AUBN 10-K
Auburn National Bancorporation, Inc (AUBN)
10-K
2024-03-14
For: 2023-12-31
View Original
Added on
April 08, 2026
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
☒
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the fiscal year ended
OR
☐
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from __________ to __________
Commission File Number:
(Exact Name of Registrant as Specified in Its Charter)
(State or other jurisdiction
of incorporation)
(I.R.S. Employer
Identification No.)
,
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (
)
Securities registered pursuant to Section 12 (b) of the Act:
Title of Each Class
Trading Symbol
Name of Exchange on which Registered
, par value $0.01
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
☐
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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
☐
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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.
☒
☐
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).
☒
☐
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
☐
☒
Smaller reporting company
☒
Emerging Growth
Company
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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.
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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.
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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.
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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).
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Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
☐
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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:
$
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:
of March 13, 2024.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders, scheduled to be held May 14, 2024, are incorporated by reference into Part II, Item 5 and
Part III of this Form 10-K.
.
TABLE OF CONTENTS
PAGE
ITEM 1.
4
ITEM 1A.
32
ITEM 1B.
48
ITEM 1C.
48
ITEM 2.
49
ITEM 3.
51
ITEM 4.
51
ITEM 5.
51
ITEM 6.
54
ITEM 7.
54
ITEM 7A.
82
ITEM 8.
82
ITEM 9.
123
ITEM 9A.
123
ITEM 9B.
123
ITEM 9C.
123
ITEM 10.
124
ITEM 11.
124
ITEM 12.
124
ITEM 13.
124
ITEM 14.
124
ITEM 15.
124
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 health crises, 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 subsequent changes in monetary policies in response to inflation, including increases in the Federal
Reserve’s target federal funds rate and reductions in the Federal Reserve’s holdings of securities through
quantitative tightening; and the duration that the Federal Reserve will keep its targeted federal funds rates at or
above current rates to meet its long term inflation target of 2%;
●
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 use, beginning January 1, 2023,
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, including those used in the Company’s CECL models to establish our
allowance for credit losses and estimate asset impairments, 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 CECL models and loan portfolio reviews;
●
the risks of changes in market interest rates and the shape of the yield curve on customer behaviors; the levels,
composition and costs of deposits, loan demand and mortgage loan originations; the values and liquidity of loan
collateral, our securities portfolio and interest-sensitive assets and liabilities; and the risks and uncertainty of the
amounts realizable on collateral;
4
●
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 and our tangible equity;
●
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
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 regulation, including capital, and supervision and examination, as the Company
and the Bank and credit unions, which are not subject to federal income taxation;
●
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;
●
the risks that our dividends, share repurchases and discretionary bonuses are limited by regulation to the
maintenance of a capital conservation buffer of 2.5% and our future earnings and “eligible retained earnings” over
rolling four calendar quarter periods;
●
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 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.
5
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
“FHLB-Atlanta”) since 1991.
General
The Company’s business is conducted primarily through the Bank and its subsidiaries. Although it has no immediate plans
to conduct any other business, the Company may engage directly or indirectly in a number of activities 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
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 12
locations in its primary service area. The Bank offers Visa
®
like checks and can be used anywhere Visa is accepted, including ATMs. The Bank’s Visa Checkcards can be used
internationally through the Plus
®
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 Bank had the largest share of the Auburn-Opelika MSA’s deposits (20.1%) at June 30, 2023. The banking business in
East Alabama, including Lee County, is highly competitive with respect to loans, deposits, and other financial services.
The area is served by 19 banks, 11 of which are headquartered outside of Alabama and have 26 offices in our market.
Larger national and regional competitors that have offices in our market include J.P. Morgan Chase, Wells Fargo, Truist,
PNC, Regions, Valley National and SouthState. The regional and national banks and bank holding companies that we
compete with 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 these other banks typically have
substantially higher lending limits than the Bank.
6
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.
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 180,773 in 2022, and has increased
approximately 29% from 2010 to 2022. The largest employers in the area are Auburn University, East Alabama Medical
Center, Lee County School System, Auburn City Schools, Wal-Mart Distribution Center, Aptar CSP Technologies,
Pharmavite, LLC, HL Mando America Corporation (automobile brakes and steering), Golden State Foods 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 near Montgomery, Alabama. Various suppliers to the automotive industry have facilities in Lee
County. The unemployment rate in Lee County was 2.4% at year end 2023 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.
Our commercial real estate (“CRE”) loans, including $66.8 million of loans on owner occupied property, as of December
31, 2023 totaled $287.3 million (52% of total loans). Our regulators’ CRE Guidance excludes loans on owner occupied
property from CRE. Excluding our owner occupied loans, our CRE loans were $220.5 million (40% of total loans) at year
end 2023. See “Lending Practices –
CRE.
”
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
owners.
7
Human Capital
At December 31, 2023, the Company and its subsidiaries had 149.5 full-time equivalent employees, including 38 officers.
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 whom, 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 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. At the time of transition, our Chairman had served the Bank
his entire 39-year career, our President and CEO had been with us 16 years and our Chief Accounting Officer had 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.
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, and
our results of operations and financial condition. 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 resulting bank’s
primary federal regulator pursuant to 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. See “Bank Regulation”.
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.
9
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 a 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.
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.
10
Bank mergers, which generally accompany holding company mergers, are also subject to the approval of the resulting
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. On January 29, 2024, the Office of the Comptroller of the Currency (“OCC”)
issue a notice of proposed rulemaking to change its standards for reviewing business combination applications and issue a
policy statement of principles used by the OCC in its merger reviews.
The FDIC Notice 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 the 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 comments 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 United States Department of Justice (“DoJ”), 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. Federal Reserve
Governor Bowman, in a March 7, 2024 speech, stated that “regulatory reforms in this area should prioritize speed and
timeliness. Stakeholders who are concerned about current bank M&A procedures and policies should consider direct
engagement with regulators.”
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, which are 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, which meet certain conditions, an exemption from 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
the House of Representatives.
11
Community Reinvestment Act and Consumer Laws
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. 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 CRA regulations require that evidence of
discriminatory, illegal or abusive lending practices be considered in the CRA evaluation.
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.
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.
The federal CRA regulations require that evidence of discriminatory, illegal or abusive lending practices be considered in
the CRA evaluation.
A financial holding company election, and the continuation of such election and financial holding company activities are
permitted, if any affiliated bank has not received less than a “satisfactory” CRA rating.
The Federal Reserve considers the effect of a bank acquisition proposal on the convenience and needs of the markets served
by the combining organizations. In the case of bank holding company applications to acquire a bank, 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 low- and moderate-income (“LMI”)
neighborhoods, and such records may be the basis for denying the application.
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 Reinvestment Coalition reported in January 2024 that it had executed more than 21 community
benefit plans with banking organizations, with an estimated value of $580 billion to LMI and under-resourced communities.
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 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.
12
New CRA Regulations
The federal banking regulators jointly proposed (the “CRA Proposal”) revised CRA regulations on June 3, 2022. Final new
joint CRA regulations were adopted by the Federal Reserve, the OCC and the FDIC on October 24, 2023, and were
finalized and published in the Federal Register on February 1, 2024. Most of the new rules’ requirements become effective
January 1, 2026, and other requirements, including required data reporting become effective January 1, 2027. The new
CRA regulations confirm that the CRA and fair lending responsibilities and compliance are mutually reinforcing and that
these regimes recognize the importance of ensuring that the credit markets are inclusive. The agencies are also retaining
the provision in the CRA regulations that allows downgrading a bank for discriminatory or other illegal credit practices.
The objectives of the new CRA regulations include:
●
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 new CRA regulations like the old rules, is based on bank size and business model create a new framework for
evaluating CRA performance. Banks are classified as either “small”, “intermediate”, “large”, or “limited purpose” banks.
The asset size thresholds would be adjusted annually for inflation and have been increased relative to the bank asset size
thresholds in the old CRA rule. The Bank is currently an “intermediate small bank,” but will become an “intermediate
bank” under the new CRA regulations because it has assets of $600 million to $2.0 billion in both of the two prior years.
The new performance evaluation framework establishes two tests for intermediate banks:
•
the Retail Lending Test; and
•
the Intermediate Bank Community Development Test, or if elected by the Bank, the Community Development
Financing Test.
Intermediate banks would be evaluated and assigned conclusions of reflecting their performance under these tests in their
facility based assessment area of “Outstanding”; “High Satisfactory”; “Low Satisfactory”; “Needs to Improve”; or
“Substantial Noncompliance.” These conclusions applied to each test would be weighted and combined to form a rating of
“Outstanding,” “Satisfactory,” “Needs to Improve,” or “Substantial Noncompliance.”
A “facility based assessment area” is an area that encompasses or is adjacent to deposit-taking facilities, including main
offices, branches, and deposit-taking remote service facilities. Intermediate banks could delineate facility-based areas of
part of a county. The banking agencies will evaluate retail lending in a bank’s “outside retail lending area” for large banks,
as well as for intermediate banks, if the majority of their retail lending is outside their facility-based assessment areas.
A retail lending volume screen would be used to measure the volume of a bank’s lending relative to its deposit base in its
facility-based assessment area and would compare that ratio to the aggregate ratio for all reporting banks with at least one
branch in the same facility-based assessment area. Second, the agencies would evaluate the geographic distribution and
borrower distribution of a bank’s major product lines in the bank’s Retail Lending Test Areas (i.e., the bank’s facility-based
assessment areas, and, as applicable, retail lending assessment areas and outside retail lending area). using a series of
metrics and benchmarks. After the agency determines a recommended conclusion for Retail Lending Test Area, the agency
would consider a list of additional factors that are intended to account for circumstances in which the retail lending
distribution metrics and benchmarks may not accurately or fully reflect a bank’s retail lending performance, or in which the
benchmarks may not appropriately represent the credit needs and opportunities in an area.
13
Banks will receive consideration for any qualified community development loans, investments, or services, regardless of
location. The extent of an agency's consideration of community development loans, community development investments,
and community development services outside of the bank's facility-based assessment areas will depend on the adequacy of
the bank's responsiveness to community development needs and opportunities within the bank's facility-based assessment
areas and applicable performance context information. The new CRA rules codify agency interpretations under the former
CRA regulations, and provide 11 community development categories. The agencies will evaluate the extent to which a
bank’s community development loans, investments, and services are impactful and responsive in meeting community
development needs. An intermediate bank's community development test performance is evaluated pursuant to the
following criteria:
•
the number and dollar amount of community development loans;
•
the number and dollar amount of community development investments;
•
the extent to which the bank provides community development services; and
•
the bank's responsiveness through community development loans, community development investments, and
community development services to community development needs.
The banking agency's evaluation of the responsiveness of the bank's activities is informed by information provided by the
bank, and may be informed by the impact and responsiveness review factors described in the new regulations.
The release proposing these new CRA rules stated 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 proposal reflected “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 new rule exempts small and intermediate banks from certain new data requirements that apply to banks with assets of
at least $2 billion and limits certain new data requirements to large banks with assets greater than $10 billion.
Overdrafts
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.
14
Residential Mortgages
CFPB regulations require that lenders determine whether a consumer has the ability to repay a mortgage loan. These
regulations establish certain minimum requirements for creditors when making ability to repay determinations, and provide
certain safe harbors from liability for mortgages that are "qualified mortgages" and are not “higher-priced.” Generally,
these CFPB regulations apply to all consumer, closed-end loans secured by a dwelling including home-purchase loans,
refinancing and home equity loans—whether first or subordinate lien. Qualified mortgages must generally satisfy detailed
requirements related to product features, underwriting standards, and requirements where the total points and fees on a
mortgage loan cannot exceed specified amounts or percentages of the total loan amount. Qualified mortgages must have:
(1) a term not exceeding 30 years; (2) regular periodic payments that do not result in negative amortization, deferral of
principal repayment, or a balloon payment; (3) and be supported with documentation of the borrower and its credit. On
December 10, 2020, the CFPB issued final rules related to “qualified mortgage” loans. Lenders are required under the law
to determine that consumers have the ability to repay mortgage loans before lenders make those loans. Loans that meet
standards for QM loans are presumed to be loans for which consumers have the ability to repay.
We focus our residential mortgage origination on qualified mortgages and those that meet our investors’ requirements, but
we may make loans that do not meet the safe harbor requirements for “qualified mortgages.”
The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (the “2018 Growth Act”) provides that
certain residential mortgages held in portfolio by banks with less than $10 billion in consolidated assets automatically are
deemed “qualified mortgages.” This relieves smaller institutions from many of the requirements to satisfy the criteria listed
above for “qualified mortgages.” Mortgages meeting the “qualified mortgage” safe harbor may not have negative
amortization, must follow prepayment penalty limitations included in the Truth in Lending Act, and may not have fees
greater than 3% of the total value of the loan.
The Bank generally services the loans it originates, including those it sells. The CFPB’s mortgage servicing standards
include requirements regarding force-placed insurance, certain notices prior to rate adjustments on adjustable rate
mortgages, and periodic disclosures to borrowers. Servicers are prohibited from processing foreclosures when a loan
modification is pending, and must wait until a loan is more than 120 days delinquent before initiating a foreclosure action.
Servicers must provide borrowers with direct and ongoing access to its personnel, and provide prompt review of any loss
mitigation application. Servicers must maintain accurate and accessible mortgage records for the life of a loan and until one
year after the loan is paid off or transferred. These standards increase the cost and compliance risks of servicing mortgage
loans, and the mandatory delays in foreclosures could result in loss of value on collateral or the proceeds we may realize
from the 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.
15
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted on March 27, 2020. Section 4013 of
the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” provides banks the option to temporarily
suspend certain requirements under ASC 340-10 TDR classifications for a limited period of time to account for the effects
of COVID-19. On April 7, 2020, the Federal Reserve and the other banking agencies and regulators issued a statement,
“Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected
by the Coronavirus (Revised)” (the “Interagency Statement on COVID-19 Loan Modifications”), to encourage banks to
work prudently with borrowers and to describe the agencies’ interpretation of how accounting rules under ASC 310-40,
“Troubled Debt Restructurings by Creditors,” apply to covered modifications. The Interagency Statement on COVID-19
Loan Modifications was supplemented on June 23, 2020 by the Interagency Examiner Guidance for Assessing Safety and
Soundness Considering the Effect of the COVID-19 Pandemic on Institutions. If a loan modification is eligible, a bank may
elect to account for the loan under section 4013 of the CARES Act. If a loan modification is not eligible under section
4013, or if the bank elects not to account for the loan modification under section 4013, the Revised Statement includes
criteria when a bank may presume a loan modification is not a TDR in accordance with ASC 310-40.
Section 4021 of the CARES Act allows borrowers under 1-to-4 family residential mortgage loans sold to Fannie Mae to
request forbearance to the servicer after affirming that such borrower is experiencing financial hardships during the
COVID-19 emergency. Such forbearance will be up to 180 days, subject to up to a 180-day extension. During forbearance,
no fees, penalties or interest shall be charged beyond those applicable if all contractual payments were fully and timely
paid. Except for vacant or abandoned properties, Fannie Mae servicers may not initiate foreclosures on similar procedures
or related evictions or sales until December 31, 2020. 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.
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.
16
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 comments on incorporating an
“effective and reasonably designed” AML/BSA program component to empower financial institutions to allocate resources
more effectively. This component also would seek to implement a common understanding between supervisory agencies
and financial institutions regarding the necessary AML/BSA program elements, and would seek to impose minimal
additional obligations on AML programs that already comply under the existing supervisory framework.
On October 23, 2020, FinCEN and the Federal Reserve invited comment on a proposed rule that would amend the
recordkeeping and travel rules under the Bank Secrecy Act, which would lower the applicable threshold from $3,000 to
$250 for international transactions and apply these rules 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 to implement the CTA. This became effective on January 1, 2024. 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. Although the Company and the
Bank are exempt from the CTA’s requirements to report their respective beneficial owners, the new laws are likely to
increase the Bank’s anti-money laundering diligence activities and costs.
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.
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.
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.
17
Other Laws and Regulations
The Company is also required to comply with various corporate governance and financial reporting requirements under the
Sarbanes-Oxley Act of 2002, as well as related rules and regulations adopted by the SEC, the Public Company Accounting
Oversight Board and Nasdaq. In particular, the Company is required to report annually on internal controls as part of its
annual report pursuant to Section 404 of the Sarbanes-Oxley Act.
The Company has evaluated its controls, including compliance with the SEC 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.
Bank Dividends
The Company is a legal entity separate and distinct from the Bank. Federal Reserve Regulation Q limits “distributions,”
including discretionary bonus payments from eligible retained income” by state member banks, such as the Bank, unless its
capital conservation buffer of common equity Tier 1 capital (“CET1”) exceeds 2.5%. “Distributions” include dividends
declared or paid on common stock, discretionary bonuses and stock repurchases, redemptions or repurchases of Tier 2
capital instruments (unless replaced by a capital instrument in the same quarter). “Eligible retained income” for the Bank
and other Federal Reserve regulated institutions is 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.
The Company’s primary source of cash is dividends from the Bank. The Bank’s Call Report are used for its calculation of
“eligible retained income.”
The Bank’s capital conservation buffer exceeded 2.5% at December 31, 2023.
As of December 31, 2023, the Bank is “well capitalized” under the regulatory framework for prompt corrective action. To
be categorized as “well capitalized,” the Bank must maintain minimum common equity Tier 1, total risk-based, Tier 1 risk-
based, and Tier 1 leverage ratios as set forth in the following table. Management has not received any notification from the
Bank's regulators that changes the Bank’s regulatory capital status.
Prior regulatory approval also is required by statute 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 2023, the Bank paid total cash dividends of
approximately $3.8 million to the Company. At December 31, 2023, the Bank had net profits for the year and its retained
net profits for the preceding two calendar years, less any required transfers to surplus, of $8.2 million.
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. See “Regulatory Capital Changes” and Note 16 to the Company’s consolidated financial
statements.
18
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.
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.
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
19
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 U.S. capital rules are called the “Basel III Capital Rules,” and generally
were fully phased-in on January 1, 2019. These are included in Federal Reserve Regulation Q.
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”).
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.
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.
Regulatory Capital Changes
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.
20
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.
In addition to the minimum risk-based capital requirements, a “capital conservation buffer” of CET1 capital of at least
2.5%, is required. The capital conservation buffer will be calculated as the
lowest
●
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:
Capital Conservation
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
Basel III Capital
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
Federal Reserve Capital Review
The Federal Reserve’s Vice Chair for Supervision has indicated he is considering a holistic review of regulatory capital
requirements, which are expected to focus on banking organizations larger than the Company.
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.
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.
23
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 elect to use the CBLR framework. 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.
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.
24
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
mortgaged backed securities.
The CARES Act provided a $2 trillion stimulus package and various measures to provide relief from the COVID-19
pandemic, including:
●
The Paycheck Protection Program (“PPP”), which expands eligibility for special new SBA guaranteed loans,
forgivable loans and other relief to small businesses affected by COVID-19.
●
A new $500 billion federal stimulus program for air carriers and other companies in severely distressed sectors of
the American economy. The lending programs impose stock buyback, dividend, executive compensation, and
other restrictions on direct loan recipients.
●
Optional temporary suspension of certain requirements under ASC 340-10 TDR classifications for a limited period
of time to account for the effects of COVID-19.
●
The creation of rapid tax rebates and expansion of unemployment benefits to provide relief to individuals.
●
Substantial federal spending and significant changes for health care companies, providers, and patients.
●
Over $525 billion of PPP loans were made in 2020.
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid
Act”) was signed into law. The Economic Aid Act 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 2021 and at the beginning of 2022, the Federal Reserve described inflation as “transitory,” but as inflation
continued at increasing rates the Federal Reserve’s policy changed. The Federal Reserve announced a 25 basis point
increase in the target federal funds range on March 17, 2022, the first change since March 2020 when the target was set to
0-0.25%. Further increases were announced in 2022: 50 basis points on May 4, 75 basis points on each of June 15, July 27,
September 21, and November 2, and 50 basis points on December 14, 2022. During 2023, the Federal Reserve announced
additional target rate increases of 25 basis points on each of February 1, 2023, March 2022, May 3 and July 26, 2023. The
federal funds target rate range remains at 5.25-5.50% at March 12, 2024.
25
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 $7.0 trillion on February 28, 2024 compared to $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.”
Although the Federal Reserve Chairman continues to maintain the 2% long term target inflation, he has indicated that the
Federal Reserve is “data dependent” and that it could cut rates depending on the data and whether recent declines in
inflation appear sustained, and alternatively, raise rates if appropriate in pursuit of its long term target inflation. 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 which failed, the Federal Reserve established a new Bank Term Funding Program
(“BTFP”). The BTFP offered 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 were valued at par and the margin was 100% of par. The BTFP expires March 11, 2024, except for
loans outstanding prior to its expiration. The Company did not participate in the BTFP in 2023.
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 was available with the same collateral margins as the
BTFP, but which offers loans of up to 90 days. Collateral is valued under the discount window is based on fair market
values, collateral margins subsequently have been reduced to less than 100% of collateral fair market value, with the
amount of discount depending on the type of collateral.
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.
26
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, which is the latest available:
Established Small Institution
CAMELS Composite
1 or 2
3
4 or 5
Initial Base Assessment Rule
5 to 18 basis points
8 to 32 basis points
18 to 32 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
Adjustment
N/A
N/A
N/A
Total Base Assessment Rate
2.5 to 18 basis points
4 to 32 basis points
13 to 32 basis points
As shown above. these assessments are adjusted based on the bank’s CAMELS rating. For example, Small Banks, with
CAMELS ratings of 1 or 2, have a current total assessment rate of 2.5 to 18 basis points for the period to be billed in June
2023.
The FDIC issued a special assessment of 3.36 basis points for a projected eight quarters on large banks with more than $5
billion of uninsured deposits as a result of the systemic risk determination to insure all depositors in connection with the
March 2023 failures of Silicon Valley Bank and Signature Bank. These special assessments do not apply to the Bank.
The minimum FDIC’s DIF reserve ratio is 1.35%, which was set by the Dodd-Frank Act. The FDIC Board of directors is
required by the Federal Deposit Insurance Act to designate a reserve ratio before the beginning of each calendar year.
There is no upper limit on the reserve ratio and thus, no statutory limit on the size of the fund. The FDI Act provides for
dividends from the fund when the reserve ratio exceeds 1.5 percent, but grants the Board sole discretion in determining
whether to suspend or limit the declaration or payment of dividends. The 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.
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, at
that time, maintained its then 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. The designated
reserve ratio has been 2% since 2010, and was set at this same level for 2024.
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, 2023, and because the Bank never participated in the PPPLF.
The Company recorded FDIC insurance premiums expenses of $0.5 and $0.3 million in 2023 and 2022, respectively, which
reflects the FDIC’s amended restoration plan increases in the initial base deposit insurance assessment rate schedules
uniformly by 2 basis points, beginning with the first quarterly assessment period of 2023.
27
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. See “Management’s Discussion and Analysis
of Financial Condition and Results of Operations - Balance Sheet Analysis” for concentrations of the various types of CRE
loans.
At December 31, 2023, the Bank had outstanding $68.3 million in construction and land development loans and $293.0
million in total CRE loans (excluding owner occupied properties), which represent approximately 62% and 264%,
respectively, of the Bank’s total risk-based capital at December 31, 2023. 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.
The Federal Reserve joined the other depository institution regulators in issuing a Policy Statement on Prudent Commercial
Real Estate Loan Accommodations and Workouts on June 30, 2023. This Policy Statement builds on and updates existing
guidance to enable financial institutions to work prudently and constructively with creditworthy borrowers during times of
financial stress. The Policy Statement provides a broad set of risk management principles relevant to CRE short term loan
accommodations and longer term workouts in all business cycles, particularly in challenging economic environments. It
states that the regulatory agencies expect their examiners to take a balanced approach in assessing the adequacy of a
financial institution's risk management practices for loan accommodation and workout activities. 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 classification. In addition, 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 outstanding loan balance. The
Policy Statement also describes the classifications of CRE loan accommodations and workouts and addresses regulatory
accounting and reporting in such situations, including CECL.
28
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 2023 or 2022 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
or other advisor.
Section 954 of the Dodd-Frank Act added section 10D to the Exchange Act. Section 10D directs the SEC to adopt rules
prohibiting a national securities exchange or association from listing a company unless it develops, implements, and
discloses a policy regarding the recovery or “claw-back” of executive compensation in certain circumstances. The policy
must require that, in the event an accounting restatement due to material noncompliance with a financial reporting
requirement under the federal securities laws, the company will recover from any current or former executive officer any
incentive-based compensation (including stock options) received during the three year period preceding the date of the
restatement, which is in excess of what would have been paid based on the restated financial statements. There is no
requirement of wrongdoing by the executive, and the claw-back is mandatory and applies to all executive officers. Section
954 augments section 304 of the Sarbanes-Oxley Act, which requires the CEO and CFO to return any bonus or other
incentive- or equity-based compensation received during the 12 months following the date of similarly inaccurate financial
statements, as well as any profit received from the sale of employer securities during the period, if the restatement was due
to misconduct. Unlike section 304, under which only the SEC may seek recoupment, the Dodd -Frank Act requires the
Company to seek the return of compensation.
The SEC adopted, effective January 27, 2023, Commission Rule 10D-1 under the Exchange Act, which requires each
national securities exchange to adopt listing standards for the recovery of erroneously awarded executive compensation.
The Commission approved Nasdaq Listing Rule 5608 (“Rule 5608”) on June 9, 2023. Under Rule 10D-1, listed companies
must recover from current and former executive officers’ incentive-based compensation received during the three
completed fiscal years preceding the date on which the issuer is required to prepare an accounting restatement.
29
Under these SEC and Nasdaq rules, 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).
Nasdaq-listed companies, such as the Company, are 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, computed without regard to any taxes paid. Nasdaq
defines “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 on or after October
2, 2023 and 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 Company adopted an Erroneously Awarded Executive Incentive Based Compensation Policy effective December 1,
2023 to comply with these rules.
The SEC adopted a rule 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 expects to adopt appropriate policies upon shareholder approval an equity incentive plan at the Annual
Stockholders’ meeting in 2024.
The Company’s has had no equity-based compensation plans or arrangements, but expects to seek stockholder approval of
an equity incentive plan at the Annual Stockholders’ meeting in 2024. 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.
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.
30
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.
Following the failures of Silicon Valley Bank and Signature Bank in early March 2023, Senator Elizabeth Warren and co-
sponsors, filed S.1045 “Failed Bank Executives Clawback Act.” This bill provides that when a bank is placed into FDIC
receivership, all or part of the compensation paid the previous five years to an institution-affiliated party responsible for the
condition of the institution must be paid to FDIC to prevent unjust enrichment and to assure that the party bears losses
consistent with their responsibility. Compensation includes salary, bonuses, awards, and profits from buying or selling
securities. The bill also expands the FDIC’s authority to claw back compensation of parties responsible for financial losses
incurred by a financial company regardless of the process by which FDIC is appointed receiver.
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, however such banks compete with banks that are subject to the Durbin Amendment, and
therefore may have to limit their interchange fees, also.
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 froze new rulemaking generally when he became President in January 2021, and 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 coins, and access to the payments system.
The DoJ’s Antitrust Division of the United States and the Federal Trade Commission issued revised Merger Guidelines on
December 18, 2023. The DoJ, the Federal Reserve and the OCC have confirmed that these new Guidelines did not modify
the 1995 Bank Merger Guidelines, however. Representatives of the Federal Reserve have indicated that updated Bank
Merger Guidelines are being considered.
31
The 2018 Growth Act, which, was enacted on May 24, 2018, amended 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 after regulations were adopted in 2019:
●
“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 Volcke r Rule.
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 businesses 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.
Reciprocal deposits have expanded our funding and liquidity sources without being subjected to FDIC limitations and
potential federal deposit insurance assessment increases for brokered deposits.
The applicable agencies also issued final rules simplifying the Volcker Rule’s 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.
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.
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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. Therefore, the transition from LIBOR did not
affect the Bank’s loan portfolio.
Certain of these new rules, and proposals, if adopted, 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.
Risk Factor Summary
The following summarizes the risks provided after this summary and is qualified by the more detailed discussion of “Risk
Factors” that follows this Summary, and which should be read in their entirety. Our risks include operational risks,
financial risks and legal and regulatory risks, which are related and intertwined as discussed more fully in the Risk Factors
that follow this summary.
Operational risks are inherent in our business, and include:
●
The effects of local, national and regional market and economic conditions and cyclicality, including inflation,
interest rates and their effects on borrowers and markets, including real estate markets
●
The risks and costs of nonperforming assets
●
Our allowance for credit losses is based on estimates and judgments and may prove to be inadequate to our credit
risks
●
The soundness of other financial institutions and perceptions regarding our industry, especially when other banks
experience difficulties or fail
●
Our concentrations in commercial real estate loans in our market
●
We operate in a highly competitive market against a number of larger national and regional competitors
●
Future acquisitions may disrupt our business, dilute shareholder value and adversely affect our operating results
and financial condition, among other risks
●
Technological changes affect our business, and we may have fewer resources than various of our larger regulated
and unregulated competitors, inside and outside our market area, which may increase the competition we face
●
Potential gaps in our risk management, including managing the risks to us of data security and cybersecurity,
including risks to our service providers could affect our results of operations, financial condition, customer
relationship and reputation
●
Our ability to attract and retain key people
●
Risks of severe weather, natural disasters, climate changes, epidemics and severe health issues in the population,
wars and acts of terrorism and other events
33
Financial risks result in part from our operational risks and the risk of our business, and include:
●
Increases in costs of funds due to inflation, monetary and fiscal policies, changes in costumer behaviors and
competitive pressures
●
Our results of operations and financial condition, including the values of our assets and liquidity, may be affected
by changes in interest rates and interest rate levels, the shape of the yield curve and economic conditions
●
Liquidity risks, including the costs and availability of funding, and the liquidity of our assets, including our
investment securities portfolio, and institutional lending sources
●
Changes in accounting and tax rules
●
The adequacy of our capital and availability of capital, if needed
●
Potentially excessive risk taking by our associates
●
Our ability to pay dividends depends on our earnings, liquidity and regulatory requirements related to our capital
and our risks
●
A limited trading market exists for our common stock
Legal and regulatory risks include:
●
The Company is a legal entity separate and distinct from the Bank, and transactions between the Bank and the
Company are limited by law
●
The Company is required to be a source of financial and managerial strength to the Bank, even where further
investment in the Bank may not be warranted in the circumstances
●
The scope, volume and complexity of regulations and regulatory and legal changes affect us, increase the time and
costs of compliance and may limit our business and adversely affect our financial condition and results of
operations
●
Litigation, investigations and other claims by government agencies and private parties and regulatory actions,
including those related to assertions of compliance failures
●
The amount of and changes in the capital we are required to maintain in respect of our business and risk, and
regulatory perceptions of us and our industry
●
Liquidity requirements
Operational Risks
Market conditions and economic cyclicality may adversely affect our industry.
We believe the following, among other things, may affect us in 2024:
●
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. At the end of 2023, many believed that the
Federal Reserve would loosen its monetary policy in response to inflation, which was declining, but remained
above the Fed’s 2% long term target level. Strong economic data and inflation reports since then appear to have
reduced expectations as to the number, timing and size of any reductions in the target federal funds rate in the near
term.
34
●
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 customers’ savings and payment behaviors, including potential increases in loan delinquencies and
default rates. These could affect our earnings and credit quality.
●
Our ability to assess the creditworthiness of our customers and those we do business with, and the values of our
assets and loan collateral may be adversely affected and less predictable as a result of 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.
Nonperforming and similar assets take significant time to resolve and may adversely affect our results of operations and
financial condition.
Our nonperforming loans were 0.16% of total loans as of December 31, 2023, and we had no 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, 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, and may
request or need loan modifications and deferrals. 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 in the current environment have not yet been determined fully due to its short existence. 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.
35
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. Inventories of existing homes for sale have
remained generally low, and many believe that higher mortgage rates are adversely affecting potential sellers from selling
their existing houses and incurring higher mortgage interest rates on their replacement home. These conditions have
adversely affected housing affordability and increased monthly mortgage payments. 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,
generally to Fannie Mae, a GSE. 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 partially 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.
36
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-Atlanta, could be adversely affected by the actions, financial
condition, and profitability of such other financial institutions, including the FHLB-Atlanta 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 stopped
being quoted June 30, 2023 and their use has been strongly discouraged by regulatory agencies. Most banks did not adopt
CECL until January 1, 2023.
The failures of Silicon Valley Bank, Signature Bank and First Republic Bank in 2023 due to concentrations of deposits and
depositors holding large amounts of deposits in excess of FDIC insurance limits, as well as flawed business models and
management, adversely affected the financial system and public confidence. These have resulted in increased regulatory
scrutiny of bank liquidity, funding and capital, depressed bank stock values generally, and higher FDIC deposit insurance
premiums on the largest banks, as well as regulatory proposals to increase large banks’ capital and expand enhanced
prudential standards starting at $100 billion of assets instead of $250 billion.
The federal bank regulators have been advocating more use of the Federal Reserve discount window to improve bank
liquidity. At the same time, these bank failures, together with the failure of the very small Heartland State bank in Kansas
due to apparent embezzlement by its president due to losses from his personal crypto trading, have also led to calls to
reduce Federal Home Loan Bank lending to banks. Traditionally, the Federal Home Loan Banks have been stable sources
of liquidity and funding for banks. The Federal Housing Finance Agency (“FHFA) regulates the Federal Home Loan
Banks. The FHFA’s
FHLBank System at 100: Focusing on the Future
(Nov. 2023) suggest less traditional Federal Home
Loan Bank lending to banks, especially banks experiencing financial stress.
These changes, together with any exposures other institutions may have to crypto or digital assets, or cybersecurity and data
breaches, 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.
Failures of several banks earlier in 2023 and in early 2024 have resulted in increased market volatility for financial service
companies’ securities and in changes in regulatory views and emphases that may adversely affect us and may not be
disclosable under law.
The failures of Silicon Valley Bank, Signature Bank, First Republic and Heartland Tri-State Bank in 2023 have resulted in
significant market volatility for bank stocks, and have caused uncertainty in the investor community and among bank
customers, generally, greater bank regulatory scrutiny of banking organizations, especially those experiencing rapid growth
and regional banks with $100 billion or more in assets. Similarly concerns about credit quality and capital adequacy at
New York Community Bank following two acquisitions raised market concerns and led to replacement of management and
a dilutive equity capital raise.
Changes in regulations have been proposed as part of the Basel III endgame to the capital, liquidity, long term debt and
resolution planning of banking organizations with over $100 billion in assets. These failures also have resulted in market
volatility in financial services securities. Regulators have focused supervisory activities, generally, at all sizes of banking
organizations on various risks, especially capital adequacy and liquidity in light of growth, asset, liability and customer
concentrations and risks; CRE, levels of uninsured deposits; crypto businesses and customers; strategic, capital and
liquidity plans and contingency plans; and risk management. Such enhanced scrutiny is often applied as part of the
regulatory examination processes, as well as through a variety of nonpublic supervisory actions such as “matters requiring
attention,” board of director resolutions, memoranda of understanding, and other regulatory criticism and informal
supervisory actions. The bank and bank holding examination processes, as well as any nonpublic supervisory actions, are
“confidential supervisory information” for regulatory purposes, whose existence and terms, if any, may not be disclosed by
banking organizations.
37
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 39.6% of our loan por tfolio in CRE loans at year-end 2023
compared to 40.4% and 42.6% at year-end 2022 and 2021, respectively. 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 fewer CRE purchase and sale transactions, and reduced availability
of, and higher interest rates and costs for, CRE loans could adversely affect CRE values and liquidity, our CRE loans and
sales of 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. Nineteen banks, including JP Morgan Chase, Wells Fargo,
Truist, PNC, Regions, Valley National and SouthState, have offices in Lee County. Eleven of these banks are
headquartered outside of Alabama. 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 compete for our customers, and may
partner with other banks and/or seek to enter the payments system. The failures of other banks with offices in our markets
could also lead to the entrance of new, stronger competitors in our markets.
Our success depends on local economic conditions.
Our success depends on the general economic conditions in the geographic markets we serve in Alabama. The local
economic conditions in our markets have a significant effect on our commercial, real estate and construction loans, the
ability of borrowers to repay these loans and the value of the collateral securing these loans. Adverse changes in the
economic conditions of the Southeastern United States in general, or in one or more of our local markets, including the
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 generally are affected adversely by higher interest rates.
38
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 and financial condition.
We regularly evaluate potential acquisitions and expansion opportunities, including new branches and other offices. To the
extent that we grow through acquisitions, we cannot assure you that we will be able to adequately or profitably manage this
growth. Acquiring other banks, branches, or businesses, as well as other geographic and product expansion activities,
involve various risks including:
●
risks of unknown or contingent liabilities, and potential asset quality issues;
●
unanticipated costs and delays;
●
risks that acquired new businesses will not perform consistent with our growth and profitability expectations;
●
risks of entering new markets or product areas where we have limited experience;
●
risks that growth will strain our infrastructure, staff, internal controls and management, which may require
additional personnel, time and expenditures;
●
difficulties, expenses and delays of integrating the operations and personnel of acquired institutions;
●
potential disruptions to our business;
●
possible loss of key employees and customers of acquired institutions;
●
potential short-term decreases in profitability; and
●
diversion of our management’s time and attention from our existing operations and business.
Technological changes affect our business, and we may have fewer resources than many competitors to invest in
technological improvements.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology
driven products and services and growing demands for mobile and user-based banking applications. In addition to allowing
us to analyze our customers better, the effective use of technology may increase efficiency and may enable financial
institutions to reduce costs, risks associated with fraud and compliance with anti-money laundering and other laws, and
various operational risks. Largely unregulated “fintech” businesses have increased their participation in the lending and
payments businesses, and have increased competition in these businesses. Our future success will depend, in part, upon our
ability to use technology to provide products and services that meet our customers’ preferences and create additional
efficiencies in operations, while avoiding cyber-attacks and disruptions, data breaches and anti-money laundering 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 and data security. 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.
39
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.
Potential gaps in our risk management policies and internal audit procedures may leave us exposed to 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 losses 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. The 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 may adversely affect the accuracy or usefulness of the models. 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 federal bank regulators issued
Principles for Climate-
Related Risk for Large Financial Institutions
$100 billion in assets. The SEC adopted a climate risk rule on March 6, to require more disclosure on climate risks, also.
All of these could adversely affect our costs, and our financial condition and results of operations.
40
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, policies 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 other 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. See Item 1C. of this report for more information about cybersecurity and our
management and strategies.
Our information systems may experience interruptions and security brea ches.
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. See Item 1C. of
this report for more information about cybersecurity and our management and strategies.
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 and other
countries. 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.
Despite our cybersecurity policies and procedures and our Board of Directors and management’s efforts to monitor and
ensure the integrity of the systems we and our third-party service providers 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.
In July 2023, the SEC adopted rules, effective September 5, 2023, that require reporting companies to disclose material
cybersecurity incidents they experience on SEC Form 8-K within four business days, nature, scope, and timing of the
incident, and the material impact or reasonably likely material impact on the registrant, including its financial condition and
results of operations. As a smaller reporting company, the Company has to comply with these Form 8-K reporting
requirements beginning June 15, 2024. Annually, reporting companies are required to disclose material information
regarding their cybersecurity risk management, strategy, and governance, beginning for years ending on or after December
15, 2023.
41
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. The Federal Reserve’s target federal funds rates declined to 0-0.25% in
March 2020, where these remained until March 17 2022. The Federal Reserve increased the target federal funds rates 11
from March 17, 2022 through July 27, 2023 to 5.25-5.50% due to inflation. As of March 6, 2023, this range remained at
5.25-5.50% and inflation remains above the Federal Reserve’s target rate of 2%. 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.
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, 2023, we had a
net deferred tax asset of $10.3 million compared to $13.8 million one year earlier. 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.
42
Our cost of funds may increase as a result of general economic conditions, interest rates, inflation and changes in customer
behaviors and competitive pressures.
Our costs of funds have increased 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-
Atlanta, which we believe are a cheaper and more stable source of funds than borrowings, generally. Increases in interest
rates have caused 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 continues to remain inverted, 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 continuing run-off of maturing securities held by the Federal Reserve in
furtherance of its quantitative tightening policy to reduce inflation generally reduce economic activity and may reduce 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.
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 costs of funds, growth, 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.
43
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-Atlanta and the Federal Reserve Bank of Atlanta, 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 valued at par. The BTFP ended March 11,
2024 and we have not used this program. 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 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, failures of other bank, such as Silicon Valley Bank,
Signature Bank and First Republic Bank in 2023, 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
.
We may need to raise additional capital in the future, but that capital may not be available when it is needed or on
favorable terms.
We anticipate that our current capital resources will satisfy our capital requirements for the foreseeable future under
currently effective rules. We may, however, need to raise additional capital to support our growth or currently
unanticipated losses, or to meet the needs of our communities, resulting from failures or cutbacks by our competitors. Our
ability to raise additional capital, if needed, will depend, among other things, on conditions in the capital markets at that
time, which are limited by events outside our control, and on our financial performance. If we cannot raise additional
capital on acceptable terms when needed, our ability to further expand our operations through internal growth and
acquisitions could be limited.
Our associates may take excessive risks which could negatively affect our financial condition and business.
Banks are in the business of accepting certain risks. Our executive officers and other members of management, sales
intermediaries, investment professionals, product managers, and other associates, make decisions and choices that involve
exposing us to risk. We endeavor, in the design and implementation of our compensation programs and practices, to avoid
giving our associates incentives to take excessive risks; however, associates may nonetheless take such risks. Similarly,
although we employ controls and procedures designed to prevent misconduct, to monitor associates’ business decisions and
prevent them from taking excessive risks, these controls and procedures may not be effective. If our associates take
excessive risks, risks to our reputation, financial condition and business operations could be materially and adversely
affected.
44
Our ability to continue to pay dividends to shareholders and repurchase stock 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. We can only pay dividends, repurchase stock and pay discretionary bonuses, if our capital
conservation buffer exceeds 2.5% and from our eligible retained income over the last four calendar quarters. Although we
believe our securities portfolio repositioning in December 2023 improved our balance sheet and reduced our interest rate
risks, the losses on such securities sales reduced our eligible retained income available for dividends, share repurchases and
discretionary bonuses. See “Supervision and Regulation - Payment of Dividends and Repurchases of Capital Instruments.”
The Federal Reserve expects bank holding companies to inform and consult with Federal Reserve supervisory staff
sufficiently in advance of (i) declaring and paying a dividend that could raise safety and soundness concerns, such as
declaring and paying a dividend that exceeds earnings for the period for which the dividend is being paid); (ii) redeeming or
repurchasing regulatory capital instruments when the bank holding company is experiencing financial weaknesses; or (iii)
redeeming or repurchasing common stock or perpetual preferred stock that would result in a net reduction as of the end of a
quarter in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the
redemption or repurchase occurred.
Further, the Company is also required to maintain sufficient capital, liquidity and resources to serve as a source of
managerial and financial strength to the Bank, which may limit its capacity to pay dividends on Company common stock.
The Federal Reserve may require the Company to commit resources to the Bank, even where it is not otherwise in the
interests of the Company or its shareholders or creditors.
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.
45
Legislative and regulatory changes
The Biden Administration and its appointees to the various government agencies, including the bank regulators, CFPB and
SEC, have proposed, and continue to propose changes to bank regulation, SEC rules and corporate tax changes that could
have an adverse effect on our results of operations and financial condition.
The bank regulators, the CFPB and the SEC have actively developed a broad range of new and changed rules over the last
several years , many of which are complex and lengthy, such as the new CRA regulations and various SEC rules, including
the cybersecurity rule adopted in September 2023 and climate change rules adopted on March 6, 2024. Some rules, such
as the SEC share repurchase modernization rules, have been struck down by the courts and have been withdrawn, creating
more compliance uncertainty during the pendency of the litigation. Ten states attorney generals immediately challenged the
new climate change rules, and the Sierra Club is reported to be considering action against the SEC rules because it was
scaled back from the original proposal.
Compliance with the volume and complexity of these rule changes is costly and imposes material time and personnel
burdens on financial services companies, especially on smaller companies, such as the Company. Increasing litigation on
regulatory rules and whether these exceed the agencies’ statutory authority or have been improperly adopted has also
created further uncertainty and risks as to the final timing, content and scope of new rules, and business changes needed to
be made to comply with the effective or compliance dates of the new or changed rules. For example, the SEC’s share
repurchase disclosure modernization amendments were adopted in May 2023, with a compliance date for calendar year
issuers beginning with their 2023 annual Form 10-K report. The SEC postponed the rule on November 22, 2023, following
a court ruling ordering the SEC to correct the defects in the rule by November 30, 2023. In December 2023, the court
vacated the rule due to inaction by the SEC, and the SEC reverted on February 9, 2024 to its pre-existing rules.
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.
46
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.
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 or sales of securities for losses;
●
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 repurchase our common 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.
47
The Federal Reserve may require us to commit capital resources to support the Bank.
As a matter of policy, the Federal Reserve expects a bank holding company to act as a source of financial and managerial
strength to a subsidiary bank and to commit resources to support such subsidiary bank. The Federal Reserve may require a
bank holding company to make capital injections into a troubled subsidiary bank. In addition, the Dodd-Frank Act amended
the FDI Act to require that all companies that control a FDIC-insured depository institution serve as a source of financial
strength to their depository institution subsidiaries. Under these requirements, we could be required to provide financial
assistance to the Bank should it experience financial distress, even if further investment was not otherwise warranted. See
“Supervision and Regulation.”
Our operations are subject to risk of loss from unfavorable fiscal, monetary and political developments in the U.S.
Our businesses and earnings are affected by the fiscal, monetary and other policies and actions of various U.S.
governmental and regulatory authorities. Changes in these are beyond our control and are difficult to predict and,
consequently, changes in these policies could have negative effects on our activities and results of operations. Failures of
the executive and legislative branches to agree on spending plans and budgets previously have led to Federal government
shutdowns, which may adversely affect the U.S. economy. Additionally, any prolonged government shutdown may inhibit
our ability to evaluate the economy, generally, and affect government workers who are not paid during such events, and
where the absence of government services and data could adversely affect consumer and business sentiment, our local
economy and our customers and therefore our business.
Litigation and regulatory investigations are increasingly common in our businesses and may result in significant financial
losses and/or harm to our reputation.
We face risks of litigation and regulatory investigations and actions in the ordinary course of operating our businesses,
including the risk of class action lawsuits. Plaintiffs in class action and other lawsuits against us may seek very large and/or
indeterminate amounts, including punitive and treble damages. Due to the vagaries of litigation, the ultimate outcome of
litigation and the amount or range of potential loss at particular points in time may be difficult to ascertain. We do not have
any material pending litigation or regulatory matters affecting us.
Failures to comply with the fair lending laws, CFPB 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. The CRA and fair lending responsibilities
are related and mutually reinforcing. 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 Reserve adopted comprehensive revisions to its CRA regulations on October 24, 2023. The other bank
regulators jointly adopted the new CRA regulations, also, and published the new rule in the Federal Register on February 1,
2024. These new rules are first effective for the Bank beginning on January 1, 2026 with data reporting beginning January
1, 2027. The Bank will be an “intermediate bank” and will be subject to the “retail lending test” and either the
“intermediate bank community development test,” or if the bank elects, “the community development financing test.” We
are evaluating the new rules but cannot predict their effects on us, but these could significantly affect our compliance costs
and activities. See “Supervision and Regulation -
Community Reinvestment Act and Consumer Laws.”
48
COVID-19 Risks
The national emergencies related to COVID-19 have been terminated by the President effective May 11, 2023 and in
February 2024 the Centers for Disease Control likened COVID-19 to the flu, and recommended continued use of booster
vaccinations. The medical and direct economic effects of COVID-19 diminished further in 2023 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 commercial 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 1C. CYBERSECURITY
We rely extensively on various information systems and other electronic resources to operate our business. In addition,
nearly all of our customers, service providers and other business partners on whom we depend, including the providers of
our online banking, mobile banking and accounting systems, use their own electronic information systems. Any of these
systems can be compromised, including by employees, customers and other individuals who are authorized to use them,
and bad actors using sophisticated and a constantly evolving set of software, tools and strategies to do so. The threats are
domestic and international and range from small to large, including state sponsored, terrorist and criminal organizations
with substantial funds, and technical and other resources
As a bank, we and our vendors, service providers and customers may be attractive targets, and we confront continuous
cybersecurity threats. Insurance to fully cover these risks is unavailable in sufficient amounts at reasonable costs. We
believe the more effective approach is taking active measures to detect, deter and reduce cybersecurity threats, and be
prepared to address and remediate any breaches and prevent similar breaches in the future. See “Risks Related to
Information Security and Business Interruption” section of the Risk Factors included in Item 1A of this Form 10-K for
additional information.
Accordingly, we have devoted significant resources to assessing, identifying and managing risks associated with
cybersecurity threats, including:
•
Implementing an Information Security Program that establishes policies and procedures for security
operations and governance;
•
Establishing an IT Steering Committee of the Board that is responsible for security administration, including
conducting regular assessments of our information systems, existing controls, vulnerabilities and potential
improvements;
•
Implementing layers of controls and not allowing excessive reliance on any single control;
•
Employing a variety of preventative and detective tools designed to monitor, block and provide alerts
regarding suspicious activity;
•
Continuously evaluating tools that can detect and help respond to cybersecurity threats in real-time;
•
Leveraging people, processes and technology to manage and maintain cybersecurity controls;
49
•
Maintaining a vendor management program with periodic review processes, and a third-party risk
management program designed to identify, assess and manage risks associated with external service providers;
•
Monitoring our systems and related software and programming periodically to update software and
programing, including updating data protection elements, and requiring that our service providers also engage
in similar programs that are reasonably designed to deter cybersecurity breaches;
•
Performing initial and ongoing due diligence with respect to our third-party service providers, including their
cybersecurity practices and safeguards, and service levels based on the risk they pose to the Bank;
•
Engaging third-party cybersecurity consultants, who conduct periodic penetration testing, vulnerability
assessments and other procedures to identify potential weaknesses in our systems and processes; and
•
Conducting periodic cybersecurity training for our employees and the Company’s board of directors.
Our Information Security Program is a key part of our overall risk management system, which is administered by our IT
Steering Committee and evaluated by our IT Steering Committee and chief risk officer. The program includes
administrative, technical and physical safeguards to help protect the security and confidentiality and availability of
customer records and information.
From time-to-time, we have identified cybersecurity threats that require us to make changes to our processes, equipment
and to implement additional safeguards. While none of these identified threats or incidents have materially affected us, it is
possible that threats and incidents we identify in the future could have a material adverse effect on our business strategy,
customer service, data privacy and security, continuity of service and reputation, and our results of operations and financial
condition.
The Company’s Chief Technology Officer is responsible for the day-to-day management of cybersecurity risks we face and
oversees the IT Steering Committee, which is chaired by a director of the Company’s board. The IT Steering Committee
oversees the information security assessment, development of policies, standards and procedures, testing, training and
security report processes. The IT Steering Committee is comprised of directors and officers with the appropriate expertise
and authority to oversee the Information Security Program.
Our Chief Technology Officer, along with the information technology department, is accountable for managing our
enterprise information security and delivering our information security program. The department, as a whole, consists of
information security professionals with varying degrees of education and experience. The Chief Technology Officer is
subject to professional education and certification requirements. In particular, our Chief Technology Officer, who is also
designated as our Information Security Officer, has relevant expertise in the areas of information security and cybersecurity
risk management.
In addition, the Company’s Board, both as a whole and through its IT Steering Committee is responsible for the oversight
of risk management, including cybersecurity risks. In that role, the Company’s Board and the IT Steering Committee, with
support from the Company’s management and third party cybersecurity advisors, are responsible for ensuring that the risk
management processes designed and implemented by management are adequate and functioning as designed. The Board
reviews and approves an information security program, vendor management policy (incl uding third-party service
providers), acceptable use policy, incident response policy and business continuity planning policy on an annual basis. All
the aforementioned policies are developed and implemented by Company management. To carry out their duties, the Board
receives updates at least quarterly from the Chief Technology Officer regarding cybersecurity risks and the Company’s
efforts to prevent, detect, mitigate and remediate any cybersecurity incidents.
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.
50
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 had 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 a leased space 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, but does not maintain 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
for approximately 28 vehicles.
In May 2017, the Bank relocated its Opelika Kroger branch to a new location the Bank purchased in August 2016 near the
Tiger Town Retail Shopping Center and the intersection of U.S. Highway 280 and Frederick Road in Opelika, Alabama.
The Tiger Town branch, built in 2017, has approximately 5,500 square feet of space. Prior to relocation, the Bank’s
Opelika Kroger branch was located inside the Kroger supermarket in the Tiger Town retail center in Opelika, Alabama. The
Opelika Kroger branch was originally opened in July 2007. The Tiger Town branch offers the full line of the Bank’s
services and has drive-through windows and an ATM. This branch offers parking for approximately 36 vehicles.
51
In addition to the eight ATMs at various branch locations, mentioned above, the Bank also has four 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 entered into a three year sublease agreement, during
2022, with a tenant, which has an option to renew that lease 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 13, 2024,
there were approximately 3,493,674 shares of the Company’s Common Stock issued and outstanding, which were held by
approximately 343 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
2023
First Quarter
$
$
$
Second Quarter
Third Quarter
Fourth Quarter
2022
First Quarter
$
$
$
Second Quarter
Third Quarter
Fourth Quarter
(1) The price information represents actual transactions.
The Company has paid cash dividends on its capital stock since 1985. Prior to this time, the Bank paid cash dividends since
its organization in 1907, except during the Depression years of 1932 and 1933. Holders of Common Stock are entitled to
receive such dividends when, as and if may be declared by the Company’s Board of Directors. The amount and frequency
of cash dividends is 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.
52
The amount of dividends payable by the Bank is limited by law and regulation. The Company relies upon dividends from
the Bank to pay Company expenses and to pay dividends on Company common stock. The need to maintain adequate
capital and liquidity in the Bank also limits the dividends that may be paid to the Company. The Bank and the Company
can only pay dividends, repurchase stock and pay discretionary bonuses, if our capital conservation buffer exceeds 2.5%
and from our eligible retained income over the last four calendar quarters. 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.
Federal Reserve policy could restrict future dividends on our Common Stock, depending on our earnings and capital
position, risks 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” and “Risk Factors -
Our ability to
continue to pay dividends to shareholders and repurchase stock in the future is subject to our profitability, capital, liquidity
and regulatory requirements and these limitations may prevent or limit future dividends.”
53
Performance Graph
The following performance graph compares the cumulative, total return on the Company’s Common Stock from
December 31, 2018 to December 31, 2023, with that of the Nasdaq Composite Index and S&P U.S. BMI Banks – Southeast
Region Index (assuming a $100 investment on December 31, 2018). 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
12/31/2018
12/31/2019
12/30/2020
12/30/2021
12/31/2022
12/31/2023
Auburn National Bancorporation, Inc.
100.00
171.98
138.22
110.10
81.48
79.19
NASDAQ Composite Index
100.00
136.69
198.10
242.03
163.28
236.17
S&P U.S. BMI Banks - Southeast Region Index
100.00
140.94
126.37
180.49
146.81
151.44
54
Issuer Purchases of Equity Securities
Period
Total Number of
Shares Purchased
Average Price Paid
per Share
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
The Approximate
Dollar Value of Shares
that May Yet Be Under
the Plans or Programs
October 1 – October 31, 2023
––
––
––
4,386,264
November 1 – November 30, 2023
––
––
––
4,386,264
December 1 – December 31, 2023
––
––
––
4,386,264
Total
––
––
––
4,386,264
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, 2023 and 2022 and our results of operations for
the years ended December 31, 2023 and 2022. 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,
Alabama.
55
Summary of Results of Operations
Year ended December 31
(Dollars in thousands, except per share data)
2023
2022
Net interest income (a)
$
26,745
$
27,622
Less: tax-equivalent adjustment
417
456
Net interest income (GAAP)
26,328
27,166
Noninterest income
(2,981)
6,506
Total revenue
23,347
33,672
Provision for credit losses
135
1,000
Noninterest expense
22,594
19,823
Income tax (benefit) expense
(777)
2,503
Net earnings
$
1,395
$
10,346
Basic and diluted net earnings per share
$
0.40
$
2.95
(a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures".
Financial Summary
The Company’s net earnings were $1.4 million for the full year 2023, compared to $10.3 million for the full year 2022.
Basic and diluted net earnings per share were $0.40 per share for the full year 2023, compared to $2.95 per share for the full
year 2022.
Net earnings for 2023 included a loss on sale of securities, while 2022 net earnings included a gain on sale of land and a
one-time payroll tax credit provided by the CARES Act. The after-tax impact of the loss on securities reduced 2023 net
earnings by $4.7 million, while non-routine items in 2022 improved net earnings by $3.6 million. Excluding non-routine
items, net earnings for the full year 2023 would have been $6.1 million, or $1.75 per share, compared to $6.7 million, or
$1.92 per share for the full year 2022.
Net interest income (tax-equivalent) was $26.7 million in 2023, a 3% decrease compared to $27.6 million in 2022. This
decrease was primarily due to a decline in interest earning assets, increased cost of funds and changes in our deposit mix,
which was partially offset by a more favorable asset mix and higher yields on interest earnings assets. The Company’s net
interest margin (tax-equivalent) was 2.89% in 2023, compared to 2.81% in 2022. Average loans for 2023 were $523.8
million, a 15% increase from 2022.
At December 31, 2023, the Company’s allowance for credit losses was $6.9 million, or 1.23% of total loans, compared to
$5.8 million, or 1.14% of total loans, at December 31, 2022. The implementation of CECL required pursuant to
Accounting Standards Codification (“ASC”) 326, which was effective January 1, 2023, increased our allowance for credit
losses by $1.0 million, or 0.20% of total loans, as a day one transition adjustment. For the full year 2023, increases in the
allowance for credit losses due to changes in the composition and balance of loans during 2023 were largely offset by
reductions in the allowance for credit losses due to the resolution of collateral dependent nonperforming loans.
The Company recorded a provision for credit losses of $0.1 million in 2023 compared to $1.0 million during 2022. The
provision for credit losses under CECL is reflective of the Company’s credit risk profile and the future economic outlook
and forecasts. Our CECL model is largely influenced by economic factors including, most notably, the anticipated
unemployment rate. The decrease in provision for credit losses was primarily related to the downgrade of one borrowing
relationship in the fourth quarter of 2022, where one of these loans was repaid in full during the second quarter of 2023.
Noninterest income was a loss of $3.0 million in 2023 compared to income of $6.5 million in 2022. Excluding the pre-tax
securities loss of $6.3 million related to the balance sheet repositioning strategy in 2023, noninterest income would have
been $3.3 million for 2023, compared to noninterest income of $3.3 million in 2022 after excluding the pre-tax gain of $3.2
million on the sale of land.
56
Noninterest expense was $22.6 million in 2023 compared to $19. 8 million in 2022. Excluding the impact of the one-
time payroll tax credit of $1.6 million, noninterest expense would have been $21.4 million in 2022. This increase in
noninterest expense reflects increases in net occupancy and equipment expenses of $0.2 million related to the Company’s
new headquarters, which opened in June 2022, professional fees expense of $0. 3 million, other real estate owned expense
of $0.1 million, FDIC and other regulatory assessments expenses of $0.2 million and other noninterest expense of $0.5
million, partially offset by decreases in salaries and benefits expense of $0.2 million.
The provision for income taxes was a benefit of $0.8 million for an effective tax rate of (125.73)% for 2023, compared to
tax expense of $2.5 million and an effective tax rate of 19.48% for 2022. This decrease was primarily due to a decrease
in pre-tax earnings in 2023 resulting from the balance sheet repositioning. The Company’s effective income tax rate
otherwise is principally affected 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 $1.08 per share in 2023, an increase of 2% from 2022. At December 31, 2023, 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 15.52%, a tier 1 leverage ratio of 9.72% and common equity tier
1 (“CET1”) of 14.52% at December 31, 2023.
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 credit losses, our
determination of credit losses for investment securities, 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. On January 1, 2023, we adopted FASB ASU 2016-13
Financial
Instruments - Credit Losses
(Topic 326) which significantly changes our methodology for determining our allowance for
credit losses, and ASU 2022-02
, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and
Vintage Disclosures
which eliminated the accounting guidance for TDRs, while enhancing disclosure requirements for
certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty.
Allowance for Credit Losses – Loans
The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net
amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the
uncollectability of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously
charged-off and expected to be charged-off. Accrued interest receivable is excluded from the estimate of credit losses.
The allowance for credit losses represents management’s estimate of lifetime credit losses inherent in loans as of the
balance sheet date. The allowance for credit losses is estimated by management using relevant available information, from
both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.
The Company’s loan loss estimation process includes procedures to appropriately consider the unique characteristics of its
loan segments (commercial and industrial, construction and land development, commercial real estate, multifamily,
residential real estate, and consumer loans). These segments are further disaggregated into loan classes, the level at which
credit quality is monitored. See Note 5, Loans and Allowance for Credit Losses, for additional information about our loan
portfolio.
Credit loss assumptions are estimated using a discounted cash flow ("DCF") model for each loan segment, except consumer
loans. The weighted average remaining life method is used to estimate credit loss assumptions for consumer loans.
57
The DCF model calculates an expected life-of-loan loss percentage by considering the forecasted probability that a
borrower will default (the “PD”), adjusted for relevant forecasted macroeconomic factors, and LGD, which is the estimate
of the amount of net loss in the event of default. This model utilizes historical correlations between default experience and
certain macroeconomic factors as determined through a statistical regression analysis. The forecasted Alabama
unemployment rate is considered in the model for commercial and industrial, construction and land development,
commercial real estate, multifamily, and residential real estate loans. In addition, forecasted changes in the Alabama home
price index is considered in the model for construction and land development and residential real estate loans; forecasted
changes in the national commercial real estate (“CRE”) price index is considered in the model for commercial real estate
and multifamily loans; and forecasted changes in the Alabama gross state product is considered in the model for
multifamily loans. Projections of these macroeconomic factors, obtained from an independent third party, are utilized to
forecast quarterly rates of default based on the statistical PD models.
Expected credit losses are estimated over the contractual term of the loan, adjusted for expected prepayments and principal
payments (“curtailments”) when appropriate. Management's determination of the contract term excludes expected
extensions, renewals, and modifications unless the extension or renewal option is included in the contract at the reporting
date and is not unconditionally cancellable by the Company. To the extent the lives of the loans in the portfolio extend
beyond the period for which a reasonable and supportable forecast can be made (which is 4 quarters for the Company), the
Company reverts, on a straight-line basis back to the historical rates over an 8 quarter reversion period.
The weighted average remaining life method was deemed most appropriate for the consumer loan segment because
consumer loans contain many different payment structures, payment streams and collateral. The weighted average
remaining life method uses an annual charge-off rate over several vintages to estimate credit losses. The average annual
charge-off rate is applied to the contractual term adjusted for prepayments.
Additionally, the allowance for credit losses calculation includes subjective adjustments for qualitative risk factors that are
believed likely to cause estimated credit losses to differ from historical experience. These qualitative adjustments may
increase or reduce reserve levels and include adjustments for lending management experience and risk tolerance, loan
review and audit results, asset quality and portfolio trends, loan portfolio growth, industry concentrations, trends in
underlying collateral, external factors and economic conditions not already captured.
Loans that do not share risk characteristics are evaluated on an individual basis. When management determines that
foreclosure is probable and the borrower is experiencing financial difficulty, the expected credit losses are based on the
estimated fair value of collateral held at the reporting date, adjusted for selling costs as appropriate.
Allowance for Credit Losses – Unfunded Commitments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial
letters of credit issued to meet customer financing needs. The Company’s exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the
contractual amount of those instruments. Such financial instruments are recorded when they are funded.
The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to
extend credit are unconditionally cancelable, through a charge to provision for credit losses in the Company’s consolidated
statements of earnings. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment
at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans,
taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for
unfunded commitments is included in other liabilities on the Company’s consolidated balance sheets.
58
Assessment for Allowance for Credit Losses – Available -for-Sale Securities
For any securities classified as available-for-sale that are in an unrealized loss position at the balance sheet date, the
Company assesses whether or not it intends to sell the security, or more likely than not will be required to sell the security,
before recovery of its amortized cost basis. If either of these criteria are met, the security's amortized cost basis is written
down to fair value through net income. If neither criterion is met, the Company evaluates whether any portion of the
decline in fair value is the result of credit deterioration. Such evaluations consider the extent to which the amortized cost of
the security exceeds its fair value, changes in credit ratings and any other known adverse conditions related to the specific
security. If the evaluation indicates that a credit loss exists, an allowance for credit losses is recorded for the amount by
which the amortized cost basis of the security exceeds the present value of cash flows expected to be collected, limited by
the amount by which the amortized cost exceeds fair value. Any impairment not recognized in the allowance for credit
losses is recognized in other comprehensive income.
The Company is required to own certain stock as a condition of membership, such as the FHLB-Atlanta and Federal
Reserve Bank of Atlanta (“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 unaudited 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.
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, 2023 we had total deferred tax assets of $12.5 million
included as “other assets”, including $9.7 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, 2023. The amount of the deferred tax assets considered realizable, however, could
be reduced if estimates of future taxable income are reduced.
59
Average Balance Sheet and Interest Rates
Year ended December 31
2023
2022
Average
Yield/
Average
Yield/
(Dollars in thousands)
Balance
Rate
Balance
Rate
Loans and loans held for sale
$
523,838
4.76%
$
454,604
4.45%
Securities - taxable
335,366
2.15%
364,006
1.81%
Securities - tax-exempt (a)
52,122
3.81%
61,614
3.53%
Total securities
387,488
2.37%
425,620
2.06%
Federal funds sold
5,221
4.79%
43,766
1.00%
Interest bearing bank deposits
8,593
4.92%
58,141
0.99%
Total interest-earning assets
925,140
3.76%
982,131
3.05%
Deposits:
NOW
193,451
0.99%
197,177
0.19%
Savings and money market
289,235
0.74%
327,139
0.20%
Certificates of deposits
175,085
2.25%
154,273
0.84%
Total interest-bearing deposits
657,771
1.21%
678,589
0.34%
Short-term borrowings
3,255
2.21%
4,516
1.33%
Total interest-bearing liabilities
661,026
1.22%
683,105
0.35%
Net interest income and margin (a)
$
26,745
2.89%
$
27,622
2.81%
(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 $26.7 million in 2023, compared to $27.6 million in 2022. This decrease was
primarily due to a decline in interest earning assets and higher costs of funds partially offset by improvements in the
Company’s yield on interest earning assets. Net interest margin (tax-equivalent) increased to 2.89% in 2023, compared to
2.81% in 2022. This increase was primarily due to a more favorable asset mix and higher yields on interest earning assets.
These higher yields on interest earning assets were partially offset by increased cost of funds. During 2023, the cost of
funds increased to 122 basis points, compared to 35 basis points during 2022. Since March of 2022, the Federal Reserve
increased the target federal funds range from 0 – 0.25% to 5.25 – 5.50%.
The tax-equivalent yield on total interest-earning assets increased by 71 basis points to 3.76% in 2023 compared to 3.05%
in 2022. This increase was primarily due to changes in our asset mix and higher market interest rates on interest earning
assets.
The cost of total interest-bearing liabilities increased by 87 basis points to 1.22% in 2023 compared to 0.35% in 2022. Our
deposit costs may continue to increase if the Federal Reserve maintains or increases its target federal funds rate, market
interest rates increase, and as customer behaviors change as a result of inflation and higher market interest rates, and we
compete for deposits against other banks, money market mutual funds , Treasury securities and other interest bearing
alternative investments.
The Company continues to deploy various asset liability management strategies to manage its risk from interest rate
fluctuations. Deposit and loan pricing remains competitive in our markets. We believe this challenging rate environment
will continue in 2024. Our ability to compete and manage our deposits costs until our interest-earning assets reprice and we
generate new fixed rate loans with current market interest rates will be important to our net interest margin during the
monetary tightening cycle that we believe will continue in 2024.
60
Provision for Credit Losses
On January 1, 2023, we adopted ASC 326, which introduces the current expected credit losses (CECL) methodology and
requires us to estimate all expected credit losses over the remaining life of our loans. Accordingly, the provision for credit
losses represents a charge to earnings necessary to establish an allowance for credit losses that, in management's evaluation,
is adequate to provide coverage for all expected credit losses. The Company recorded a provision for credit losses of $0.1
million during 2023, compared to a provision for loan losses of $1.0 million for 2022. Provision for credit losses expense is
affected by organic loan growth in our loan portfolio, our internal assessment of the credit quality of the loan portfolio, our
expectations about future economic conditions and net charge-offs. Our CECL model is largely influenced by economic
factors including, most notably, the anticipated unemployment rate, which may be affected by monetary policy. The
provision for credit losses during 2023 was primarily related to an increase in the calculation of current expected credit
losses due to loan growth during 2023. This was largely offset by the resolution of a collateral dependent nonperforming
loan, with a recorded investment of $1.3 million and a corresponding allowance of $0.5 million, that was collected in full
during the second quarter of 2023.
Our allowance for credit losses reflects an amount we believe appropriate, based on our allowance assessment
methodology, to adequately cover all expected credit losses as of the date the allowance is determined. At December 31,
2023, the Company’s allowance for credit losses was $6.9 million, or 1.23% of total loans, compared to $5.8 million, or
1.14% of total loans, at December 31, 2022. The implementation of CECL, as of January 1, 2023, increased our allowance
for credit losses by $1.0 million, or 0.20% of total loans, as a day one transition adjustment to ASC 326.
Noninterest Income
Year ended December 31
(Dollars in thousands)
2023
2022
Service charges on deposit accounts
$
603
$
598
Mortgage lending
430
650
Bank-owned life insurance
411
317
Gain on sale of premises and equipment
—
3,234
Securities (losses) gains, net
(6,295)
12
Other
1,870
1,695
Total noninterest income
$
(2,981)
$
6,506
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.
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 2023 and 2022.
Year ended December 31
(Dollars in thousands)
2023
2022
Origination income
$
71
$
309
Servicing fees, net
359
341
Total mortgage lending income
$
430
$
650
61
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 and mortgage loan volumes also decreased. The decrease in origination income was partially
offset by an increase in mortgage servicing fees, net of related amortization expense as mortgage prepayment speeds
slowed, resulting in decreased amortization expense.
Income from bank-owned life insurance was $411 thousand and $317 thousand for 2023 and 2022, respectively. Excluding
a $52 thousand non-taxable death benefit received during 2023, income from bank -owned life insurance would have been
$359 thousand and $317 thousand for 2023 and 2022, respectively.
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.
In December 2023, the Company announced it had repositioned its balance sheet by selling approximately $117.6 million,
or 27%, of its available-for-sale securities with a weighted average book yield of 2.11% and a weighted average duration of
4.0 years, resulting in net losses on sale of the securities of approximately $6.3 million. Proceeds of $111.3 million from the
sale of securities were used to repay wholesale funding of $48.0 million with a weighted average cost of 5.38%, while the
remaining amounts were held in cash to fund future loan growth, higher-yielding securities, and other banking operations.
Other noninterest income was $1.9 million and $1.7 million for 2023 and 2022, respectively. The increase in other
noninterest income was primarily related to insurance proceeds of $0.2 million received during 2023 related to property
claims.
Noninterest Expense
Year ended December 31
(Dollars in thousands)
2023
2022
Salaries and benefits
$
12,101
$
12,307
Employee retention credit
—
(1,569)
Net occupancy and equipment
2,954
2,742
Professional fees
1,299
975
FDIC and other regulatory assessments
631
404
Other
5,609
4,964
Total noninterest expense
$
22,594
$
19,823
Salaries and benefits decreased during 2023 compared to 2022. A decrease in the number of full-time equivalents was
partially offset by routine annual increases in salaries and wages.
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 Company’s
new headquarters in downtown Auburn. This amount includes depreciation expense and costs associated with ope rating of
the new headquarters. The Company relocated its main office branch and bank operations into its newly constructed
headquarters during June 2022.
The increase in professional fees expense during 2023 compared to 2022 was primarily related to increased consulting and
audit related fees during 2023.
The increase in FDIC and other regulatory assessments during 2023 compared to 2022 was primarily related to increases in
the FDIC’s initial base deposit insurance assessment rate. On October 18, 2022, the FDIC adopted an amended restoration
plan to increase the likelihood that the reserve ratio would be restored to at least 1.35% by September 30, 2028. The
FDIC’s amended restoration plan increases the initial base deposit insurance assessment rate schedules uniformly by 2 basis
points, which began the first quarterly assessment period of 2023.
62
The increase in other noninterest expense was due to a variety of items including software costs, ATM and checkcard
expenses, impairment related to new market tax credit investment due to remaining tax credit being less than the
Company’s investment, and a gain on sale of other real estate owned that was realized in 2022.
Income Tax Expense
The provision for income taxes was a benefit of $0.8 million for an effective tax rate of (125.73)% for 2023, compared to
tax expense of $2.5 million and an effective tax rate of 19.48% for 2022. This decrease was primarily due to a decrease
in pre-tax earnings in 2023 resulting from the balance sheet repositioning. The Company’s effective income tax rate
otherwise is principally affected 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 $270.9 million at December 31, 2023, compared to $405.3 million at December 31, 2022.
This decrease reflects a decrease in the amortized cost basis of securities available-for-sale of $150.3 million, offset by an
increase of $15.9 million in the fair value of securities available-for-sale. The decrease in the amortized cost basis of
securities available-for-sale was primarily attributable to the sale of $117.6 million securities available-for-sale as part of
the balance sheet repositioning in December 2023 and normal paydowns and maturities on other securities. The increase
in the fair value of securities was primarily due to a decrease in long-term market interest rates at the end of 2023. The
average annualized tax-equivalent yields earned on total securities were 2.37 % in 2023 and 2.06% in 2022.
The following table shows the carrying value and weighted average yield of securities available -for-sale as of December
31, 2023 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, 2023
1 year
1 to 5
5 to 10
After 10
Total
(Dollars in thousands)
or less
years
years
years
Fair Value
Agency obligations
$
331
10,339
43,209
—
53,879
Agency MBS
32
15,109
22,090
161,058
198,289
State and political subdivisions
—
—
9,691
9,051
18,742
Total available-for-sale
$
363
25,448
74,990
170,109
270,910
Weighted average yield (1):
Agency obligations
3.40%
0.99%
1.66%
—
1.54%
Agency MBS
3.47%
1.19%
1.84%
2.20%
2.08%
State and political subdivisions
—
—
1.95%
2.55%
2.23%
Total available-for-sale
3.41%
1.11%
1.75%
2.21%
1.98%
(1) Yields are calculated based on amortized cost.
Loans
December 31
(In thousands)
2023
2022
Commercial and industrial
$
73,374
66,212
Construction and land development
68,329
66,479
Commercial real estate
287,307
264,573
Residential real estate
117,457
97,648
Consumer installment
10,827
9,546
Total loans
557,294
504,458
63
Total loans, net of unearned income, were $557.3 million at December 31, 2023, and $504.5 million at December 31, 2022,
an increase of $52.8 million, or 11%. Four loan categories represented the majority of the loan portfolio at December 31,
2023: commercial real estate (52%), residential real estate (21%), construction and land development (12%), and
commercial and industrial (13%). Approximately 23% of the Company’s commercial real estate loans were classified as
owner-occupied at December 31, 2023.
Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $8.7 million,
or 2%, and $7.4 million, or 1%, of total loans at December 31, 2023 and 2022, respectively. For residential real estate
mortgage loans with a consumer purpose, the Company had no loans that required interest only payments at December 31,
2023 and 2022. 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 4.76% in 2023 and 4.45% in 2022.
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 higher levels of 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 the higher interest rates currently in effect
and which may exist 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, our 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 $22.2 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus
unfunded commitments) to a single borrower of $20.0 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, 2023, the Bank had one
loan relationship exceeding our internal limit.
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, 2023 (and related balances at December 31, 2022).
December 31
(In thousands)
2023
2022
Lessors of 1-4 family residential properties
$
56,912
$
52,278
Multi-family residential properties
45,841
41,084
Hotel/motel
39,131
33,378
Office buildings
30,871
27,074
The Company maintains the allowance for credit losses at a level that management believes appropriate to adequately cover
the Company’s estimate of expected losses in the loan portfolio. The allowance for credit losses was $6.9 million at
December 31, 2023 compared to $5.8 million at December 31, 2022, which management believed to be adequate at each of
the respective dates. The assumptions, judgments and estimates, as well as the methodologies and models associated with
the determination of the allowance for credit losses are described under “Critical Accounting Policies.”
64
On January 1, 2023, we adopted ASC 326, which introduces the current expected credit losses (CECL) methodology and
requires us to estimate all expected credit losses over the remaining life of our loan portfolio. Accordingly, beginning in
2023, the allowance for credit losses represents an amount that, in management's evaluation, is adequate to provide
coverage for all expected future credit losses on outstanding loans. As of December 31, 2023 and December 31, 2022, our
allowance for credit losses was approximately $6.9 million and $5.8 million, respectively, which our management believes
to be adequate at each of the respective dates. Our allowance for credit losses as a percentage of total loans was 1.23% at
December 31, 2023, compared to 1.14% at December 31, 2022.
The increase in the allowance for credit losses is largely the result of the implementation of ASC 326 on January 1, 2023,
which resulted in an adjustment to the opening balance of the allowance for credit losses of $1.0 million. Our CECL models
rely largely on projections of macroeconomic conditions to estimate future credit losses. Macroeconomic factors used in the
model include the Alabama unemployment rate, the Alabama home price index, the national commercial real estate price
index and the Alabama gross state product. Projections of these macroeconomic factors, obtained from an independent third
party, are utilized to predict quarterly rates of default. See Note 5 to our Financial Statements.
Under the CECL methodology the allowance for credit losses is measured on a collective basis for pools of loans with
similar risk characteristics, and for loans that do not share similar risk characteristics with the collectively evaluated pools,
evaluations are performed on an individual basis. Losses are predicted over a period of time determined to be reasonable
and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages.
At December 31, 2023, reasonable and supportable periods of 4 quarters were utilized followed by an 8 quarter straight line
reversion period to long term averages.
A summary of the changes in the allowance for credit losses and certain asset quality ratios for the years ended December
31, 2023 and 2022 are presented below.
Year ended December 31
(Dollars in thousands)
2023
2022
Allowance for credit losses:
Balance at beginning of period
$
5,765
4,939
Impact of adopting ASC 326
1,019
—
Charge-offs:
Commercial and industrial
(164)
(222)
Consumer installment
(105)
(70)
Total charge -offs
(269)
(292)
Recoveries:
Commercial and industrial
204
7
Commercial real estate
—
23
Residential real estate
14
26
Consumer installment
5
62
Total recoveries
223
118
Net charge-offs
(46)
(174)
Provision for credit losses
125
1,000
Ending balance
$
6,863
5,765
as a % of loans
1.23
%
1.14
as a % of nonperforming loans
753
%
211
Net charge-offs as a % of average loans
0.01
%
0.04
Nonperforming Assets
At December 31, 2023 the Company had $0.9 million in nonperforming assets compared to $2.7 million at December 31,
2022. The decrease in nonperforming was primarily related to the resolution of a collateral dependent nonperforming loan
relationship, with a recorded investment of $1.3 million, that was collected in full during the second quarter of 2023.
65
The table below provides information concerning total nonperforming assets and certain asset quality ratios.
December 31
(Dollars in thousands)
2023
2022
Nonperforming assets:
Nonperforming (nonaccrual) loans
$
911
2,731
Total nonperforming assets
$
911
2,731
as a % of loans and other real estate owned
0.16
%
0.54
as a % of total assets
0.09
%
0.27
Nonperforming loans as a % of total loans
0.16
%
0.54
Accruing loans 90 days or more past due
$
—
—
The table below provides information concerning the composition of nonaccrual loans at December 31, 2023 and 2022,
respectively.
December 31
(In thousands)
2023
2022
Nonaccrual loans:
Commercial and industrial
$
—
443
Commercial real estate
783
2,116
Residential real estate
128
172
Total nonaccrual loans
$
911
2,731
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.
There were no loans 90 days past due and still accruing interest at December 31, 2023 and 2022, respectively.
The Company had no OREO at December 31, 2023 and 2022, respectively.
Deposits
December 31
(In thousands)
2023
2022
Noninterest bearing demand
$
270,723
311,371
NOW
190,724
178,641
Money market
148,040
214,298
Savings
88,541
95,652
Certificates of deposit under $250,000
100,572
93,017
Certificates of deposit and other time deposits of $250,000 or more
97,643
57,358
Total deposits
$
896,243
950,337
Total deposits decreased $54.1 million, or 6%, to $896.2 million at December 31, 2023, compared to $950.3 million at
December 31, 2022. During 2023, deposit outflows due to the sale of $59.0 million of reciprocal deposits were partially
offset by net deposit inflows of $4.9 million. The Company had no brokered deposits at December 31, 2023 and 2022. The
Company had no FHLB-Atlanta advances or other wholesale borrowings outstanding at December 31, 2023 and 2022.
Noninterest-bearing deposits were $270.7 million, or 30% of total deposits, at December 31, 2023, compared to $311.4
million, or 33% of total deposits at December 31, 2022. The 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.
The average rates paid on total interest-bearing deposits were 1.21 % in 2023 and 0.34% in 2022.
66
At December 31, 2023, estimated uninsured deposits totaled $356.3 million, or 40% of total deposits, compared to $381.7
million, or 40% of total deposits at December 2022. During 2023, the Bank began participating in the Certificates of
Deposit Account Registry Service (the “CDARS”) and the Insured Cash Sweep product (“ICS”), which provide for
reciprocal (“two-way”) transactions among banks facilitated by IntraFi for the purpose of maximizing FDIC insurance. The
Company had no reciprocal deposits at December 31, 2023. Uninsured amounts are estimated based on the portion of
account balances that exceed FDIC insurance limits. The Bank’s uninsured deposits at December 31, 2023 and 2022
include approximately $206.2 million and $155.0 million, respectively, of deposits of state, county and local governments
that are collateralized by securities having a fair value equal to such deposits. Deposits of state, county and local
governments were 53% and 41% of our estimated uninsured deposits at December 31, 2023 and 2022, respectively.
The FDIC has proposed a special assessment on uninsured deposits of banks with over $5 billion in uninsured deposits to
the FDIC Deposit Insurance Fund’s costs of the systemic risk determination made in connection with two recent bank
failures. This proposal will not apply to AuburnBank.
Other Borrowings
The Company had no long-term debt at December 31, 2023 and 2022. The Bank utilizes short and long-term non-deposit
borrowings from time to time. 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 funds lines totaling
$61.0 million with no federal funds borrowed at December 31, 2023 and 2022, respectively. Securities sold under
agreements to repurchase, which were entered into on behalf of certain customers totaled $1.5 million and $2.6 million at
December 31, 2023 and 2022, respectively. At December 31, 2023 and 2022, the Bank had no borrowings from the
Federal Reserve discount window. The Company did not borrow under the Federal Reserve BTFP during 2023.
The Bank is a member of the FHLB-Atlanta and has borrowed, and may in the future borrow from time to time under the
FHLB-Atlanta’s advance program to obtain funding for its growth. FHLB-Atlanta advances include both fixed and
variable terms and are taken out with varying maturities, and which generally are secured by eligible assets. The Bank had
no borrowings under FHLB-Atlanta’s advance program at December 31, 2023 and 2022, respectively. At those dates, the
Bank had $309.1 million and $312.6 million, respectively, of available lines of credit at the FHLB-Atlanta. Advances
include both fixed and variable terms and may be taken out with varying maturities.
The average rates paid on short-term borrowings were 2.21% and 1.33% in 2023 and 2022, respectively.
CAPITAL ADEQUACY
At December 31, 2023, the Company’s cons olidated stockholders’ equity (book value) was $76.5 million, or $21.90 per
share, compared to $68.0 million, or $19.42 per share, at December 31, 2022. The increase from December 31, 2022 was
primarily driven by net earnings of $1.4 million and other comprehensive income of $11.9 million related to unrealized
gains/losses on securities available-for-sale, net of tax. These increases were partially offset by cash dividends paid of
$3.8 million, a one-time charge of $0.8 million, net of tax, for the cumulative effect to adopt the CECL accounting standard
on January 1, 2023, and $0.2 million in repurchases of the Company’s common stock. Unrealized securities losses do not
affect the Bank’s capital for regulatory capital purposes.
The Company paid cash dividends of $1.08 per share in 2023, an increase of 2% from the same period in 2022. The
Company’s share repurchases of $0.2 million since December 31, 2022 resulted in 10,108 fewer outstanding common
shares at December 31, 2023. These shares were repurchased at an average cost per share of $22.63.
On January 1, 2015, the Company and Bank became subject to the Basel III regulatory capital framework. The rules
included the implementation of a capital conservation buffer of CET1 capital of 2.5% that is added to the minimum
requirements for capital adequacy purposes. A banking organization with a capital conservation buffer of 2.5% or less is
subject to limitations on capital distributions from “eligible retained earnings”, including dividend payments, share
repurchases and certain discretionary bonus payments. At December 31, 2023 and 2022, the Bank had a capital
conservation buffer of 7.52% and 8.25%, respectively.
67
On August 26, 2020, the Federal Reserve and the other federal banking regulators adopted a final rule that amended the
capital conservation buffer. 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. This 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 Small Bank Holding
Company Policy. Accordingly, our capital adequacy is evaluated at the Bank level, and not for the Company and its
consolidated subsidiaries. The Bank’s tier 1 leverage ratio was 9.72%, CET1 risk-based capital ratio was 14.52%, tier 1
risk-based capital ratio was 14.52%, and total risk-based capital ratio was 15.52% at December 31, 2023. 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 7.52% at December 31, 2023.
On July 27, 2023, the Federal Reserve, the Comptroller of the Currency and the FDIC issued a joint notice of proposed
rulemaking to implement the Basel III endgame components. The proposal which is subject to public comment and change
only applies to banks and holding companies with $100 billion or more of assets. The proposal includes provisions dealing
with:
●
Credit risk, which arises from the risk than an obligor fails to perform on an obligation ;
●
Market risk, which results from changes in the value of trading positions;
●
Operational risk, which is the risk of losses resulting from inadequate or failed internal process, people, and
systems, or from external events; and
●
Credit valuation adjustment risk, which results from the risk of losses on certain derivative contracts.
The Basel III endgame regulatory proposals are not applicable to the Company or the Bank.
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 during 2023 and in the first months of 2024. 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.
68
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
interest rates up or down when compared to the baseline net interest income forecast at December 31, 2023.
Changes in Interest Rates
Net Interest Income % Variance
(5.45)
%
(3.85)
(2.32)
(1.03)
(0.57)
(1.33)
(2.12)
(2.95)
At December 31, 2023, our earnings simulation model indicated that we were in compliance with the policy guidelines
noted above.
Economic Value of Equity
Economic value of equity (“EVE”) measures the extent that estimated economic values of our assets, liabilities and off-
balance sheet items will change as a result of interest rate changes. Economic values are estimated by discounting expected
cash flows from assets, liabilities and off-balance sheet items, to which establish a base case EVE. In contrast with our
earnings simulation model which evaluates interest rate risk over a 12-month timeframe, EVE uses a terminal horizon
which allows for the re-pricing of all assets, liabilities, and off-balance sheet items. Further, EVE is measured using values
as of a point in time and does not reflect any actions that ALCO might take in responding to or anticipating changes in
interest rates, or market and competitive conditions.
69
To help limit interest rate risk, we have stated policy guidelines for an instantaneous basis point change in interest rates,
such that our EVE should not decrease from our base case by more than the following:
35% for an instantaneous change of +/- 400 basis points
30% for an instantaneous change of +/- 300 basis points
25% for an instantaneous change of +/- 200 basis points
15% for an instantaneous change of +/- 100 basis points
The following table reports the variance of EVE assuming an immediate change in interest rates up or down when
compared to the baseline EVE at December 31, 2023.
Changes in Interest Rates
EVE % Variance
(20.15)
%
(12.94)
(6.79)
(2.76)
(0.13)
(3.45)
(10.88)
(12.07)
At December 31, 2023, our EVE model indicated that we were in compliance with the policy guidelines noted above.
Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by
changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities
may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest
rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates, and other
economic and market factors, including market perceptions. Interest rates on certain types of assets and liabilities fluctuate
in advance of changes in general market rates, while interest rates on other types of assets and liabilities may lag behind
changes in general market rates. In addition, certain assets, such as adjustable-rate mortgage loans, have features (generally
referred to as “interest rate caps and floors”) which limit changes in interest rates. Prepayment and early withdrawal levels
also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many
borrowers to service their debts also may decrease during periods of rising interest rates or economic stress, which may
differ across industries and economic sectors. ALCO reviews each of the above interest rate sensitivity analyses along with
several different interest rate scenarios in seeking satisfactory, consistent levels of profitability within the framework of the
Company’s established liquidity, loan, investment, borrowing, and capital policies.
The Company may also use derivative financial instruments to improve the balance between interest-sensitive assets and
interest-sensitive liabilities and as one tool to manage interest rate sensitivity while continuing to meet the credit and
deposit needs of our customers. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate
customer transactions and meet their financing needs. These swaps qualify as derivatives, but are not designated as hedging
instruments. At December 31, 2023 and 2022, the Company had no derivative contracts to assist in managing interest rate
sensitivity.
Liquidity Risk Management
Liquidity is the Company’s ability to convert assets into cash equivalents in order to meet daily cash flow requirements,
primarily for deposit withdrawals, loan demand and maturing obligations. Without proper management of its liquidity, the
Company could experience higher costs of obtaining funds due to insufficient liquidity, while excessive liquidity can lead
to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.
70
Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the Bank. The
management of liquidity at both levels is essential, because the Company and the Bank are separate and distinct legal
entities with different funding needs and sources, and each are subject to regulatory guidelines and requirements. The
Company depends upon dividends from the Bank for liquidity to pay its operating expenses, debt obligations and
dividends. The Bank’s payment of dividends depends on its earnings, liquidity, capital and the absence of any regulatory
restrictions.
The primary source of funding and liquidity for the Company has been dividends received from the Bank. The Company
depends upon dividends from the Bank for liquidity to pay its operating expenses, debt obligations, if any, and cash
dividends on, and repurchases of, Company common stock. The Bank’s payment of dividends depends on its earnings,
liquidity, capital and the absence of any regulatory restrictions. If needed, the Company could also issue common stock or
other securities.
Primary sources of funding for the Bank include customer deposits, other borrowings, interest payments on earning assets,
repayment and maturity of securities and loans, sales of securities, and the sale of loans, particularly residential mortgage
loans. Primary uses of funds include repayment of maturing obligations and growing the loan portfolio.
The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window,
although it was not used by the Bank, the Federal Reserve’s BTFP borrowing facility was available to the Bank during
2023. In addition to these sources, the Bank is eligible to participate in the FHLB-Atlanta’s advance program to obtain
funding for growth and liquidity. Advances include both fixed and variable terms and may be taken out with varying
maturities. At December 31, 2023, the Bank had no FHLB-Atlanta advances outstanding and available credit from the
FHLB-Atlanta of $312.6 million. At December 31, 2023, the Bank also had $61.0 million of available federal funds lines
with no borrowings outstanding.
The following table presents additional information about our contractual obligations as of December 31, 2023, which by
their terms had contractual maturity and termination dates subsequent to December 31, 2023:
Payments due by period
1 year
1 to 3
3 to 5
More than
(Dollars in thousands)
Total
or less
years
years
5 years
Contractual obligations:
Deposit maturities (1)
$
896,243
864,461
16,866
14,916
Operating lease obligations
551
123
210
177
41
Total
$
896,794
864,584
17,076
15,093
41
(1) Deposits with no stated maturity (demand, NOW, money market, and savings deposits) are presented in the "1 year or less" column
Management believes that the Company and the Bank have adequate sources of liquidity to meet all known contractual
obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor
requirements over the next 12 months.
Off-Balance Sheet Arrangements
At December 31, 2023, the Bank had outstanding standby letters of credit of $0.6 million and unfunded loan commitments
outstanding of $73.6 million. Because these commitments generally have fixed expiration dates and many will expire
without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to
fund these outstanding commitments, the Bank has the ability to liquidate federal funds sold , obtain FHLB-Atlanta
advances, raise deposits, sell securities available-for-sale, or purchase federal funds from other financial institutions on a
short-term basis while it obtains the other longer-term funding.
71
Residential mortgage lending and servicing activities
We primarily sell conforming residential mortgage loans in the secondary market to Fannie Mae while retaining the
servicing of these loans (MSRs). The sale agreements for these residential mortgage loans with Fannie Mae and other
investors include various representations and warranties regarding the origination and characteristics of the residential
mortgage loans. Although the representations and warranties vary among investors, they typically cover ownership of the
loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan,
compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local
laws, among other matters.
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.
As of December 31, 2023, the unpaid principal balance of residential mortgage loans, which we have originated and sold,
but retained the servicing rights (MSRs) totaled $215.5 million. Although these loans are generally sold on a non-recourse
basis, except for breaches of customary seller representations and warranties, we may have to repurchase residential
mortgage loans in cases where we breach such representations or warranties or the other terms of the sale, such as where we
fail to deliver required documents or the documents we deliver are defective. Investors also may require the repurchase of a
mortgage loan when an early payment default underwriting review reveals significant underwriting deficiencies, even if the
mortgage loan has subsequently been brought current. Repurchase demands are typically reviewed on an individual loan by
loan basis to validate the claims made by the investor and to determine if a contractually required repurchase event has
occurred. We seek to reduce and manage the risks of potential repurchases or other claims by mortgage loan investors
through our underwriting, quality assurance and servicing practices, including good communications with our residential
mortgage investors.
We service all residential mortgage loans originated and sold by us to Fannie Mae. As servicer, our primary duties are to:
(1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain
and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any
required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on
defaulted mortgage loans or take other actions to mitigate the potential losses to investors consistent with the agreements
governing our rights and duties as servicer.
The agreement under which we act as servicer generally specifies our standards of responsibility for actions taken by us in
such capacity and provides protection against expenses and liabilities incurred by us when acting in compliance with the
respective servicing agreements. However, if we commit a material breach of our obligations as servicer, we may be subject
to termination if the breach is not cured within a specified period following notice. The standards governing servicing and
the possible remedies for violations of such standards are determined by servicing guides issued by Fannie Mae as well as
the contract provisions established between Fannie Mae and the Bank. Remedies could include repurchase of an affected
loan.
Although to date repurchase requests related to representation and warranty provisions, and servicing activities have been
limited, it is possible that requests to repurchase mortgage loans may increase in frequency if investors more aggressively
pursue all means of recovering losses on their purchased loans. As of December 31, 2023, we believe that this exposure is
not material due to the historical level of repurchase requests and loss trends, the results of our quality control reviews, and
the fact that 99% of our residential mortgage loans serviced for Fannie Mae were current as of such date. We maintain
ongoing communications with our investors and will continue to evaluate this exposure by monitoring the level and number
of repurchase requests as well as the delinquency rates in our investor portfolios.
The Company was not required to repurchase any loans during 2023 and 2022 as a result of representation and warranty
provisions contained in the Company’s sale agreements with Fannie Mae, and had no pending repurchase or make-whole
requests at December 31, 2023.
72
Effects of Inflation and Changing Prices
The consolidated financial statements and related consolidated financial data presented herein have been prepared in
accordance with GAAP and practices within the banking industry which require the measurement of financial position and
operating results in terms of historical dollars without considering the changes in the relative purchasing power of money
over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution
are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance
than the effects of general levels of inflation.
Inflation can affect our noninterest expenses. It also can affect our customers’ behaviors, and can affect the interest rates we
have to pay on our deposits and other borrowings, and the interest rates we earn on our earning assets. The difference
between our interest expense and interest income is also affected by the shape of the yield curve and the speeds at which
our assets and liabilities, respectively, reprice in response to interest rate changes. The yield curve was inverted on
December 31, 2023, which means shorter term interest rates are higher than longer interest rates. 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 our assets or liabilities are priced with the
same index. Higher market interest rates and sales or maturities of securities held by the Federal Reserve to reduce inflation
generally reduce economic activity and may reduce loan demand and growth. Inflation and related changes in market
interest rates, as the Federal Reserve acts to meet its long term inflation goal of 2%, also can adversely affect the values and
liquidity of our loans and securities, the value of collateral for our loans, and the success of our borrowers and such
borrowers’ available cash to pay interest on and principal of our loans to them.
Inflation is running at levels unseen in decades and, while it has declined during 2023, it remains above the Federal
Reserve’s long term inflation goal of 2% 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. During 2022, the Federal
Reserve increased the target federal funds range from 0 – 0.25% to 4.25 – 4.50%. The target federal funds rate was
increased another 25 basis points on each of January 31, March 7, May 3 and July 26, 2023 to 5.25-5.50%, and further
increases in the target federal funds rate may be made if inflation remains elevated. The Federal Reserve has indicated it
will maintain higher target rates and restrictive monetary policy to meet its 2% inflation rate over the longer term and
maximum employment goals. 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 customers seek higher
market interest rates on deposits and other alternative investments. Monetary efforts to control inflation pursuant to the
Federal Act’s mandate to “promote effectively the goals of maximum employment, stable prices, and moderate long-term
interest rates,” may also affect unemployment which is an important component in our CECL model used to estimate our
allowance for credit losses.
CURRENT ACCOUNTING DEVELOPMENTS
The following ASU has been issued by the FASB but is not yet effective.
●
ASU 2023-02,
Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax
Credit Structures Using the Proportional Amortization Method; and
●
ASU 2023-09,
Income Taxes (Topic 740): Improvements to Income Tax Disclosures.
Information about this pronouncement is described in more detail below.
ASU 2023-02,
Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit
Structures Using the Proportional Amortization Method
, The amendments in this Update permit reporting entities to elect
to account for their tax equity investments, regardless of the tax credit program from which the income tax credits are
received, using the proportional amortization method if certain conditions are met. The new standard is effective for fiscal
years, and interim periods within those fiscal years, beginning after December 15, 2023. The Company does not expect the
new standard to have a material impact on the Company’s consolidated financial statements.
ASU 2023-09,
Income Taxes (Topic 740): Improvements to Income Tax Disclosures
, The amendments in this Update
enhance the transparency and decision usefulness of income tax disclosures. For public business entities, the new standard
is effective for annual periods beginning after December 15, 2024. The Company does not expect the new standard to have
a material impact on the Company’s consolid ated financial statements.
73
Table 1 – Explanation of Non-GAAP Financial Measures
In addition to results presented in accordance with GAAP, this annual report on Form 10-K includes certain designated net
interest income amounts presented on a tax-equivalent basis, a non-GAAP financial measure, including the presentation of
total revenue and the calculation of the efficiency ratio.
The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net
interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the
Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance,
these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliation of these non-
GAAP financial measures from GAAP to non-GAAP is presented below.
Year ended December 31
(In thousands)
2023
2022
2021
2020
2019
Net interest income (GAAP)
$
26,328
27,166
23,990
24,338
26,064
Tax-equivalent adjustment
417
456
470
492
557
Net interest income (Tax-equivalent)
$
26,745
27,622
24,460
24,830
26,621
74
Table 2 - Selected Financial Data
Year ended December 31
(Dollars in thousands, except per share amounts)
2023
2022
2021
2020
2019
Income statement
Tax-equivalent interest income (a)
$
34,791
30,001
26,977
28,686
30,804
Total interest expense
8,046
2,379
2,517
3,856
4,183
Tax equivalent net interest income (a)
26,745
27,622
24,460
24,830
26,621
Provision for credit losses
135
1,000
(600)
1,100
(250)
Total noninterest income
(2,981)
6,506
4,288
5,375
5,494
Total noninterest expense
22,594
19,823
19,433
19,554
19,697
Net earnings before income taxes and
tax-equivalent adjustment
1,035
13,305
9,915
9,551
12,668
Tax-equivalent adjustment
417
456
470
492
557
Income tax expense
(777)
2,503
1,406
1,605
2,370
Net earnings
$
1,395
10,346
8,039
7,454
9,741
Per share data:
Basic and diluted net earnings
$
0.40
2.95
2.27
2.09
2.72
Cash dividends declared
$
1.08
1.06
1.04
1.02
1.00
Weighted average shares outstanding
Basic and diluted
3,498,030
3,510,869
3,545,310
3,566,207
3,581,476
Shares outstanding
3,493,614
3,503,452
3,520,485
3,566,276
3,566,146
Stockholders' equity (book value)
$
21.90
19.42
29.46
30.20
27.57
Common stock price
High
$
24.50
34.49
48.00
63.40
53.90
Low
18.80
22.07
31.32
24.11
30.61
Period-end
$
21.28
23.00
32.30
42.29
53.00
To earnings ratio
53.20
x
7.80
14.23
20.23
19.49
To book value
97
%
118
110
140
192
Performance ratios:
Return on average equity
2.05
%
12.48
7.54
7.12
10.35
Return on average assets
0.14
%
0.96
0.78
0.83
1.18
Dividend payout ratio
270.00
%
35.93
45.81
48.80
36.76
Average equity to average assets
6.66
%
7.72
10.39
11.63
11.39
Asset Quality:
Allowance for credit losses as a % of:
Loans
1.23
%
1.14
1.08
1.22
0.95
Nonperforming loans
753
%
211
1,112
1,052
2,345
Nonperforming assets as a % of:
Loans and other real estate owned
0.16
%
0.54
0.18
0.12
0.04
Total assets
0.09
%
0.27
0.07
0.06
0.02
Nonperforming loans as % of loans
0.16
%
0.54
0.10
0.12
0.04
Net charge-offs (recoveries) as a % of average loans
0.01
%
0.04
0.02
(0.03)
0.03
Capital Adequacy (c):
CET 1 risk-based capital ratio
14.52
%
15.39
16.23
17.27
17.28
Tier 1 risk-based capital ratio
14.52
%
15.39
16.23
17.27
17.28
Total risk-based capital ratio
15.52
%
16.25
17.06
18.31
18.12
Tier 1 leverage ratio
9.72
%
10.01
9.35
10.32
11.23
Other financial data:
Net interest margin (a)
2.89
%
2.81
2.55
2.92
3.43
Effective income tax rate
(125.73)
%
19.48
14.89
17.72
19.57
Efficiency ratio (b)
95.08
%
58.08
67.60
64.74
61.33
Selected period end balances:
Securities
$
270,910
405,304
421,891
335,177
235,902
Loans, net of unearned income
557,294
504,458
458,364
461,700
460,901
Allowance for credit losses
6,863
5,765
4,939
5,618
4,386
Total assets
975,255
1,023,888
1,105,150
956,597
828,570
Total deposits
896,243
950,337
994,243
839,792
724,152
Total stockholders’ equity
76,507
68,041
103,726
107,689
98,328
(a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures".
(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.
(c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank.
75
Table 3 - Average Balance and Net Interest Income Analysis
Year ended December 31
2023
2022
Interest
Interest
Average
Income/
Yield/
Average
Income/
Yield/
(Dollars in thousands)
Balance
Expense
Rate
Balance
Expense
Rate
Interest-earning assets:
Loans and loans held for sale (1)
$
523,838
$
24,925
4.76%
$
454,604
$
20,241
4.45%
Securities - taxable
335,366
7,208
2.15%
364,006
6,576
1.81%
Securities - tax-exempt (2)
52,122
1,985
3.81%
61,614
2,172
3.53%
Total securities
387,488
9,193
2.37%
425,620
8,748
2.06%
Federal funds sold
5,221
250
4.79%
43,766
435
1.00%
Interest bearing bank deposits
8,593
423
4.92%
58,141
577
0.99%
Total interest-earning assets
925,140
34,791
3.76%
982,131
30,001
3.05%
Cash and due from banks
15,230
15,108
Other assets
81,438
77,496
Total assets
$
1,021,808
$
1,074,735
Interest-bearing liabilities:
Deposits:
NOW
$
193,451
1,907
0.99%
$
197,177
370
0.19%
Savings and money market
289,235
2,132
0.74%
327,139
649
0.20%
Certificates of deposits
175,085
3,935
2.25%
154,273
1,300
0.84%
Total interest-bearing deposits
657,771
7,974
1.21%
678,589
2,319
0.34%
Short-term borrowings
3,255
72
2.21%
4,516
60
1.33%
Total interest-bearing liabilities
661,026
8,046
1.22%
683,105
2,379
0.35%
Noninterest-bearing deposits
289,019
306,772
Other liabilities
3,697
1,933
Stockholders' equity
68,066
82,925
Total liabilities and
and stockholders' equity
$
1,021,808
$
1,074,735
Net interest income and margin
$
26,745
2.89%
$
27,622
2.81%
(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included
in the computation of average balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate
of 21%.
76
Table 4 - Volume and Rate Variance Analysis
Year ended December 31, 2023 vs. 2022
Year ended December 31, 2022 vs. 2021
Net
Due to change in
Net
Due to change in
(Dollars in thousands)
Change
Rate (2)
Volume (2)
Change
Rate (2)
Volume (2)
Interest income:
Loans and loans held for sale
$
4,684
1,390
3,294
$
(232)
(5)
(227)
Securities - taxable
632
1,247
(615)
2,469
1,687
782
Securities - tax-exempt (1)
(187)
174
(361)
(70)
(30)
(40)
Total securities
445
1,421
(976)
2,399
1,657
742
Federal funds sold
(185)
1,661
(1,846)
380
329
51
Interest bearing bank deposits
(154)
2,285
(2,439)
477
666
(189)
Total interest income
$
4,790
6,757
(1,967)
$
3,024
2,647
377
Interest expense:
Deposits:
NOW
$
1,537
1,574
(37)
$
158
122
36
Savings and money market
1,483
1,762
(279)
(6)
(66)
60
Certificates of deposits
2,635
2,167
468
(333)
(292)
(41)
Total interest-bearing deposits
5,655
5,503
152
(181)
(236)
55
Short-term borrowings
12
40
(28)
43
8
35
Total interest expense
5,667
5,543
124
(138)
(228)
90
Net interest income
$
(877)
1,214
(2,091)
$
3,162
2,875
287
(1) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income
tax rate of 21%.
(2) Changes that are not solely a result of volume or rate have been allocated to volume.
77
Table 5 - Net Charge-Offs (Recoveries) to Average Loans
2023
2022
Net
Net
Net
(recovery)
Net
charge-off
(recoveries)
Average
charge-off
charge-offs
Average
(recovery)
(Dollars in thousands)
charge-off
Loans (2)
ratio
(recoveries)
Loans (2)
ratio
Commercial and industrial (1)
$
(40)
64,565
(0.06)
%
$
215
69,973
0.31
%
Construction and land development
—
66,492
—
—
44,177
—
Commercial real estate
—
274,779
—
(23)
247,374
(0.01)
Residential real estate
(14)
108,891
(0.01)
(26)
85,223
(0.03)
Consumer installment
100
9,638
1.04
8
7,915
0.10
Total
$
46
524,365
0.01
%
$
174
454,662
0.04
%
(1) Excludes PPP loans, which are guaranteed by the SBA.
(2) Gross loan balances.
78
Table 6 - Loan Maturities
December 31, 2023
1 year
1 to 5
5 to 15
After 15
(Dollars in thousands)
or less
years
years
years
Total
Commercial and industrial
$
15,455
22,999
33,269
1,651
73,374
Construction and land development
37,684
27,105
3,540
68,329
Commercial real estate
23,139
111,988
148,200
3,980
287,307
Residential real estate
5,250
24,880
37,391
49,936
117,457
Consumer installment
4,159
5,536
1,132
—
10,827
Total loans
$
85,687
192,508
223,532
55,567
557,294
79
Table 7 - Sensitivities to Changes in Interest Rates on Loans Maturing in More Than One Year
December 31, 2023
Variable
Fixed
(Dollars in thousands)
Rate
Rate
Total
Commercial and industrial
$
84
57,835
57,919
Construction and land development
6,548
24,097
30,645
Commercial real estate
161
264,007
264,168
Residential real estate
49,561
62,646
112,207
Consumer installment
135
6,533
6,668
Total loans
$
56,489
415,118
471,607
80
Table 8 - Allocation of Allowance for Credit Losses
2023
2022
(Dollars in thousands)
Amount
%*
Amount
%*
Commercial and industrial
$
1,288
13.2
$
747
13.1
Construction and land development
960
12.3
949
13.2
Commercial real estate
3,921
51.5
3,109
52.4
Residential real estate
546
21.1
828
19.4
Consumer installment
148
1.9
132
1.9
Total allowance for credit losses
$
6,863
$
5,765
* Loan balance in each category expressed as a percentage of total loans.
81
Table 9 - Estimated Uninsured Time Deposits by Maturity
(Dollars in thousands)
December 31, 2023
Maturity of:
3 months or less
$
12,503
Over 3 months through 6 months
21,940
Over 6 months through 12 months
50,384
Over 12 months
12,816
Total estimated uninsured time deposits
$
97,643
82
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by ITEM 7A is set forth in ITEM 7 under the caption “Market and Liquidity Risk Management”
and is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index
Page
)
91
83
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
Auburn National Bancorporation, Inc. and Subsidiary
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Auburn National Bancorporation, Inc. and
Subsidiary (the “Company”) as of December 31, 2023 and 2022, the related consolidated statements of earnings,
comprehensive income, stockholders’ equity and cash flows for the years then ended, and the related notes to
the consolidated financial statements (collectively, the “financial statements”). In our opinion, the financial
statements present fairly, in all material respects, the financial position of the Company as of December 31,
2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for credit
losses effective January 1, 2023, due to the adoption of Financial Accounting Standards Board Accounting
Standards Codification No. 326
, Financial Instruments – Credit Losses (ASC 326).
new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted
and continue to be reported in accordance with the previously applicable generally accepted accounting
principles. The adoption of the new credit loss standard and its subsequent applications is also communicated as
a critical audit matter below.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express
an opinion on the Company’s financial statements based on our audits. We are a public accounting firm
registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to
be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable
rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to
perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain
an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on
the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such
opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial
statements, whether due to error or fraud, and performing procedures that respond to those risks. Such
procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial statements. We believe that our
audits provide a reasonable basis for our opinion.
84
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial
statements that were communicated or required to be communicated to the audit committee and that: (1) relate
to accounts or disclosures that are material to the financial statements and (2) involved our especially
challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any
way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical
audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to
which they relate.
Allowance for Credit Losses
As described in Note 5 to the Company’s consolidated financial statements, the Company has a gross loan
portfolio of $557.3 million and related allowance for credit losses of $6.9 million as of December 31, 2023. As
described by the Company in Note 1, the allowance for credit losses is estimated by management using relevant
available information, from both internal and external sources, relating to past events, current conditions, and
reasonable and supportable forecasts. The Company’s credit loss assumptions are estimated using a discounted
cash flow ("DCF") model for each loan segment, except consumer loans. The weighted average remaining life
method is used to estimate credit loss assumptions for consumer loans. The DCF model calculates an expected
life-of-loan loss percentage by considering the forecasted probability that a borrower will default (the “PD”),
adjusted for relevant forecasted macroeconomic factors, and loss given default (“LGD”), which is the estimate
of the amount of net loss in the event of default. This model utilizes historical correlations between default
experience and certain macroeconomic factors as determined through a statistical regression analysis.
Projections of macroeconomic factors are obtained from an independent third party and are utilized to predict
quarterly rates of default based on the statistical PD models. The weighted average remaining life method uses
an annual charge-off rate over several vintages to estimate credit losses. Additionally, the allowance for credit
losses calculation includes subjective adjustments for qualitative risk factors that are believed likely to cause
estimated credit losses to differ from historical experience.
We identified the Company’s estimate of the allowance for credit losses (“ACL”) as a critical audit matter. The
principal considerations for our determination of the allowance for credit losses as a critical audit matter related
to the high degree of subjectivity in the Company’s judgments in determining the macroeconomic data in the
reasonable and supportable forecasts, as well as the qualitative factors. Auditing these complex judgments and
assumptions by the Company involves especially challenging auditor judgment due to the nature and extent of
audit evidence and effort required to address these matters, including the extent of specialized skill or
knowledge needed.
The primary procedures we performed to address this critical audit matter included the following:
●
We obtained an understanding of the Company’s process for establishing the ACL, including the
selection and application of forecasts and the basis for development and related adjustments of the
qualitative factor components of the ACL.
●
We evaluated the design and tested the operating effectiveness of controls relating to management’s
determination of the ACL, including controls over:
o
Management’s process for selection of forecasts and the basis for development of qualitative
factors of the ACL.
o
Management’s review of reliability and accuracy of data used to calculate and estimate the
various components of the ACL, including accuracy of the calculation and validation
procedures.
o
Management’s process to review the reasonableness of the forecasts and the qualitative factors,
including any adjustments.
85
●
We evaluated the reasonableness of management’s application of qualitative factor adjustments to the
ACL, including the comparison of factors considered by management to third party or internal sources
as well as evaluated the appropriateness and level of the qualitative factor adjustments.
●
We assessed the overall trends in credit quality, including adjustments for the qualitative factors by
comparing the overall allowance for credit losses to those recorded by the Company’s peer institutions.
●
We evaluated subsequent events and transactions and considered whether they corroborated or
contradicted the Company’s conclusion.
/s/
We have served as the Company's auditor since 2015.
March 14, 2024
86
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31
(Dollars in thousands, except share data)
2023
2022
Assets:
Cash and due from banks
$
$
Federal funds sold
Interest bearing bank deposits
Cash and cash equivalents
Securities available-for-sale
Loans, net of unearned income
Allowance for credit losses
(6,863 )
(5,765 )
Loans, net
Premises and equipment, net
Bank-owned life insurance
Other assets
Total assets
$
$
Liabilities:
Deposits:
Noninterest-bearing
$
$
Interest-bearing
Total deposits
Federal funds purchased and securities sold under agreements to repurchase
Accrued expenses and other liabilities
Total liabilities
Stockholders' equity:
Preferred stock of $
issued shares - none
Common stock of $
issued
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss, net
(29,029 )
(40,920 )
Less treasury stock, at cost -
at December 31, 2023 and 2022, respectively
(11,702 )
(11,475 )
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
$
See accompanying notes to consolidated financial statements
87
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
Year ended December 31
(Dollars in thousands, except share and per share data)
2023
2022
Interest income:
Loans, including fees
$
$
Securities:
Taxable
Tax-exempt
Federal funds sold and interest bearing bank deposits
Total interest income
Interest expense:
Deposits
Short-term borrowings
Total interest expense
Net interest income
Provision for credit losses
Net interest income after provision for credit losses
Noninterest income:
Service charges on deposit accounts
Mortgage lending
Bank-owned life insurance
Gain on sale of premises and equipment
—
Other
Securities (losses) gains, net
(6,295 )
Total noninterest income
(2,981 )
Noninterest expense:
Salaries and benefits
Employee retention credit
(1,569 )
Net occupancy and equipment
Professional fees
FDIC and other regulatory assessments
Other
Total noninterest expense
Earnings before income taxes
Income tax (benefit) expense
(777 )
Net earnings
$
$
Net earnings per share:
Basic and diluted
$
$
Weighted average shares outstanding:
Basic and diluted
See accompanying notes to consolidated financial statements
88
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Year ended December 31
(Dollars in thousands)
2023
2022
Net earnings
$
$
Other comprehensive gain (loss), net of tax:
Unrealized net holding gain (loss) on securities
(41,802 )
Reclassification adjustment for net loss (gain) on securities
recognized in net earnings
(9 )
Other comprehensive income (loss)
(41,811 )
Comprehensive income (loss)
$
$
(31,465 )
See accompanying notes to consolidated financial statements
89
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
Accumulated
Common
Additional
other
Shares
Common
paid-in
Retained
comprehensive
Treasury
(Dollars in thousands, except share data)
Outstanding
Stock
capital
earnings
(loss) income
stock
Total
Balance, December 31, 2021
$
(10,972 )
$
Net earnings
—
Other comprehensive loss
—
(41,811 )
(41,811 )
Cash dividends paid ($
—
(3,720 )
(3,720 )
Stock repurchases
(17,183 )
(504 )
(504 )
Sale of treasury stock
Balance, December 31, 2022
$
$
$
$
(40,920 )
$
(11,475 )
$
Cumulative effect of change in
accounting standard
—
(821 )
(821 )
Net earnings
—
Other comprehensive income
—
Cash dividends paid ($
—
(3,776 )
(3,776 )
Stock repurchases
(10,108 )
(229 )
(229 )
Sale of treasury stock
Balance, December 31, 2023
$
$
$
$
(29,029 )
$
(11,702 )
$
See accompanying notes to consolidated financial statements
90
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year ended December 31
(In thousands)
2023
2022
Cash flows from operating activities:
Net earnings
$
$
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Provision for credit losses
Depreciation and amortization
Premium amortization and discount accretion, net
Deferred tax (benefit) expense
(195 )
Net loss (gain) on securities available for sale
(12 )
Net gain on sale of loans held for sale
(71 )
(309 )
Net gain on other real estate owned
(162 )
Loans originated for sale
(4,141 )
(8,850 )
Proceeds from sale of loans
Net loss (gain) on disposition of premises and equipment
—
(3,234)
Decrease (increase) in cash surrender value of bank owned life insurance
(359 )
(317 )
Income recognized from death benefit on bank-owned life insurance
(52 )
Net decrease (increase) in other assets
(2,441 )
Net decrease in accrued expenses and other liabilities
(2,011 )
(770 )
Net cash provided by operating activities
$
$
Cash flows from investing activities:
Proceeds from sales of securities available-for-sale
Proceeds from maturities, paydowns and calls of securities available-for-sale
Purchase of securities available-for-sale
(93,106 )
Increase in loans, net
(52,892 )
(46,268 )
Net purchases of premises and equipment
(418 )
(7,049 )
Increase in FHLB stock
(164 )
(74 )
Proceeds from bank-owned life insurance death benefit
Proceeds from surrender of bank-owned like insurance death benefit
Proceeds from sale of premises and equipment
—
Proceeds from sale of other real estate owned
—
Net cash provided by (used in) investing activities
$
$
(90,958 )
Cash flows from financing activities:
Net decrease in noninterest-bearing deposits
(40,648 )
(4,761 )
Net decrease in interest-bearing deposits
(13,446 )
(39,145 )
Net decrease in federal funds purchased and securities sold
under agreements to repurchase
(1,065 )
(897 )
Stock repurchases
(229 )
(504 )
Dividends paid
(3,776 )
(3,720 )
Net cash used in financing activities
$
(59,164 )
$
(49,027 )
Net change in cash and cash equivalents
$
$
(129,005 )
Cash and cash equivalents at beginning of period
27,254
Cash and cash equivalents at end of period
$
$
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest
$
$
Income taxes
See accompanying notes to consolidated financial statements
91
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company whose primary business is conducted
by its wholly-owned subsidiary, AuburnBank (the “Bank”). AuburnBank is a commercial bank located in Auburn,
Alabama. The Bank provides a full range of banking services in its primary market area, Lee County, which includes the
Auburn-Opelika Metropolitan Statistical Area.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which are
managed as a single business segment. Significant intercompany transactions and accounts are eliminated in consolidation.
Revenue Recognition
The Company’s sources of income that fall within the scope of ASC 606 include service charges on deposits, investment
services, interchange fees and gains and losses on sales of other real estate, all of which are presented as components of
noninterest income. The following is a summary of the revenue streams that fall within the scope of ASC 606:
Service charges on deposits, investment services, ATM and interchange fees – Fees from these services are either
transaction-based, for which the performance obligations are satisfied when the individual transaction is processed, or set
periodic service charges, for which the performance obligations are satisfied over the period the service is provided.
Transaction-based fees are recognized at the time the transaction is processed, and periodic service charges are recognized
over the service period.
Gains on sales of other real estate
A gain on sale should be recognized when a contract for sale exists and control of the
asset has been transferred to the buyer. ASC 606 lists several criteria required to conclude that a contract for sale exists,
including a determination that the institution will collect substantially all of the consideration to which it is entitled. In
addition to the loan-to-value, the analysis is based on various other factors, including the credit quality of the borrower, the
structure of the loan, and any other factors that may affect collectability.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities as of the balance sheet date and the reported amounts of income and expense during the
reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to
significant change in the near term include the determination of the allowance for credit losses, fair value measurements,
valuation of other real estate owned, and valuation of deferred tax assets.
Reclassifications
Certain amounts reported in the prior period have been reclassified to conform to the current -period presentation. These
reclassifications had no impact on the Company’s previously reported net earnings or total stockholders’ equity.
Subsequent Events
The Company has evaluated the effects of events or transactions through the date of this filing that have occurred
subsequent to December 31, 2023. The Company does not believe there are any material subsequent events that would
require further recognition or disclosure.
92
Accounting Standards Adopted in 2023
On January 1, 2023, the Company adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326):
with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. CECL
requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience,
current conditions, and reasonable and supportable forecasts and generally applies to financial assets measured at amortized
cost, including loan receivables and held-to-maturity debt securities, and some off -balance sheet credit exposures such as
unfunded commitments to extend credit. Financial assets measured at amortized cost will be presented at the net amount
expected to be collected by using an allowance for credit losses.
In addition, CECL made changes to the accounting for available for sale debt securities. One such change is to require
credit losses to be presented as an allowance rather than as a write-down on available for sale debt securities if management
does not intend to sell and does not believe that it is more likely than not, they will be required to sell.
The Company adopted ASC 326 and all related subsequent amendments thereto effective January 1, 2023 using the
modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit
exposures.The transition adjustment upon the adoption of CECL on January 1, 2023 included an increase in the allowance
for credit losses on loans of $
allowance for credit losses on unfunded loan commitments of $
Company recorded a net decrease to retained earnings of $
adopting CECL, which reflects the transition adjustments noted above, net of the applicable deferred tax assets recorded.
Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts
continue to be reported in accordance with previously applicable accounting standards.
The Company adopted ASC 326 using the prospective transition approach for debt securities for which other-than-
temporary impairment had been recognized prior to January 1, 2023. As of December 31, 2022, the Company did not have
any other-than-temporarily impaired investment securities. Therefore, upon adoption of ASC 326, the Company determined
that an allowance for credit losses on available for sale securities was not deemed material.
The Company elected not to measure an allowance for credit losses for accrued interest recei vable and instead elected to
reverse interest income on loans or securities that are placed on nonaccrual status, which is generally when the instrument is
90 days past due, or earlier if the Company believes the collection of interest is doubtful. The Company has concluded that
this policy results in the timely reversal of uncollectible interest.
The Company also adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt
Restructurings and Vintage Disclosures” on January 1, 2023, the effective date of the guidance, on a prospective basis.
ASU 2022-02 eliminated the accounting guidance for TDRs, while enhancing disclosure requirements for certain loan
refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Specifically, rather than
applying the recognition and measurement guidance for TDRs, an entity must apply the loan refinancing and restructuring
guidance to determine whether a modification results in a new loan or a continuation of an existing loan. Additionally,
ASU 2022-02 requires an entity to disclose current-period gross write-offs by year of origination for financing receivables
within the scope of Subtopic 326-20, Financial Instruments—Credit Losses—Measured at Amortized Cost. ASU 2022-02
did not have a material impact on the Company’s consolidated financial statements.
Issued not yet effective accounting standards
ASU 2023-02,
Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit
Structures Using the Proportional Amortization Method
, The amendments in this Update permit reporting entities to elect
to account for their tax equity investments, regardless of the tax credit program from which the income tax credits are
received, using the proportional amortization method if certain conditions are met. The new standard is effective for fiscal
years, and interim periods within those fiscal years, beginning after December 15, 2023. The Company does not expect the
new standard to have a material impact on the Company’s consolidated financial statements.
ASU 2023-09,
Income Taxes (Topic 740): Improvements to Income Tax Disclosures
, The amendments in this Update
enhance the transparency and decision usefulness of income tax disclosures. For public business entities, the new standard
is effective for annual periods beginning after December 15, 2024. The Company does not expect the new standard to have
a material impact on the Company’s consolidated financial statements.
93
Cash Equivalents
Cash equivalents include cash on hand, cash items in process of collection, amounts due from banks, including interest
bearing deposits with other banks, and federal funds sold.
Securities
Securities are classified based on management’s intention at the date of purchase. At December 31, 2023, all of the
Company’s securities were classified as available-for-sale. Securities available-for-sale are used as part of the Company’s
interest rate risk and liquidity management strategy, and they may be sold in response to changes in interest rates, changes
in prepayment risks or other factors. All securities classified as available-for-sale are recorded at fair value with any
unrealized gains and losses reported in accumulated other comprehensive income (loss), net of the deferred income tax
effects. Interest and dividends on securities, including the amortization of premiums and accretion of discounts are
recognized in interest income using the effective interest method. Premiums are amortized to the earliest call date while
discounts are accreted over the estimated life of the security. Realized gains and losses from the sale of securities are
determined using the specific identification method.
For any securities classified as available-for-sale that are in an unrealized loss position at the balance sheet date, the
Company assesses whether or not it intends to sell the security, or more likely than not will be required to sell the security,
before recovery of its amortized cost basis. If either of these criteria are met, the security's amortized cost basis is written
down to fair value through net income. If neither criterion is met, the Company evaluates whether any portion of the decline
in fair value is the result of credit deterioration. Such evaluations consider the extent to which the amortized cost of the
security exceeds its fair value, changes in credit ratings and any other known adverse conditions related to the specific
security. If the evaluation indicates that a credit loss exists, an allowance for credit losses is recorded for the amount by
which the amortized cost basis of the security exceeds the present value of cash flows expected to be collected, limited by
the amount by which the amortized cost exceeds fair value. Any impairment not recognized in the allowance for credit
losses is recognized in other comprehensive income.
Loans held for sale
The Company originates residential mortgage loans for sale. Such loans are carried at the lower of cost or estimated fair
value in the aggregate. Loan sales are recognized when the transaction closes, the proceeds are collected, and ownership is
transferred. Continuing involvement, through the sales agreement, consists of the right to service the loan for a fee for the
life of the loan, if applicable. Gains on the sale of loans held for sale are recorded net of related costs, such as
commissions, and reflected as a component of mortgage lending income in the consolidated statements of earnings.
The Bank makes various representations and warranties to the purchaser of the residential mortgage loans they originated
and sells, primarily to Fannie Mae. Every loan closed by the Bank’s mortgage center is run through Fannie Mea or other
purchasing government sponsored enterprise (“GSE”) automated underwriting system. Any exceptions noted during this
process are remedied prior to sale. These representations and warranties also apply to underwriting the real estate appraisal
opinion of value for the collateral securing these loans. Failure by the Company to comply with the underwriting and/or
appraisal standards could result in the Company being required to repurchase the mortgage loan or to reimburse the investor
for losses incurred (make whole requests) if the Company cannot cure such failure within the specified period following
discovery.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported
at amortized cost. Amortized cost is the principal balance outstanding, net of purchase premiums and discounts and
deferred fees and costs. Accrued interest receivable related to loans is recorded in other assets on the consolidated balance
sheets. Interest income is accrued on the unpaid principal balance.
Loan origination fees, net of certain direct origination
costs, are deferred and recognized in interest income using methods that approximate a level yield without anticipating
prepayments.
The accrual of interest is generally discontinued when a loan becomes 90 days past due and is not well collateralized and in
the process of collection, or when management believes, after considering economic and business conditions and collection
efforts, that the principal or interest will not be collectible in the normal course of business. Past due status is based on
contractual terms of the loan. A loan is considered to be past due when a scheduled payment has not been received 30 days
after the contractual due date.
94
All accrued but unpaid interest is reversed against interest income when a loan is placed on nonaccrual status. Interest
received on such loans is accounted for using the cost-recovery method, until the loan qualifies for return to accrual. Loans
are returned to accrual status when all the principal and interest amounts contractually due are brought current, there is a
sustained period of repayment performance, and future payments are reasonably assured. Otherwise, under the cost
recovery method, interest income is not recognized until the loan balance is reduced to zero.
Allowance for Credit Losses – Loans
The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net
amount expected to be collected on the loans. Loans are charged off against the allowance when management confirms the
loan balance is uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged -off and
expected to be charged-off. Accrued interest receivable is excluded from the estimate of credit losses.
The allowance for credit losses represents management’s estimate of lifetime credit losses inherent in loans as of the
balance sheet date. The allowance for credit losses is estimated by management using relevant available information, from
both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.
The Company’s loan loss estimation process includes procedures to appropriately consider the unique characteristics of its
respective loan segments (commercial and industrial, construction and land development, commercial real estate,
residential real estate, and consumer loans). These segments are further disaggregated into loan classes, the level at which
credit quality is monitored. See Note 5, Loans and Allowance for Credit Losses, for additional information about our loan
portfolio.
Credit loss assumptions are estimated using a discounted cash flow ("DCF") model for each loan segment, except consumer
loans. The weighted average remaining life method is used to estimate credit loss assumptions for consumer loans.
The DCF model calculates an expected life-of-loan loss percentage by considering the forecasted probability that a
borrower will default (the “PD”), adjusted for relevant forecasted macroeconomic factors, and loss given default (“LGD”),
which is the estimate of the amount of net loss in the event of default. This model utilizes historical correlations between
default experience and certain macroeconomic factors as determined through a statistical regression analysis. The
forecasted Alabama unemployment rate is considered in the model for commercial and industrial, construction and land
development, commercial real estate, and residential real estate loans. In addition, forecasted changes in the Alabama
home price index is considered in the model for construction and land development and residential real estate loans.
Forecasted changes in the national commercial real estate (“CRE”) price index is considered in the model for commercial
real estate and multifamily loans; and forecasted changes in the Alabama gross state product is considered in the model for
multifamily loans. Projections of these macroeconomic factors, obtained from an independent third party, are utilized to
predict quarterly rates of default based on the statistical PD models.
Expected credit losses are estimated over the contractual term of the loan, adjusted for expected prepayments and principal
payments (“curtailments”) when appropriate. Management's determination of the contract term excludes expected
extensions, renewals, and modifications unless the extension or renewal option is included in the contract at the reporting
date and is not unconditionally cancellable by the Company. To the extent the lives of the loans in the portfolio extend
beyond the period for which a reasonable and supportable forecast can be made (which is 4 quarters for the Company), the
Company reverts, on a straight-line basis back to the historical rates over an 8 quarter reversion period.
The weighted average remaining life method was deemed most appropriate for the consumer loan segment because
consumer loans contain many different payment structures, payment streams and collateral. The weighted average
remaining life method uses an annual charge-off rate over several vintages to estimate credit losses. The average annual
charge-off rate is applied to the contractual term adjusted for prepayments.
Additionally, the allowance for credit losses calculation includes subjective adjustments for qualitative risk factors that are
believed likely to cause estimated credit losses to differ from historical experience. These qualitative adjustments may
increase reserve levels and include adjustments for lending management experience and risk tolerance, loan review and
audit results, asset quality and portfolio trends, loan portfolio growth, industry concentrations, trends in underlying
collateral, external factors and economic conditions not already captured.
95
Loans secured by real estate with balances equal to or greater than $500 thousand and loans not secured by real estate with
balances equal to or greater than $250 thousand that do not share risk characteristics are evaluated on an individual basis.
When management determines that foreclosure is probable and the borrower is experiencing financial difficulty, the
expected credit losses are based on the estimated fair value of collateral held at the reporting date, adjusted for selling costs
as appropriate.
Allowance for Credit Losses – Unfunded Commitments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial
letters of credit issued to meet customer financing needs. The Company’s exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the
contractual amount of those instruments. Such financial instruments are recorded when they are funded.
The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to
extend credit are unconditionally cancelable, through a charge to provision for credit losses in the Company’s consolidated
statements of earnings. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment
at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans,
taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for
unfunded commitments is included in other liabilities on the Company’s consolidated balance sheets.
On January 1, 2023, the Company recorded an adjustment for unfunded commitments of $77 thousand upon the adoption of
ASC 326. At December 31, 2023, the liability for credit losses on off-balance-sheet credit exposures included in other
liabilities was $
Provision for Credit Losses
The composition of the provision for credit losses for the respective periods is presented below.
Years ended December 31,
(Dollars in thousands)
2023
2022
Provision for credit losses:
Loans
$
$
Unfunded commitments (1)
Total provision for credit losses
$
$
(1)
Reserve requirements for unfunded commitments were reported as a component of other noninterest expense prior
to the adoption of ASC 326.
Premises and Equipment
Land is carried at cost. Land improvements, buildings and improvements, and furniture, fixtures, and equipment are carried
at cost, less accumulated depreciation computed on a straight-line method over the estimated useful lives of the assets or the
expected terms of the leases, if shorter. Expected terms include lease option periods to the extent that the exercise of such
options is reasonably assured.
96
Nonmarketable equity investments
Nonmarketable equity investments include equity securities that are not publicly traded and securities acquired for various
purposes. The Bank is required to maintain certain minimum levels of equity investments in (i) Federal Reserve Bank of
Atlanta based on the Bank’s capital stock and surplus, and the (ii) Federal Home Bank of Atlanta (“FHLB – Atlanta”)
based on various factors including, the Bank’s total assets, its borrowings and outstanding letters of credit from the FHLB -
Atlanta and its “acquired member asset” sales to FHLB - Atlanta. These nonmarketable equity securities are accounted for
at cost which equals par or redemption value. These securities do not have a readily determinable fair value as their
ownership is restricted and there is no market for these securities. These securities can only be redeemed or sold at their par
value by the respective issuer bank or, in the case of FHLB – Atlanta stock upon FHLB – Atlanta approval sale to another
member of FHLB – Atlanta and law applicable to the member. The Company records these nonmarketable equity securities
as a component of other assets, which are periodically evaluated for impairment. Management considers these
nonmarketable equity securities to be long-term investments. Accordingly, when evaluating these securities for impairment,
management considers the ultimate recoverability of the par value rather than by recognizing temporary declines in value.
Transfers of Financial Assets
Transfers of an entire financial asset (i.e. loan sales), a group of entire financial assets, or a participating interest in an entire
financial asset (i.e. loan participations sold) are accounted for as sales when control over the assets have been surrendered.
Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company,
(2) the transferee obtains the right (free of conditions that constrain it from taking that right) to pledge or exchange the
transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an
agreement to repurchase them before their maturity.
Mortgage Servicings Rights
The Company recognizes as assets the rights to service mortgage loans which it originates and sells to others, principally
Fannie Mae. These servicing rights are called “MSRs”. The Company determines the fair value of MSRs on sold loans at
the date the loan is transferred. An estimate of the Company’s MSRs is determined using assumptions that market
participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate,
default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees.
Subsequent to the date of sale of the residential mortgage loans, the Company has elected to measure its MSRs on such sold
mortgage loans under the amortization method. Under the amortization method, MSRs are amortized in proportion to, and
over the period of, estimated net servicing income. The amortization of MSRs is analyzed monthly and is adjusted to
reflect changes in prepayment speeds, as well as other factors. MSRs are evaluated for impairment based on the fair value
of those assets. Impairment is determined by stratifying MSRs into groupings based on predominant risk characteristics,
such as interest rate and loan type. If, by individual stratum, the carrying amount of the MSRs exceeds fair value, a
valuation allowance is established through a charge to earnings. The valuation allowance is adjusted as the fair value
changes. MSRs are included in the other assets category in the accompanying consolidated balance sheets at the lower of
cost or fair value.
See Note 14 “Fair Value”
Securities sold under agreements to repurchase
Securities sold under agreements to repurchase generally mature less than one year from the transaction date. Securities
sold under agreements to repurchase are reflected as a secured borrowing in the accompanying consolidated balance sheets
at the amount of cash received in connection with each transaction.
Income Taxes
Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying
amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces
deferred tax assets to the amount expected to be realized. The net deferred tax asset is reflected as a component of other
assets in the accompanying consolidated balance sheets.
97
Income tax expense or benefit for the year is allocated among continuing operations and other comprehensive income
(loss), as applicable. The amount allocated to continuing operations is the income tax effect of the pretax income or loss
from continuing operations that occurred during the year, plus or minus income tax effects of (1) changes in certain
circumstances that cause a change in judgment about the realization of deferred tax assets in future years, (2) changes in
income tax laws or rates, and (3) changes in income tax status, subject to certain exceptions. The amount allocated to other
comprehensive income (loss) is related solely to changes in the valuation allowance on items that are normally accounted
for in other comprehensive income (loss) such as unrealized gains or losses on available -for-sale securities.
In accordance with ASC 740,
Income Taxes
, a tax position is recognized as a benefit only if it is “more likely than not” that
the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount
recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax
positions not meeting the “more likely than not” test, no tax benefit is recorded. It is the Company’s policy to recognize
interest and penalties related to income tax matters in income tax expense. The Company and its wholly-owned subsidiaries
file consolidated Federal and State of Alabama income tax returns.
Fair Value Measurements
ASC 820,
Fair Value Measurements,
which defines fair value, establishes a framework for measuring fair value in U.S.
generally accepted accounting principles and expands disclosures about fair value measurements. ASC 820 applies only to
fair-value measurements that are already required or permitted by other accounting standards. The definition of fair value
focuses on the exit price, i.e., the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date, not the entry price, i.e., the price that would be paid to
acquire the asset or received to assume the liability at the measurement date. The statement emphasizes that fair value is a
market-based measurement; not an entity-specific measurement. Therefore, the fair value measurement should be
determined based on the assumptions that market participants would use in pricing the asset or liability. For more
information related to fair value measurements, please refer to Note 14, Fair Value.
NOTE 2: BASIC AND DILUTED NET EARNINGS PER SHARE
Basic net earnings per share is computed by dividing net earnings by the weighted average common shares outstanding for
the year. Diluted net earnings per share reflect the potential dilution that could occur upon exercise of securities or other
rights for, or convertible into, shares of the Company’s common stock. As of December 31, 2023 and 2022, respectively,
the Company had no such securities or other rights issued or outstanding, and therefore, no dilutive effect to consider for
the diluted net earnings per share calculation.
The basic and diluted net earnings per share computations for the respective years are presented below.
Year ended December 31
(Dollars in thousands, except share and per share data)
2023
2022
Basic and diluted:
Net earnings
$
$
Weighted average common shares outstanding
Net earnings per share
$
$
NOTE 3: VARIABLE INTEREST ENTITIES
Generally, a variable interest entity (“VIE”) is a corporation, partnership, trust or other legal structure that does not have
equity investors with substantive or proportional voting rights or has equity investors that do not provide sufficient financial
resources for the entity to support its activities.
At December 31, 2023, the Company did not have any consolidated VIEs and had one nonconsolidated VIE, which is
discussed below.
New Markets Tax Credit Investment
The New Markets Tax Credit (“NMTC”) program provides federal tax incentives to investors to make investments in
distressed communities and promotes economic improvement through the development of successful businesses in these
communities. The NMTC is available to investors over seven years and is subject to recapture if certain events occur
98
during such period. The Company had one NMTC investment with a balance of $1.7 million and $
December 31, 2023 and 2022, respectively, which is included in other assets in the Company’s consolidated balance sheets
as a VIE. While the Company’s investment exceeds 50% of the outstanding equity interests in this VIE, the Company does
not consolidate the VIE because the Company lacks the power to direct the activities of the VIE, and therefore is not a
primary beneficiary of the VIE.
(Dollars in thousands)
Maximum
Loss Exposure
Asset Recognized
Classification
Type:
New Markets Tax Credit investment
$
$
Other assets
NOTE 4: SECURITIES
At December 31, 2023 and 2022, respectively, all securities within the scope of ASC 320,
Investments – Debt and Equity
Securities
were classified as available-for-sale. The fair value and amortized cost for securities available-for-sale by
contractual maturity at December 31, 2023 and 2022, respectively, are presented below.
1 year
1 to 5
5 to 10
After 10
Fair
Gross Unrealized
Amortized
(Dollars in thousands)
or less
years
years
years
Value
Gains
Losses
Cost
December 31, 2023
Agency obligations (a)
$
$
Agency MBS (a)
State and political subdivisions
Total available-for-sale
$
$
December 31, 2022
Agency obligations (a)
$
$
Agency MBS (a)
State and political subdivisions
Total available-for-sale
$
$
(a) Includes securities issued by U.S. government agencies or government sponsored entities. Expected lives of
these securities may differ from contractual maturities because (i) issuers may have the right to call or repay such securities
obligations with or without prepayment penalties and (ii) loans included in Agency MBS generally have the right to prepay
such loans in whole or in part at any time.
Securities with aggregate fair values of $
were pledged to secure public deposits, securities sold under agreements to repurchase, FHLB advances, and for other
purposes required or permitted by law.
Included in other assets on the accompanying consolidated balance sheets are nonmarketable equity investments. The
carrying amounts of nonmarketable equity investments were $
respectively. Nonmarketable equity investments include FHLB-Atlanta stock, Federal Reserve Bank stock, and stock in a
privately held financial institution.
99
Fair Value and Gross Unrealized Losses
The fair values and gross unrealized losses on securities at December 31, 2023 and 2022, respectively, segregated by those
securities that have been in an unrealized loss position for less than 12 months and 12 months or more are presented below.
Less than 12 Months
12 Months or Longer
Total
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
(Dollars in thousands)
Value
Losses
Value
Losses
Value
Losses
December 31, 2023:
Agency obligations
$
$
Agency MBS
State and political subdivisions
Total
$
$
December 31, 2022:
Agency obligations
$
$
Agency MBS
State and political subdivisions
Total
$
$
For the securities in the previous table, the Company considers the severity of the unrealized loss as well as the Company’s
intent to hold the securities to maturity or the recovery of the cost basis. Unrealized losses have not been recognized into
income as the decline in fair value is largely due to changes in interest rates and other market conditions. For the securities
in the previous table, as of December 31, 2023, management does not intend to sell and it is likely that management will
not be required to sell the securities prior to their anticipated recovery.
Agency Obligations
Investments in agency obligations are guaranteed of full and timely payments by the issuing agency. Based on
management's analysis and judgement, there were no credit losses attributable to the Company’s investments in
agency obligations at December 31, 2023.
Agency MBS
Investments in agency MBS are issued by Ginnie Mae, Fannie Mae, and Freddie Mac. Each of these agencies provide a
guarantee of full and timely payments of principal and interest by the issuing agency. Based on management's analysis and
judgement, there were no credit losses attributable to the Company’s investments in agency MBS at December 31, 2023.
State and Political Subdivisions
Investments in state and political subdivisions are securities issued by various municipalities in the United States. The
majority of the portfolio was rated AA or higher, with no securities rated below investment grade at December 31,
2023. Based on management's analysis and judgement, there were no credit losses attributable to the Company’s
investments in state and political subdivisions at December 31, 2023.
Realized Gains and Losses
The following table presents the gross realized gains and losses on sales related to securities.
(Dollars in thousands)
2023
2022
Gross realized gains
$
Gross realized losses
(6,296 )
(36 )
Realized gains, net
$
(6,295 )
100
NOTE 5: LOANS AND ALLOWANCE FOR CREDIT LOSSES
December 31
(In thousands)
2023
2022
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
Multifamily
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total loans, net of unearned income
Loans secured by real estate were approximately
% of the total loan portfolio at December 31, 2023. At December 31,
2023, the Company’s geographic loan distribution was concentrated primarily in Lee County, Alabama and surrounding
areas.
The loan portfolio segment is defined as the level at which an entity develops and documents a systematic method for
determining its allowance for credit losses. As part of the Company’s quarterly assessment of the allowance, the loan
portfolio is disaggregated into the following portfolio segments: commercial and industrial, construction and land
development, commercial real estate, residential real estate and consumer installment. Where appropriate, the Company’s
loan portfolio segments are further disaggregated into classes. A class is generally determined based on the initial
measurement attribute, risk characteristics of the loan, and an entity’s method for monitoring and determining credit risk.
The following describe the risk characteristics relevant to each of the portfolio segments and classes.
Commercial and industrial (“C&I”) —
includes loans to finance business operations, equipment purchases, or other needs
for small and medium-sized commercial customers. Also included in this category are loans to finance agricultural
production. Generally, the primary source of repayment is the cash flow from business operations and activities of the
borrower.
Construction and land development (“C&D”) —
includes both loans and credit lines for the purpose of purchasing,
carrying and developing land into commercial developments or residential subdivisions. Also included are loans and lines
for construction of residential, multi-family and commercial buildings. Generally the primary source of repayment is
dependent upon the sale or refinance of the real estate collateral.
Commercial real estate (“CRE”) —
includes loans disaggregated in these classes:
– includes loans for hotels and motels. Generally, the primary source of repayment is dependent upon
101
Residential real estate (“RRE”) —
includes loans disaggregated into two classes:
Consumer installment —
includes loans to individuals both secured by personal property and unsecured. Loans include
personal lines of credit, automobile loans, and other retail loans. These loans are underwritten in accordance with the
Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s
financial condition, satisfactory credit history, and if applicable, property value.
102
The following is a summary of current, accruing past due and nonaccrual loans by portfolio class as of December 31, 2023
and 2022.
Accruing
Accruing
Total
30-89 Days
Greater than
Accruing
Non-
Total
(In thousands)
Current
Past Due
90 days
Loans
Accrual
Loans
December 31, 2023:
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
Multifamily
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total
$
$
December 31, 2022:
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
Multifamily
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total
$
$
103
Credit Quality Indicators
The credit quality of the loan portfolio is summarized no less frequently than quarterly using categories similar to the
standard asset classification system used by the federal banking agencies. The following table presents credit quality
indicators for the loan portfolio segments and classes by year of origination as of December 31, 2023. These categories are
utilized to develop the associated allowance for credit losses using historical losses adjusted for qualitative and
environmental factors and are defined as follows:
●
Pass – loans which are well protected by the current net worth and paying capacity of the obligor (or guarantors, if
any) or by the fair value, less cost to acquire and sell, of any underlying collateral.
●
Special Mention – loans with potential weakness that may, if not reversed or corrected, weaken the credit or
inadequately protect the Company’s position at some future date. These loans are not adversely classified and do
not expose an institution to sufficient risk to warrant an adverse classification.
●
Substandard Accruing – loans that exhibit a well-defined weakness which presently jeopardizes debt repayment,
even though they are currently performing. These loans are characterized by the distinct possibility that the
Company may incur a loss in the future if these weaknesses are not corrected.
●
Nonaccrual – includes loans where management has determined that full payment of principal and interest is not
expected.
104
(Dollars in thousands)
2023
2022
2021
2020
2019
Prior to
2019
Revolving
Loans
Total
Loans
December 31, 2023:
Commercial and industrial
Pass
$
$
Special mention
Substandard
Nonaccrual
Total commercial and industrial
Current period gross charge-offs
Construction and land development
Pass
$
Special mention
Substandard
Nonaccrual
Total construction and land development
Current period gross charge-offs
Commercial real estate:
Owner occupied
Pass
$
Special mention
Substandard
Nonaccrual
Total owner occupied
Current period gross charge-offs
Hotel/motel
Pass
$
Special mention
Substandard
Nonaccrual
Total hotel/motel
Current period gross charge-offs
105
(Dollars in thousands)
2023
2022
2021
2020
2019
Prior to
2019
Revolving
Loans
Total
Loans
December 31, 2023:
Multi-family
Pass
Special mention
Substandard
Nonaccrual
Total multi-family
Current period gross charge-offs
Other
Pass
Special mention
Substandard
Nonaccrual
Total other
Current period gross charge-offs
Residential real estate:
Consumer mortgage
Pass
Special mention
Substandard
Nonaccrual
Total consumer mortgage
Current period gross charge-offs
Investment property
Pass
Special mention
Substandard
Nonaccrual
Total investment property
56,912
Current period gross charge-offs
Consumer installment
Pass
Special mention
Substandard
Nonaccrual
Total consumer installment
Current period gross charge-offs
Total loans
Pass
Special mention
Substandard
Nonaccrual
Total loans
$
$
Total current period gross charge-offs
$
106
(In thousands)
Mention
Substandard
Accruing
Nonaccrual
Total loans
December 31, 2022
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
Multifamily
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total
$
$
The following table is a summary of the Company’s nonaccrual loans by major categories as of December 31, 2023 and
2022.
CECL
Incurred Loss
December 31, 2023
December 31, 2022
Nonaccrual
Nonaccrual
Total
Loans with
Loans with an
Nonaccrual
Nonaccrual
(Dollars in thousands)
No Allowance
Allowance
Loans
Loans
Commercial and industrial
$
—
—
—
$
Commercial real estate
—
Residential real estate
—
Total
$
$
The Company did not recognize any interest income on nonaccrual loans during 2023.
The Company designates individually evaluated loans on nonaccrual status as collateral -dependent loans, as well as other
loans that management of the Company designates as having higher risk. Collateral-dependent loans are loans for which
the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is
experiencing financial difficulty. These loans do not share common risk characteristics and are not included within the
collectively evaluated loans for determining the allowance for credit losses. Under CECL, for collateral-dependent loans,
the Company has adopted the practical expedient to measure the allowance for credit losses based on the fair value of
collateral. The allowance for credit losses is calculated on an individual loan basis based on the shortfall between the fair
value of the loan’s collateral, which is adjusted for liquidation costs/discounts, and amortized costs. If the fair value of the
collateral exceeds the amortized cost, no allowance is required.
The following table presents the amortized cost basis of collateral dependent loans, which are individually evaluated to
determine expected credit losses:
(Dollars in thousands)
Real Estate
Total Loans
December 31, 2023:
Commercial real estate
$
$
783
Total
$
$
The gross interest income which would have been recorded under the original terms of those nonaccrual loans had they
been accruing interest, amounted to approximately $
and 2022, respectively.
107
Allowance for Credit Losses
The Company adopted ASC 326 on January 1, 2023, which introduced the CECL methodology for estimating all expected
losses over the life of a financial asset. Under the CECL methodology, the allowance for credit losses is measured on a
collective basis for pools of loans with similar risk characteristics, and for loans that do not share similar risk characteristics
with the collectively evaluated pools, evaluations are performed on an individual basis.
The following table details the changes in the allowance for credit losses by portfolio segment for the years ended
December 31, 2023 and 2022.
(in thousands)
Commercial
and industrial
Construction
and land
Development
Commercial
Real Estate
Residential
Real Estate
Consumer
Installment
Total
Balance, December 31, 2021
$
$
Charge-offs
(222 )
(70 )
(292 )
Recoveries
Net (charge-offs) recoveries
(215 )
(8 )
(174 )
Provision
Balance, December 31, 2022
$
$
Impact of adopting ASC 326
(17 )
(347 )
(22 )
Charge-offs
(164 )
(105 )
(269 )
Recoveries
Net recoveries (charge-offs)
(100 )
(46 )
Provision
(31 )
(61 )
Balance, December 31, 2023
$
$
The following table presents an analysis of the allowance for loan losses and recorded investment in loans by portfolio
segment and impairment methodology as of December 31, 2022, as determined, prior to adoption of ASC 326.
Collectively evaluated (1)
Individually evaluated (2)
Total
Allowance
Recorded
Allowance
Recorded
Allowance
Recorded
for loan
investment
for loan
investment
for loan
investment
(In thousands)
losses
in loans
losses
in loans
losses
in loans
December 31, 2022:
Commercial and industrial
$
$
Construction and land
development
Commercial real estate
Residential real estate
Consumer installment
Total
$
$
(1) Represents loans collectively evaluated for impairment prior to the adoption of ASC 326, in accordance with ASC 450-20,
Loss
Contingencies,
and pursuant to amendments by ASU 2010-20 regards allowance for non-impaired loans.
(2) Represents loans individually evaluated for impairment, prior to adoption of ASC 326, in accordance with ASC 310-30,
Receivables
,
pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.
108
Impaired loans
The following tables present impaired loans at December 31, 2022 as determined under ASC 310 prior to the adoption of
ASC 326. Loans that have been fully charged-off are not included in the following table. The related allowance generally
represents the following components which correspond to impaired loans:
●
Individually evaluated impaired loans equal to or greater than $500 thousand secured by real estate (nonaccrual
construction and land development, commercial real estate, and residential real estate).
●
Individually evaluated impaired loans equal to or greater than $250 thousand not secured by real estate
(nonaccrual commercial and industrial and consumer loans).
The following table sets forth certain information regarding the Company’s impaired loans that were individually evaluated
for impairment at December 31, 2022.
December 31, 2022
(In thousands)
Unpaid
principal
balance (1)
Charge-offs
and payments
applied (2)
Recorded
investment (3)
Related
allowance
With no allowance recorded:
Commercial and industrial
$
(1 )
$
$
—
Commercial real estate:
Owner occupied
(3 )
—
Total commercial real estate
(3
—
Total
(4 )
—
With allowance recorded:
Commercial and industrial
Commercial real estate:
Owner occupied
Total commercial real estate
Total
Total impaired loans
$
(4 )
$
$
(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been
applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before
Pursuant to the adoption of ASU 2022-02, effective January 1, 2023, the Company prospectively discontinued the
recognition and measurement guidance previously required for troubled debt restructurings (TDRs). As of December 31,
2023, the Company had no loans that would have previously required disclosure as TDRs.
109
The following table provides the average recorded investment in impaired loans, if any, by portfolio segment, and the
amount of interest income recognized on impaired loans after impairment by portfolio segment and class for the year ended
December 31, 2022 as determined under ASC 310 prior to adoption of ASC 326.
Year ended December 31, 2022
Average recorded
Total interest
(In thousands)
investment
income recognized
Impaired loans:
Commercial and industrial
$
$
Commercial real estate:
Owner occupied
Other
Total commercial real estate
Residential real estate:
Investment property
Total residential real estate
Total
$
$
NOTE 6: PREMISES AND EQUIPMENT
Premises and equipment at December 31, 2023 and 2022 is presented below.
December 31
(Dollars in thousands)
2023
2022
Land and improvements
$
Buildings and improvements
Furniture, fixtures, and equipment
Construction in progress
Total premises and equipment
Less: accumulated depreciation
(6,732 )
(5,354 )
Premises and equipment, net
$
Depreciation expense was approximately $
respectively, and is a component of net occupancy and equipment expense in the consolidated statements of earnings.
NOTE 7: MORTGAGE SERVICING RIGHTS, NET
MSRs are recognized based on the fair value of the servicing rights on the date the corresponding mortgage loans are sold.
An estimate of the Company’s MSRs is determined using assumptions that market participants would use in estimating
future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service, escrow
account earnings, contractual servicing fee income, ancillary income, and late fees. Subsequent to the date of transfer, the
Company has elected to measure its MSRs under the amortization method. Under the amortization method, MSRs are
amortized in proportion to, and over the period of, estimated net servicing income. Servicing fee income is recorded net of
related amortization expense and recognized in earnings as part of mortgage lending income.
The Company has recorded MSRs related to loans sold without recourse to Fannie Mae. The Company generally sells
conforming, fixed-rate, closed-end, residential mortgages to Fannie Mae. MSRs are included in other assets on the
accompanying consolidated balance sheets.
110
The Company evaluates MSRs for impairment on a quarterly basis. Impairment is determined by stratifying MSRs into
groupings based on predominant risk characteristics, such as interest rate and loan type. If, by individual stratum, the
carrying amount of the MSRs exceeds fair value, a valuation allowance is established. The valuation allowance is adjusted
as the fair value changes. Changes in the valuation allowance are recognized in earnings as a component of mortgage
lending income.
The following table details the changes in amortized MSRs and the related valuation allowance for the years ended
December 31, 2023 and 2022.
Year ended December 31
(Dollars in thousands)
2023
2022
Beginning balance
$
Additions, net
Amortization expense
(197 )
(269 )
Ending balance
$
1,151
Valuation allowance included in MSRs, net:
Beginning of period
$
End of period
—
Fair value of amortized MSRs:
Beginning of period
$
End of period
2,369
Data and assumptions used in the fair value calculation related to MSRs at December 31, 2023 and 2022, respectively, are
presented below.
December 31
(Dollars in thousands)
2023
2022
Unpaid principal balance
$
Weighted average prepayment speed (CPR)
%
Discount rate (annual percentage)
%
Weighted average coupon interest rate
%
Weighted average remaining maturity (months)
Weighted average servicing fee (basis points)
At December 31, 2023, the weighted average amortization period for MSRs was
for each of the next five years is presented below.
(Dollars in thousands)
December 31, 2023
2024
$
2025
2026
2027
2028
111
NOTE 8: DEPOSITS
At December 31, 2023, the scheduled maturities of certificates of deposit and other time deposits are presented below.
(Dollars in thousands)
December 31, 2023
2024
$
2025
2026
2027
2028
Thereafter
Total certificates of deposit and other time deposits
$
Additionally, at December 31, 2023 and 2022, approximately $
of deposit and other time deposits were issued in denominations greater than $250 thousand.
At December 31, 2023 and 2022, the amount of deposit accounts in overdraft status that were reclassified to loans on the
accompanying consolidated balance sheets was not material.
NOTE 9: LEASE COMMITMENTS
We lease certain office facilities and equipment under operating leases. Rent expense for all operating leases totaled $
million for both years ended December 31, 2023 and 2022. Aggregate lease right of use assets were $
$
thousand at December 31, 2023 and 2022, respectively. Rent expense includes amounts related to items that are not
included in the determination of lease right of use assets including expenses related to short-term leases totaling $
million for the year ended December 31, 2023.
Lease payments under operating leases that were applied to our operating lease liability totaled $
year ended December 31, 2023. The following table reconciles future undiscounted lease payments due under non-
cancelable operating leases (those amounts subject to recognition) to the aggregate operating lease liability as of December
31, 2023.
(Dollars in thousands)
Future lease
payments
2024
$
2025
2026
2027
2028
Thereafter
Total undiscounted operating lease liabilities
$
Imputed interest
Total operating lease liabilities included in the accompanying consolidated balance sheets
$
509
Weighted-average lease terms in years
Weighted-average discount rate
%
112
NOTE 10: OTHER COMPREHENSIVE LOSS
Comprehensive income is defined as the change in equity from all transactions other than those with stockholders, and it
includes net earnings and other comprehensive loss. Other comprehensive loss for the years ended December 31, 2023 and
2022, is presented below.
Pre-tax
Tax benefit
Net of
(Dollars in thousands)
amount
(expense)
tax amount
2023:
Unrealized net holding gain on securities
$
(2,407 )
Reclassification adjustment for net loss on securities recognized in net earnings
(1,581 )
Other comprehensive income
$
(3,988 )
2022:
Unrealized net holding loss on securities
$
(55,819 )
(41,802 )
Reclassification adjustment for net gain on securities recognized in net earnings
(12 )
(9 )
Other comprehensive loss
$
(55,831 )
(41,811 )
NOTE 11: INCOME TAXES
For the years ended December 31, 2023 and 2022 the components of income tax expense from continuing operations are
presented below.
Year ended December 31
(Dollars in thousands)
2023
2022
Current income tax (benefit) expense:
Federal
$
(448 )
State
(134 )
Total current income tax (benefit) expense
(582 )
Deferred income tax (benefit) expense:
Federal
(293 )
State
Total deferred income tax (benefit) expense
(195 )
Total income tax (benefit) expense
$
(777 )
113
Total income tax expense differs from the amounts computed by applying the statutory federal income tax rate of 21% to
earnings before income taxes. A reconciliation of the differences for the years ended December 31, 2023 and 2022, is
presented below.
2023
2022
Percent of
Percent of
pre-tax
pre-tax
(Dollars in thousands)
Amount
earnings
Amount
earnings
Earnings before income taxes
$
Income taxes at statutory rate
%
%
Tax-exempt interest
(493 )
(79.8 )
(523 )
(4.1 )
State income taxes, net of
federal tax effect
(43 )
(7.0 )
New Markets Tax Credit
(356 )
(57.6 )
(356 )
(2.8 )
Bank-owned life insurance
(88 )
(14.2 )
Other
Total income tax (benefit) expense
$
(777 )
(125.7 )
%
%
At December 31, 2023 and 2022, the Company had a net deferred tax asset of $10.3 million and $13.8 million, respectively,
included in other assets on the consolidated balance sheet. The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2023 and 2022 are presented
below.
December 31
(Dollars in thousands)
2023
2022
Deferred tax assets:
Allowance for credit losses
$
Unrealized loss on securities
Net operating loss carry-forwards
—
Tax credit carry-forwards
—
Accrued bonus
Right of use liability
Other
Total deferred tax assets
Deferred tax liabilities:
Premises and equipment
Originated mortgage servicing rights
Right of use asset
New Markets Tax Credit investment
Other
Total deferred tax liabilities
Net deferred tax asset
$
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-
than-not that some portion of the entire deferred tax asset will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the periods in which those temporary differences
become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable
income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and
projection for future taxable income over the periods which the temporary differences resulting in the remaining deferred
tax assets are deductible, management believes it is more-likely-than -not that the Company will realize the benefits of these
deductible differences at December 31, 2023. The amount of the deferred tax assets considered realizable, however, could
be reduced in the near term if estimates of future taxable income are reduced.
114
The change in the net deferred tax asset for the years ended December 31, 2023 and 2022, is presented
Year ended December 31
(Dollars in thousands)
2023
2022
Net deferred tax asset (liability):
Balance, beginning of year
$
13,769
Cumulative effect of change in accounting standard
276
—
Deferred tax expense related to continuing operations
(686 )
Stockholders' equity, for accumulated other comprehensive income
(3,988 )
Balance, end of year
$
ASC 740,
Income Taxes,
as “more-likely-than-not” to be sustained by the taxing authority. This section also provides guidance on the de-
recognition, measurement, and classification of income tax uncertainties in interim periods. As of December 31, 2023, the
Company had no unrecognized tax benefits related to federal or state income tax matters. The Company does not anticipate
any material increase or decrease in unrecognized tax benefits during 2024 relative to any tax positions taken prior to
December 31, 2023. As of December 31, 2023, the Company has accrued no interest and no penalties related to uncertain
tax positions. It is the Company’s policy to recognize interest and penalties related to income tax matters in income tax
expense.
The Company and its subsidiaries file consolidated U.S. federal and State of Alabama income tax returns. The Company is
currently open to audit under the statute of limitations by the Internal Revenue Service and the State of Alabama for the
years ended December 31, 2020 through 2023.
NOTE 12: EMPLOYEE BENEFIT PLAN
The Company sponsors a qualified defined contribution retirement plan, the Auburn National Bancorporation, Inc. 401(k)
Plan (the "Plan"). Eligible employees may contribute up to 100% of eligible compensation, subject to statutory limits upon
completion of 2 months of service. Furthermore, the Company allows employer Safe Harbor contributions. Participants are
immediately vested in employer Safe Harbor contributions. The Company's matching contributions on behalf of
participants were equal to $1.00 for each $1.00 contributed by participants, up to 3% of each participant's eligible
compensation, and $0.50 for every $1.00 contributed by participants, above 3% up to 5% of each participant's eligible
compensation, for a maximum matching contribution of 4% of the participants' eligible compensation. Company matching
contributions to the Plan were approximately $
and are included in salaries and benefits expense.
NOTE 13: COMMITMENTS AND CONTINGENT LIABILITIES
Credit-Related Financial Instruments
The Company is party to credit related financial instruments with off -balance sheet risk in the normal course of business to
meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby
letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company
follows the same credit policies in making commitments as it does for on-balance sheet instruments.
At December 31, 2023 and 2022, the following financial instruments were outstanding whose contract amount represents
credit risk.
December 31
(Dollars in thousands)
2023
2022
Commitments to extend credit
$
$
Standby letters of credit
115
Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition
established in the commitment agreement and provided the commitments are not otherwise cancelable by the Bank.
Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The
commitments for lines of credit may expire without being drawn upon. Therefore, total commitment amounts do not
necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the
Company, is based on management’s credit evaluation of the customer. The Company records an allowance for credit
losses on off-balance sheet exposures, unless the commitments to extend credit are unconditionally cancelable, through a
charge to provision for credit losses in the Company’s Consolidated Statement of Earnings, prior to the adoption of ASC
326, changes in the allowance were recorded as a component of other noninterest expense. The allowance for credit losses
related to unfunded commitments was $
included in other liabilities on the Company’s Consolidated Balance Sheet.
See “Note 1: Summary of Significant
Accounting Policies – Allowanace for credit losses – Unfunded commitments.”
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer
to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan
facilities to customers. The Company holds various assets as collateral, including accounts receivable, inventory,
equipment, marketable securities, and property to support those commitments for which collateral is deemed necessary.
The Company has a recorded a liability for the estimated fair value of these standby letters of credit in the amount of $
thousand and $
Contingent Liabilities
The Company and the Bank are involved in various legal proceedings, arising in connection with their business. In the
opinion of management, based upon consultation with legal counsel, the ultimate resolution of these proceedings will not
have a material adverse effect upon the consolidated financial condition or results of operations of the Company and the
Bank.
NOTE 14: FAIR VALUE
Fair Value Hierarchy
“Fair value” is defined by ASC 820,
Fair Value Measurements and Disclosures
, as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction occurring in the principal market (or most advantageous
market in the absence of a principal market) for an asset or liability at the measurement date. GAAP establishes a fair
value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or
liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1—inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active
markets.
Level 2—inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets,
quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs that are observable for the
asset or liability, either directly or indirectly.
Level 3—inputs to the valuation methodology are unobservable and reflect the Company’s own assumptions about the
inputs market participants would use in pricing the asset or liability.
Level changes in fair value measurements
Transfers between levels of the fair value hierarchy are generally recognized at the end of the reporting period. The
Company monitors the valuation techniques utilized for each category of financial assets and liabilities to ascertain when
transfers between levels have been affected. The nature of the Company’s financial assets and liabilities generally is such
that transfers in and out of any level are expected to be infrequent. For the years ended December 31, 2023 and 2022, there
were no transfers between levels and no changes in valuation techniques for the Company’s financial assets and liabilities.
116
Assets and liabilities measured at fair value on a recurring basis
Securities available-for-sale
Fair values of securities available for sale were primarily measured using Level 2 inputs. For these securities, the Company
obtains pricing from third party pricing services. These third-party pricing services consider observable data that may
include broker/dealer quotes, market spreads, cash flows, market consensus prepayment speeds, benchmark yields, reported
trades for similar securities, credit information and the securities’ terms and conditions. On a quarterly basis, management
reviews the pricing received from the third-party pricing services for reasonableness given current market conditions. As
part of its review, management may obtain non-binding third party broker quotes to validate the fair value measurements.
In addition, management will periodically submit pricing provided by the third-party pricing services to another
independent valuation firm on a sample basis. This independent valuation firm will compare the price provided by the
third-party pricing service with its own price and will review the significant assumptions and valuation methodologies used
with management.
The following table presents the balances of the assets and liabilities measured at fair value on a recurring as of December
31, 2023 and 2022, respectively, by caption, on the accompanying consolidated balance sheets by ASC 820 valuation
hierarchy (as described above).
Quoted Prices in
Significant
Active Markets
Other
Significant
for
Observable
Unobservable
Identical Assets
Inputs
Inputs
(Dollars in thousands)
Amount
(Level 1)
(Level 2)
(Level 3)
December 31, 2023:
Securities available-for-sale:
Agency obligations
$
Agency MBS
State and political subdivisions
Total securities available-for-sale
Total assets at fair value
$
December 31, 2022:
Securities available-for-sale:
Agency obligations
$
Agency MBS
State and political subdivisions
Total securities available-for-sale
Total assets at fair value
$
Assets and liabilities measured at fair value on a nonrecurring basis
Collateral Dependent Loans
Collateral dependent loans are measured at the fair value of the collateral securing loan less estimated selling costs. The
fair value of real estate collateral is determined based on real estate appraisals which are generally based on recent sales of
comparable properties which are then adjusted for property specific factors. Non-real estate collateral is valued based on
various sources, including third party asset valuations and internally determined values based on cost adjusted for
depreciation and other judgmentally determined discount factors. Collateral dependent loans are classified within Level 3
of the hierarchy due to the unobservable inputs used in determining their fair value such as collateral values and the
borrower’s underlying financial condition.
117
Mortgage servicing rights, net
Mortgage servicing rights, net, included in other assets on the accompanying consolidated balance sheets, are carried at the
lower of cost or estimated fair value. MSRs do not trade in an active market with readily observable prices. To determine
the fair value of MSRs, the Company engages an independent third party. The independent third party’s valuation model
calculates the present value of estimated future net servicing income using assumptions that market participants would use
in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to
service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Periodically, the
Company will review broker surveys and other market research to validate significant assumptions used in the model. The
significant unobservable inputs include prepayment speeds or the constant prepayment rate (“CPR”) and the weighted
average discount rate. Because the valuation of MSRs requires the use of significant unobservable inputs, all of the
Company’s MSRs are classified within Level 3 of the valuation hierarchy.
118
The following table presents the balances of the assets and liabilities measured at fair value on a nonrecurring basis as of
December 31, 2023 and 2022, respectively, by caption, on the accompanying consolidated balance sheets and by ASC 820
valuation hierarchy (as described above):
Quoted Prices in
Active Markets
Other
Significant
for
Observable
Unobservable
Identical Assets
Inputs
Inputs
(Dollars in thousands)
Amount
(Level 1)
(Level 2)
(Level 3)
December 31, 2023:
Loans, net
(1)
$
Other assets
(2)
Total assets at fair value
$
December 31, 2022:
Loans, net
(3)
$
Other assets
(2)
Total assets at fair value
$
(1)
Loans considered collateral dependent under ASC 326
(2)
Represents MSRs, net carried at lower of cost or estimated fair value.
(3)
Loans considered impaired under ASC 310-10-35 Receivables, prior to the adoption of ASC 326. This amount reflects
the recorded investment in impaired loans, net of any related allowance for loan losses.
Quantitative Disclosures for Level 3 Fair Value Measurements
At December 31, 2023 and 2022, the Company had no Level 3 assets measured at fair value on a recurring basis. For Level
3 assets measured at fair value on a non-recurring basis as of December 31, 2023 and 2022, the significant unobservable
inputs used in the fair value measurements are presented below.
Weighted
Carrying
Significant
Average
(Dollars in thousands)
Amount
Valuation Technique
Range
of Input
December 31, 2023:
Collateral dependent loans
$
Appraisal
Appraisal discounts
-
%
%
Mortgage servicing rights, net
Discounted cash flow
Prepayment speed or CPR
-
%
%
Discount rate
-
%
%
December 31, 2022:
Impaired loans
$
Appraisal
Appraisal discounts
-
%
%
Mortgage servicing rights, net
Discounted cash flow
Prepayment speed or CPR
-
%
%
Discount rate
-
%
%
Fair Value of Financial Instruments
ASC 825,
Financial Instruments
, requires disclosure of fair value information about financial instruments, whether or not
recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the
estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are
not available, fair values are based on estimates using discounted cash flow analyses. Discounted cash flows can be
significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The
following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered
representative of the liquidation value of the Company’s financial instruments, but rather are good faith estimates of the fair
value of financial instruments held by the Company. ASC 825 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements.
119
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Loans, net
Fair values for loans were calculated using discounted cash flows. The discount rates reflected current rates at which similar
loans would be made for the same remaining maturities. Expected future cash flows were projected based on contractual
cash flows, adjusted for estimated prepayments. The fair value of loans was measured using an exit price notion.
Time Deposits
Fair values for time deposits were estimated using discounted cash flows. The discount rates were based on rates currently
offered for deposits with similar remaining maturities.
The carrying value, related estimated fair value, and placement in the fair value hierarchy of the Company’s financial
instruments at December 31, 2023 and 2022 are presented below. This table excludes financial instruments for which the
carrying amount approximates fair value. Financial assets for which fair value approximates carrying value included cash
and cash equivalents. Financial liabilities for which fair value approximates carrying value included noninterest-bearing
demand deposits, interest-bearing demand deposits, and savings deposits. Fair value approximates carrying value in these
financial liabilities due to these products having no stated maturity. Additionally, financial liabilities for which fair value
approximates carrying value included overnight borrowings such as federal funds purchased and securities sold under
agreements to repurchase.
The following table summarizes our fair value estimates:
Fair Value Hierarchy
Carrying
Estimated
Level 1
Level 2
Level 3
(Dollars in thousands)
amount
fair value
inputs
inputs
Inputs
December 31, 2023:
Financial Assets:
Loans, net (1)
$
$
$
$
$
Financial Liabilities:
Time Deposits
$
$
$
$
$
December 31, 2022:
Financial Assets:
Loans, net (1)
$
$
$
$
$
Financial Liabilities:
Time Deposits
$
$
$
$
$
(1) Represents loans, net and the allowance for credit losses. The fair value of loans was measured using an exit price notion.
NOTE 15: RELATED PARTY TRANSACTIONS
The Bank has made, and expects in the future to continue to make in the ordinary course of business, loans to directors and
executive officers of the Company, the Bank, and their immediate families and affiliates. These persons, corporations, and
firms have had transactions in the ordinary course of business with the Company and Bank, including borrowings, all of
which management believes were on substantially the same terms, including interest rates and collateral, as those prevailing
at the time of comparable tranactions with unaffiliated persons and did not involve more than the normal risk of
collectability or present other unfavorable features. A summary of such outstanding loans is presented below:
(Dollars in thousands)
Amount
Loans outstanding at December 31, 2022
$
New loans/advances
Repayments
(316 )
Loans outstanding at December 31, 2023
$
120
During 2023 and 2022, certain executive officers, directors and principal shareholders’ of the Company and the Bank,
including companies and related parties with which they are affiliated, were deposit customers of the bank. Total deposits
for these persons at December 31, 2023 and 2022 amounted to $
NOTE 16: REGULATORY RESTRICTIONS AND CAPITAL RATIOS
As required by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, the Federal Reserve Board
issued rule that expanded applicability of the Board’s small bank holding company policy statement (the “Small BHC
Policy Statement”) and has been added as Appendix C to Federal Reserve Regulation Y. These increased the Small BHC
Policy Statement’s asset limit from $1 billion to $3 billion in total consolidated assets for a bank holding company or
savings and loan holding company that: (1) is not engaged in significant nonbanking activities; (2) does not conduct
significant off-balance sheet activities; and (3) does not have a material amount of debt or equity securities, other than trust-
preferred securities, outstanding that are registered with the SEC. The interim final rule provides that, if warranted for
supervisory purposes, the Federal Reserve may exclude a company from this asset level increase. The Federal Reserve has
treated the Company as a small bank holding company for purposes of the Small BHC Policy Statement and therefore has
considered only the Bank’s capital and not the Company’s consolidated capital.
The Bank remains subject to regulatory capital requirements of the Alabama Banking Department and the Federal Reserve.
Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary -
actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities and certain off -balance sheet items as calculated
under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, necessary capital to support risks and other factors. Notwithstanding the
minimum capital requirements, Federal Reserve Regulation Q states that a Federal Reserve -regulated institution must
maintain capital commensurate with the level and nature of all risks to which such institution is exposed.
Federal Reserve Regulation Q limits “distributions” and discretionary bonus payments from eligible retained income” by
sate member banks, such as the Bank, unless its capital conservation buffer of common equity Tier 1 capital (“CET1”)
exceeds 2.5%. “Distributions” include dividends declared or paid on common stock, and stock repurchases, redemptions or
repurchases of Tier 2 capital instruments (unless replaced by a capital instrument in the same quarter). “Eligible retained
income” for the Bank and other Federal Reserve regulated institutions is the greater of:
(A) The Board-regulated institution's net income, calculated in accordance with the instructions to the institution’s FR Y–
9C or Call Report, for the four calendar quarters preceding the current calendar quarter, net of any distributions and
associated tax effects not already reflected in net income; and
(B) The average of the Board-regulated institution’s net income, calculated in accordance with the instructions to the
institutions’ FR Y–9C or Call Report, as applicable, for the four calendar quarters preceding the current calendar quarter.
The Bank’s Call Report is used for its calculation of “eligible retained income”.
As of December 31, 2023, the Bank is “well capitalized” under the regulatory framework for prompt corrective action. To
be categorized as “well capitalized,” the Bank must maintain minimum common equity Tier 1, total risk-based, Tier 1 risk-
based, and Tier 1 leverage ratios as set forth in the following table. Management has not received any notification from the
Bank's regulators that changes the Bank’s regulatory capital status.
121
The actual capital amounts and ratios for the Bank and the aforementioned minimums as of December 31, 2023 and 2022
are presented below.
Minimum for capital
Minimum to be
Actual
adequacy purposes
well capitalized
(Dollars in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
At December 31, 2023:
Tier 1 Leverage Capital
$
%
$
%
$
%
Common Equity Tier 1 Capital
Tier 1 Risk-Based Capital
Total Risk-Based Capital
At December 31, 2022:
Tier 1 Leverage Capital
$
%
$
%
$
%
Common Equity Tier 1 Capital
Tier 1 Risk-Based Capital
15.39
Total Risk-Based Capital
Dividends paid by the Bank are a principal source of funds available to the Company for payment of dividends to its
stockholders and for other needs which are restricted by Alabama and Federal law and regulations as described above.
Capital adequacy considerations could further limit the availability of dividends from the Bank. At December 31, 2023, the
Bank could have declared additional dividends of approximately $
authorities. As a result of this limitation, approximately $
restricted from transfer in the form of dividends.
NOTE 17: AUBURN NATIONAL BANCORPORATION (PARENT COMPANY)
The Parent Company’s condensed balance sheets and related condensed statements of earnings and cash flows are as
follows.
CONDENSED BALANCE SHEETS
December 31
(Dollars in thousands)
2023
2022
Assets:
Cash and due from banks
$
Investment in bank subsidiary
Other assets
Total assets
$
Liabilities:
Accrued expenses and other liabilities
$
Total liabilities
Stockholders' equity
Total liabilities and stockholders' equity
$
122
CONDENSED STATEMENTS OF EARNINGS
Year ended December 31
(Dollars in thousands)
2023
2022
Income:
Dividends from bank subsidiary
$
Noninterest income
Total income
Expense:
Noninterest expense
Total expense
Earnings before income tax expense and equity
in undistributed earnings of bank subsidiary
Income tax benefit
(30 )
(48 )
Earnings before equity in undistributed earnings
of bank subsidiary
Equity in (distributed) undistributed earnings of bank subsidiary
(2,180 )
Net earnings
$
CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31
(Dollars in thousands)
2023
2022
Cash flows from operating activities:
Net earnings
$
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Net (increase) decrease in other assets
(1 )
Net increase (decrease) in other liabilities
(408 )
Equity in (distributed) undistributed earnings of bank subsidiary
(6,827 )
Net cash provided by operating activities
Cash flows from financing activities:
Dividends paid
(3,776 )
(3,720 )
Stock repurchases
(229 )
(504 )
Net cash used in financing activities
(4,005 )
(4,224 )
Net change in cash and cash equivalents
(423 )
(1,005 )
Cash and cash equivalents at beginning of period
1,700
Cash and cash equivalents at end of period
$
123
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company’s
management, under the supervision and with the participation of its principal executive and principal financial officer,
conducted an evaluation as of the end of the period covered by this report, of the effectiveness of the Company’s disclosure
controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on that evaluation, and the results of
the audit process described below, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s
disclosure controls and procedures were effective to ensure that information required to be disclosed in the Company’s
reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the
SEC’s rules and regulations, and that such information is accumulated and communicated to the Company’s management,
including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding
disclosure.
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial
reporting. The Company’s internal control system was designed to provide reasonable assurance to the Company’s
management and board of directors regarding the preparation and fair presentation of published financial statements. All
internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined
to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Under the direction of the Company’s Chief Executive Officer and Chief Financial Officer, management has assessed the
effectiveness of the Company’s internal control over financial reporting as of December 31, 2023 in accordance with the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal
Control – Integrated Framework (2013). Based on this assessment, management has concluded that such internal control
over financial reporting was effective as of December 31, 2023.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm
regarding internal control over financial reporting because it is a smaller reporting company.
Changes in Internal Control Over Financial Reporting
During the period covered by this report, there has not been any change in the Company’s internal controls over financial
reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over
financial reporting.
ITEM 9B. OTHER INFORMATION
None.
ITEM 9C. DISCLOSURE REGARDING FORGEIN JURISDICTIONS THAT PREVENT INSPECTION
None.
124
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is set forth under the headings “Proposal One: Election of Directors - Information about
Nominees for Directors,” and “Executive Officers,” “Additional Information Concerning the Company’s Board of
Directors and Committees,” “Executive Compensation,” “Audit Committee Report” and “Compliance with Section 16(a) of
the Securities Exchange Act of 1934” in the Proxy Statement, and is incorporated herein by reference.
The Board of Directors has adopted a Code of Conduct and Ethics applicable to the Company’s directors, officers and
employees, including the Company’s principal executive officer, principal financial and principal accounting officer,
controller and other senior financial officers. The Code of Conduct and Ethics, as well as the charters for the Audit
Committee, Compensation Committee, and the Nominating and Corporate Governance Committee, can be found by
hovering over the heading “About Us” on the Company’s website,
www.auburnbank.com
, and then clicking on “Investor
Relations”, and then clicking on “Governance Documents”. In addition, this information is available in print to any
shareholder who requests it. Written requests for a copy of the Company’s Code of Conduct and Ethics or the Audit
Committee, Compensation Committee, or Nominating and Corporate Governance Committee Charters may be sent to
Auburn National Bancorporation, Inc., 100 N. Gay Street, Auburn, Alabama 36830, Attention: Marla Kickliter, Senior Vice
President of Compliance and Internal Audit. Requests may also be made via telephone by contacting Marla Kickliter,
Senior Vice President of Compliance and Internal Audit, or Laura Carrington, Vice President of Human Resources, at
(334) 821-9200.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is set forth under the headings “Additional Information Concerning the Company’s Board
of Directors and Committees – Board Compensation,” and “Executive Officers” in the Proxy Statement, and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information required by this item is set forth under the headings “Proposal One: Election of Directors - Information about
Nominees for Directors and Executive Officers” and “Stock Ownership by Certain Persons” in the Proxy Statement, and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information required by this item is set forth under the headings “Additional Information Concerning the Company’s Board
of Directors and Committees – Committees of the Board of Directors – Independent Directors Committee” and “Certain
Transactions and Business Relationships” in the Proxy Statement, and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by this item is set forth under the heading “Independent Public Accountants” in the Proxy Statement,
and is incorporated herein by reference.
125
PART IV
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
List of all Financial Statements
The following consolidated financial statements and report of independent registered public accounting firm of the
Company are included in this Annual Report on Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2023 and 2022
Consolidated Statements of Earnings for the years ended December 31, 2023 and 2022
Consolidated Statements of Comprehensive Income for the years ended December 31, 2023 and 2022
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2023 and 2022
Consolidated Statements of Cash Flows for the years ended December 31, 2023 and 2022
Notes to the Consolidated Financial Statements
(b)
Exhibits
3.1.
Certificate of Incorporation of Auburn National Bancorporation, Inc. (incorporated by reference from
3.2.
Amended and Restated Bylaws of Auburn National Bancorporation, Inc., adopted as of November 13, 2007
4.1.
21.1
31.1
31.2
32.1
32.2
101.INS
Inline XBRL Instance Document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
104
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101
*
The certifications attached as exhibits 32.1 and 32.2 to this annual report on Form 10-K are “furnished” to the Securities
and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed”
by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
126
Financial Statement Schedules
All financial statement schedules required pursuant to this item were either included in the financial information set
forth in (a) above or are inapplicable and therefore have been omitted.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Auburn, State of
Alabama, on March 14, 2024.
AUBURN NATIONAL BANCORPORATION, INC.
(Registrant)
By:
David A. Hedges
President and CEO
persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
David A. Hedges
President and Chief Executive Officer
(Principal Executive Officer)
March 14, 2024
W. James Walker, IV
SVP, Chief Financial Officer
(Principal Financial and Accounting Officer)
March 14, 2024
Robert W. Dumas
Chairman of the Board
March 14, 2024
C. Wayne Alderman
Director
March 14, 2024
Terry W. Andrus
Director
March 14, 2024
J. Tutt Barrett
Director
March 14, 2024
Laura Cooper
Director
March 14, 2024
William F. Ham, Jr.
Director
March 14, 2024
David E. Housel
Director
March 14, 2024
Anne M. May
Director
March 14, 2024