL model, either
 
improve or
weaken.
 
In addition our regulators, as an integral part of their examination process,
 
will periodically review the Company’s
loans and 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, 2022 the Company had $2.7 million in nonperforming assets compared to $0.8 million at December 31, The table below provides information concerning total nonperforming assets and certain asset quality ratios.
2021.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
64
 
December 31
(Dollars in thousands)
2022
2021
Nonperforming assets:
Nonperforming (nonaccrual) loans
$
2,731
444
Other real estate owned
374
Total nonperforming assets
$
2,731
818
as a % of loans and other real estate owned
0.54
%
0.18
as a % of total assets
0.27
%
0.07
Nonperforming loans as a % of total loans
0.54
%
0.10
Accruing loans 90 days or more past due
$
The table below provides information concerning the composition of nonaccrual
 
loans at December 31, 2022 and 2021,
respectively.
 
December 31
(In thousands)
2022
2021
Nonaccrual loans:
Commercial and industrial
$
443
Commercial real estate
2,116
187
Residential real estate
172
257
Total nonaccrual loans /
 
nonperforming loans
$
2,731
444
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, 2022 and
2021, respectively, the Company
 
had $2.7 million and $0.4
 
million in nonaccrual loans.
There were no loans 90 days past due and still accruing interest at December 31, 2022
 
and 2021, respectively.
 
The table below provides information concerning the composition of OREO at December
 
31, 2022 and 2021, respectively.
December 31
(In thousands)
2022
2021
Other real estate owned:
Commercial real estate
$
 
374
Total other real estate owned
$
 
374
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 $1.3
 
million, or 0.3% of total loans at
December 31, 2022, compared to $2.4 million, or 0.5% of total loans at December 31, 2021.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
65
The table below provides information concerning the composition of potential
 
problem loans at December 31, 2022 and
2021, respectively.
 
December 31
(In thousands)
2022
2021
Potential problem loans:
Commercial and industrial
$
212
226
Construction and land development
 
218
Commercial real estate
161
156
Residential real estate
835
1,748
Consumer installment
47
12
Total potential problem loans
$
1,255
2,360
At December 31, 2022, there were no potential problem loans 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, 2022 and 2021, respectively.
 
December 31
(In thousands)
2022
2021
Performing loans past due 30 to 89 days:
Commercial and industrial
$
5
3
Construction and land development
 
204
Commercial real estate
 
 
Residential real estate
38
516
Consumer installment
40
25
Total performing loans past due
 
30 to 89 days
$
83
748
Deposits
December 31
(In thousands)
2022
2021
Noninterest bearing demand
$
311,371
316,132
NOW
178,641
183,021
Money market
214,298
244,195
Savings
95,652
91,245
Certificates of deposit under $250,000
93,017
101,660
Certificates of deposit and other time deposits of $250,000 or more
57,358
57,990
Total deposits
$
950,337
994,243
Total deposits decreased
 
$43.9 million, or 4%, to $950.3 million at December 31, 2022,
 
compared to $994.2 million at
December 31, 2021.
 
This decrease reflects net outflows to higher yield investment alternatives in
 
a rising interest rate
environment and a decline in balances in existing accounts due to increased customer
 
spending.
 
Noninterest-bearing
deposits were $311.4 million, or 33% of total
 
deposits, at December 31, 2022, compared to $316.1 million, or 32% of total
deposits at December 31, 2021. We
 
had no brokered deposits at December 31, 2022 or at December 31, 2021.
Estimated uninsured deposits totaled $381.7 million and $420.8 million at December 31,
 
2022 and 2021, 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 0.34%
 
in 2022 and 0.39% in 2021.
 
66
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 $61.0 million and $41.0
 
million with none outstanding at December 31,
2022 and 2021, respectively. Securities
 
sold under agreements to repurchase totaled $2.6 million and $3.4
 
million at
December 31, 2022 and 2021, respectively.
The average rates paid on short-term borrowings were 1.33%
 
and 0.51% in 2022 and 2021, respectively.
 
The Company had no long-term debt outstanding at December 31, 2022 and 2021, respectively.
CAPITAL ADEQUACY
The Company's consolidated stockholders' equity was $68.0 million and $103.7
 
million as of December 31, 2022 and 2021,
respectively.
 
The decrease from December 31, 2021 was primarily driven by an other comprehensive
 
loss due to the
change in unrealized gains/losses on securities available-for-sale,
 
net of tax, of $41.8 million, cash dividends paid of $3.7
million and stock repurchases of $0.5 million, representing 17,183 shares,
 
which was partially offset by net earnings of
$10.3 million.
 
Our unrealized losses on securities and the related decline in our accumulated other comprehensive
 
income (“AOCI”)
resulted from increases in market interest rates in 2022 due to inflation and Federal Reserve
 
monetary policy actions.
 
Our
AOCI declined $41.8 million from $0.9 million at December 31, 2021
 
to ($40.9) million
 
This is the primary reason both
our shareholders’ equity and book value per share declined 34%, respectively,
 
in 2022.
 
The Bank and the Company, as
permitted by the Federal Reserve and the other Federal bank regulators, made a
 
permanent election in March 2015 to opt
out of the requirement to include most components of AOCI in regulatory capital.
 
Accordingly, AOCI does not affect
 
our
capital for regulatory purposes.
 
If our tangible GAAP equity, however,
 
ever became negative, Federal Housing Finance
Agency rules could prevent us from obtaining new FHLB lines or advances, even though
 
renewals of existing lines and
advance may be permissible.
 
Investors may also view tangible GAAP equity,
 
net of AOCI as important in connection with
capital raising, if any, especially
 
in stressed economic conditions.
 
On a GAAP basis, our returns on equity increased as
result of the negative AOCI’s
 
reduction of stockholders’ equity.
On January 1, 2015, the Company and Bank became subject to 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 fully phased-in on January 1, 2019 at 2.5%. A banking organization
 
with a capital conservation buffer of less
than the required minimum amount will be subject to limitations on capital distributions,
 
including dividend payments and
certain discretionary bonus payments to executive officers.
 
At December 31, 2022, the Bank’s
 
ratio exceeded 2.5% and the
capital conservation buffer requirements.
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 10.01%, CET1 risk-based capital ratio
 
was 15.39%, tier 1 risk-based capital ratio was 15.39%, and
total risk-based capital ratio was 16.25%
 
at December 31, 2022. 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
8.25%
 
at December 31, 2022.
67
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.
The yield curve has been inverted at various times in 2022 and in the first months of 2023.
 
An inverted yield curve reduces
the net interest margin expansion that may be expected otherwise as interest
 
rates rise.
 
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, we simulate the following 12-month time period 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