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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
 
20549
 
FORM
10-K
Annual report pursuant to Section 13 or 15(d) of the Securities
 
Exchange Act of 1934.
For the quarterly period ended
December 31, 2021
OR
 
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period __________ to __________
Commission File Number:
0-26486
Auburn National Bancorporation, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
 
63-0885779
(State or other jurisdiction
of incorporation)
 
(I.R.S. Employer
Identification No.)
132 N. Gay Street
,
Auburn,
Alabama
 
36830
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (
334
)
821-9200
 
Securities registered pursuant to Section 12 (b) of the Act:
 
Title of Each Class
 
Trading Symbol
 
Name of Exchange on which Registered
Common Stock
, par value $0.01
 
AUBN
 
NASDAQ
 
Global Market
Securities registered to Section 12(g) of the Act:
 
None
Indicate by check mark if the registrant
 
is a well-known seasoned issuer, as defined in Rule 405
 
of the Securities Act. Yes
No
 
Indicate by check mark if the registrant
 
is not required to file reports pursuant
 
to Section 13 or Section 15(d) of the Act.
 
Yes
No
 
Indicate by check mark whether the registrant
 
(1) has filed all reports required to be
 
filed by Section 13 or 15(d) of
 
the Securities Exchange Act of 1934 during
 
the
preceding 12 months (or for such shorter
 
period that the registrant was required
 
to file such reports), and (2) has been subject
 
to such filing requirements for the past
90 days.
Yes
 
No
 
Indicate by check mark whether the registrant
 
has submitted electronically every Interactive
 
Data File required to be submitted pursuant
 
to Rule 405 of Regulation S-
T (§ 232.405 of this chapter) during
 
the preceding 12 months (or for such
 
shorter period that the registrant was required
 
to submit such files).
Yes
 
No
Indicate by check mark whether the registrant
 
is a large accelerated filer, an accelerated filer, a non-accelerated filer, or
 
a smaller reporting company. See the
definitions of “large accelerated filer,” “accelerated filer”
 
and “smaller reporting company” in
 
Rule 12b-2 of the Exchange Act. (Check
 
one):
 
Large Accelerated filer
 
 
Accelerated filer
Non-accelerated filer
 
 
Smaller reporting company
Emerging Growth
 
Company
If an emerging growth company, indicate by check mark if the registrant
 
has selected not to use the extended
 
transition period for complying with any
 
new or revised
financial accounting standards provided pursuant
 
to Section 13(a) of the Exchange Act. Yes
 
No
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.
 
Indicate by check mark if the registrant
 
is a shell company (as defined in Rule
 
12b-2 of the Act). Yes
 
No
 
State the aggregate market value of the voting
 
and non-voting common equity held by
 
non-affiliates computed by reference to the price
 
at which the common equity
was last sold, or the average bid and
 
asked price of such common equity
 
as of the last business day of the registrant’s most recently
 
completed second fiscal quarter:
$
81,577,219
 
as of June 30, 2021.
 
APPLICABLE ONLY TO CORPORATE REGISTRANTS
 
Indicate the number of shares outstanding
 
of each of the registrant’s classes of common stock,
 
as of the latest practicable date:
3,516,971
 
shares of common stock as
of March 7, 2022.
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Proxy Statement for the
 
Annual Meeting of Shareholders, scheduled
 
to be held May 10, 2022, are incorporated
 
by reference into Part II, Item 5 and
Part III of this Form 10-K.
 
3
PART
 
I
 
SPECIAL CAUTIONARY NOTE REGARDING
 
FORWARD
 
-LOOKING STATEMENTS
Various
 
of the statements made herein under the captions “Management’s
 
Discussion and Analysis of Financial Condition
and Results of Operations”, “Quantitative and Qualitative Disclosures about Market
 
Risk”, “Risk Factors” “Description of
Property” and elsewhere, are “forward-looking statements” within the
 
meaning and protections of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
 
as amended (the “Exchange Act”).
Forward-looking statements include statements with respect to our beliefs, plans, objectives,
 
goals, expectations,
anticipations, assumptions, estimates, intentions and future performance, and involve
 
known and unknown risks,
uncertainties and other factors, which may be beyond our control, and
 
which may cause the actual results, performance,
achievements or financial condition of the Company to be materially different
 
from future results, performance,
achievements or financial condition expressed or implied by such forward-looking
 
statements.
 
You
 
should not expect us to
update any forward-looking statements.
All statements other than statements of historical fact are statements that could be forward-looking
 
statements.
 
You
 
can
identify these forward-looking statements through our use of words such as “may,”
 
“will,” “anticipate,” “assume,”
“should,” “indicate,” “would,” “believe,” “contemplate,” “expect,”
 
“estimate,” “continue,” “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 seasonality, inflation and
 
supply chain disruptions, including those resulting from natural disasters
 
or
climate change, such as rising sea and water levels, hurricanes and tornados, coronavirus
 
or other epidemics or
pandemics;
the effects of war, invasions of other countries
 
or other conflicts, acts of terrorism, or other events that may affect
general economic conditions;
governmental monetary and fiscal policies;
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;
the failure of assumptions and estimates, as well as differences in, and changes to, economic,
 
market and credit
conditions, including changes in borrowers’ credit risks and payment behaviors from
 
those used in our loan
portfolio reviews;
the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand,
 
and the values
and liquidity of loan collateral, securities, and interest-sensitive assets and liabilities, and
 
the risks and uncertainty
of the amounts realizable;
changes in borrower credit risks and payment behaviors;
changes occurring in business conditions and inflation;
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 disruption effects of
 
financial technology and other competitors
who are not subject to the same regulations as the Company and the Bank;
4
the failure of assumptions and estimates underlying the establishment of allowances
 
for possible loan losses and
other asset impairments, losses valuations of assets and liabilities and other estimates;
the costs of redeveloping our headquarters campus and the timing and amount of rental income
 
upon completion
of the project, and the satisfaction of closing conditions and the amount and timing of expected
 
gain on the
pending sale of part of our campus for development as a hotel;
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
 
vendor systems or customers’ information;
the risks that our deferred tax assets (“DTAs”),
 
if any, could be reduced
 
if estimates of future taxable income from
our operations and tax planning strategies are less than currently estimated, and sales
 
of our capital stock could
trigger a reduction in the amount of net operating loss carry-forwards that we may be able
 
to utilize for income tax
purposes; and
other factors and risks described under “Risk Factors” herein and in any of our subsequent
 
reports that we make
with the Securities and Exchange Commission (the “Commission” or “SEC”)
 
under the Exchange Act.
All written or oral forward-looking statements that are made by us or are attributable
 
to us are expressly qualified in their
entirety by this cautionary notice.
 
We have no obligation and
 
do not undertake to update, revise or correct any of the
forward-looking statements after the date of this report, or after the respective dates on which such
 
statements otherwise are
made.
ITEM 1.
 
BUSINESS
Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company registered
 
with the Board of Governors
of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding
 
Company Act of 1956, as amended (the
“BHC Act”).
 
The Company was incorporated in Delaware in 1990, and in 1994 it succeeded
 
its Alabama predecessor as
the bank holding company controlling AuburnBank, an Alabama state
 
member bank with its principal office in Auburn,
Alabama (the “Bank”).
 
The Company and its predecessor have controlled the Bank since 1984.
 
As a bank holding
company, the Company
 
may diversify into a broader range of financial services and other business activities than currently
are permitted to the Bank under applicable laws and regulations.
 
The holding company structure also provides greater
financial and operating flexibility than is presently permitted to the Bank.
 
The Bank has operated continuously since 1907 and currently conducts its business
 
primarily in East Alabama, including
Lee County and surrounding areas.
 
The Bank has been a member of the Federal Reserve System since April 1995.
 
The
Bank’s primary regulators are the Federal
 
Reserve and the Alabama Superintendent of Banks (the “Alabama
Superintendent”).
 
The Bank has been a member of the Federal Home Loan Bank of Atlanta (the “FHLB”)
 
since 1991.
 
General
The Company’s business is conducted
 
primarily through the Bank and its subsidiaries.
 
Although it has no immediate plans
to conduct any other business, the Company may engage directly or indirectly in a number
 
of activities that the Federal
Reserve has determined to be so closely related to banking or managing or controlling banks
 
as to be a proper incident
thereto.
 
 
5
The Company’s principal executive offices
 
are located at 132 N. Gay Street, Auburn, Alabama 36830, and its telephone
number at such address is (334) 821-9200.
 
The Company maintains an Internet website at
www.auburnbank.com
.
 
The
Company’s website and the information
 
appearing on the website are not included or incorporated in, and are not part
 
of,
this report.
 
The Company files annual, quarterly and current reports, proxy statements, and
 
other information with the
SEC.
 
You
 
may read and copy any document we file with the SEC at the SEC’s
 
public reference room at 100 F Street, N.E.,
Washington, DC 20549.
 
Please call the SEC at 1-800-SEC-0330 for more information on the operation of the public
reference rooms.
 
The SEC maintains an Internet site at
www.sec.gov
 
that contains reports, proxy, and other
 
information,
where SEC filings are available to the public free of charge.
 
Services
The Bank offers checking, savings, transaction deposit accounts and
 
certificates of deposit, and is an active residential
mortgage lender in its primary service area.
 
The Bank’s primary service area includes the
 
cities of Auburn and Opelika,
Alabama and nearby surrounding areas in East Alabama, primarily in
 
Lee County.
 
The Bank also offers commercial,
financial, agricultural, real estate construction and consumer loan products
 
and other financial services.
 
The Bank is one of
the largest providers of automated teller services in East Alabama and
 
operates ATM
 
machines in 13 locations in its
primary service area.
 
The Bank offers Visa
®
 
Checkcards, which are debit cards with the Visa
 
logo that work like checks
but can be used anywhere Visa is accepted,
 
including ATM
 
s.
 
The Bank’s Visa
 
Checkcards can be used internationally
through the Plus
®
 
network.
 
The Bank offers online banking, bill payment and other electronic
 
services through its Internet
website,
www.auburnbank.com
.
 
Our online banking services, bill payment and electronic services are subject
 
to certain
cybersecurity risks.
 
See “Risk Factors – Our information systems may experience interruptions
 
and security breaches.”
 
Competition
The banking business in East Alabama, including Lee County,
 
is highly competitive with respect to loans, deposits, and
other financial services.
 
The area is dominated by a number of regional and national banks and bank
 
holding companies
that have substantially greater resources, and numerous offices and affiliates
 
operating over wide geographic areas.
 
The
Bank competes for deposits, loans and other business with these banks, as
 
well as with credit unions, mortgage companies,
insurance companies, and other local and nonlocal financial institutions, including
 
institutions offering services through the
mail, by telephone and over the Internet.
 
As more and different kinds of businesses enter the market for financial
 
services,
competition from nonbank financial institutions may be expected to
 
intensify further.
 
Among the advantages that larger financial institutions have
 
over the Bank are their ability to finance extensive advertising
campaigns, to diversify their funding sources, and to allocate and diversify their assets among
 
loans and securities of the
highest yield in locations with the greatest demand.
 
Many of the major commercial banks or their affiliates operating in
 
the
Bank’s service area offer services
 
which are not presently offered directly by the Bank and they typically have substantially
higher lending limits than the Bank.
 
Banks also have experienced significant competition for deposits from mutual
 
funds, insurance companies and other
investment companies and from money center banks’ offerings
 
of high-yield investments and deposits.
 
Certain of these
competitors are not subject to the same regulatory restrictions as the Bank.
 
Selected Economic Data
The U.S. Census Bureau estimates Lee County’s
 
population was 174,241 in 2020, and has increased approximately 24.2%
from 2010 to 2020.
 
The largest employers in the area are Auburn University,
 
East Alabama Medical Center, a Wal
 
-Mart
Distribution Center, Mando America Corporation,
 
and Briggs & Stratton.
 
Auto manufacturing and related suppliers are
increasingly important along Interstate Highway 85 to the east and west of
 
Auburn.
 
Kia Motors has a large automobile
factory in nearby West Point,
 
Georgia, and Hyundai Motors has a large automobile
 
factory in Montgomery,
 
Alabama.
Between 2010 and 2022, the Auburn-Opelika MSA grew an estimated 23.9%,
 
the second fastest growing MSA in
Alabama.
 
The Auburn-Opelika MSA population is estimated to grow 6.73% from 2022
 
to 2027.
 
During the same time,
household income is estimated to increase 13.34%, to $67,593.
6
Loans and Loan Concentrations
The Bank makes loans for commercial, financial and agricultural purposes, as
 
well as for real estate mortgages, real estate
acquisition, construction and development and consumer purposes.
 
While there are certain risks unique to each type of
lending, management believes that there is more risk associated
 
with commercial, real estate acquisition, construction and
development, agricultural and consumer lending than with residential real estate
 
mortgage loans.
 
To help manage these
risks, the Bank has established underwriting standards used in evaluating
 
each extension of credit on an individual basis,
which are substantially similar for each type of loan.
 
These standards include a review of the economic conditions
affecting the borrower, the borrower’s
 
financial strength and capacity to repay the debt, the underlying collateral and the
borrower’s past credit performance.
 
We apply these standards
 
at the time a loan is made and monitor them periodically
throughout the life of the loan.
 
See “Lending Practices” for a discussion of regulatory guidance on commercial real
 
estate
lending.
 
The Bank has loans outstanding to borrowers in all industries within our primary
 
service area.
 
Any adverse economic or
other conditions affecting these industries would also likely
 
have an adverse effect on the local workforce, other local
businesses, and individuals in the community that have entered
 
into loans with the Bank.
 
For example, the auto
manufacturing business and its suppliers have positively affected
 
our local economy, but automobile
 
manufacturing is
cyclical and adversely affected by increases in interest rates.
 
Decreases in automobile sales, including adverse changes due
to interest rate increases, and the economic effects of the impact
 
of COVID-19, including continuing supply chain
disruptions, could adversely affect nearby Kia and Hyundai automotive plants and their suppliers'
 
local spending and
employment, and could adversely affect economic conditions
 
in the markets we serve. However,
 
management believes that
due to the diversified mix of industries located within the Bank’s
 
primary service area, adverse changes in one industry may
not necessarily affect other area industries to the same degree or
 
within the same time frame.
 
The Bank’s primary service
area also is subject to both local and national economic conditions and fluctuations.
 
While most loans are made within our
primary service area, some residential mortgage loans are originated outside the
 
primary service area, and the Bank from
time to time has purchased loan participations from outside its primary
 
service area.
Human Capital
At December 31, 2021, the Company and its subsidiaries had 152
 
full-time equivalent employees, including 39 officers. In
response to the COVID-19 pandemic, our business continuity plan worked to provide
 
essential banking services to our
communities and customers, while protecting our employees’ health.
 
As part of our efforts to exercise social distancing in
accordance with the guidelines of the Centers for Disease Control and the Governor
 
of the State of Alabama, starting March
23, 2020, we limited branch lobby service to appointment only while continuing to operate
 
our branch drive-thru facilities
and ATMs.
 
We continue to provide
 
services through our online and other electronic channels. In addition,
 
we established
remote work access to help employees stay at home where job duties permit.
 
We experienced
 
little turnover as a result of the COVID-19 pandemic.
 
We also have
 
strong employee retention
historically.
 
Our average term of service is approximately 10 years.
We seek to provide
 
competitive compensation and benefits.
 
We encourage and support
 
the growth and development of our
employees and, wherever possible, seek to fill positions by promotion and transfer
 
from within the organization.
 
Career
development is advanced through ongoing performance and development conversations
 
with employees, internally
developed training programs and other training and development opportunities.
 
Our employees are encouraged to be active
in our communities as part of our commitment to these communities and our employees.
Statistical Information
Certain statistical information is included in response to Item 7 of this
 
Annual Report on Form 10-K.
 
Certain statistical
information is also included in response to Item 6, Item 7A and Item 8 of this Annual Report
 
on Form 10-K.
 
7
SUPERVISION AND REGULATION
The Company and the Bank are extensively regulated under federal and state laws applicable
 
to bank holding companies
and banks.
 
The supervision, regulation and examination of the Company and the Bank and
 
their respective subsidiaries by
the bank regulatory
 
agencies are primarily intended to maintain the safety and soundness
 
of depository institutions and the
federal deposit insurance system, as well as the protection of depositors,
 
rather than holders of Company capital stock and
other securities.
 
Any change in applicable law or regulation may have a material effect
 
on the Company’s business.
 
The
following discussion is qualified in its entirety by reference to the particular laws and
 
rules referred to below.
Bank Holding Company Regulation
The Company, as a bank holding company,
 
is subject to supervision, regulation and examination by the Federal Reserve
under the BHC Act.
 
Bank holding companies generally are limited to the business of banking,
 
managing or controlling
banks, and certain related activities.
 
The Company is required to file periodic reports and other information
 
with the
Federal Reserve.
 
The Federal Reserve examines the Company and its subsidiaries.
 
The State of Alabama currently does
not regulate bank holding companies.
The BHC Act requires prior Federal Reserve approval for,
 
among other things, the acquisition by a bank holding company
of direct or indirect ownership or control of more than 5% of the voting shares or
 
substantially all the assets of any bank, or
for a merger or consolidation of a bank holding company
 
with another bank holding company.
 
The BHC Act generally
prohibits a bank holding company from acquiring direct or indirect ownership
 
or control of voting shares of any company
that is not a bank or bank holding company and from engaging directly or indirectly in any
 
activity other than banking or
managing or controlling banks or performing services for its authorized
 
subsidiary.
 
A bank holding company may,
however, engage in or acquire an interest in a company that
 
engages in activities that the Federal Reserve has determined
by regulation or order to be so closely related to banking or managing or controlling banks
 
as to be a proper incident
thereto. On January 30, 2020, the Federal Reserve adopted new rules, effective
 
September 30, 2020 simplifying
determinations of control of banking organizations for BHC Act purposes.
Bank holding companies that are and remain “well-capitalized” and “well-managed,”
 
as defined in Federal Reserve
Regulation
Y,
and whose insured depository institution subsidiaries maintain
 
“satisfactory” or better ratings under the
Community Reinvestment Act of 1977 (the “CRA”), may elect to
 
become “financial holding companies.” Financial holding
companies and their subsidiaries are permitted to acquire or engage in activities
 
such as insurance underwriting, securities
underwriting, travel agency activities, broad insurance agency activities,
 
merchant banking and other activities that the
Federal Reserve determines to be financial in nature or complementary thereto.
 
In addition, under the BHC Act’s
 
merchant
banking authority and Federal Reserve regulations, financial holding companies
 
are authorized to invest in companies that
engage in activities that are not financial in nature, as long as the financial
 
holding company makes its investment, subject
to limitations, including a limited investment term, no day-to-day
 
management, and no cross-marketing with any depositary
institutions controlled by the financial holding company.
 
The Federal Reserve recommended repeal of the merchant
banking powers in its September 16, 2016 study pursuant to Section 620 of the Dodd
 
-Frank Wall Street Reform and
Consumer Protection Act of 2010 (the “Dodd-Frank Act”), but has taken no action.
 
The Company has not elected to
become a financial holding company,
 
but it may elect to do so in the future.
Financial holding companies continue to be subject to Federal Reserve supervision,
 
regulation and examination, but the
Gramm-Leach-Bliley Act of 1999 the “GLB Act”) applies the concept
 
of functional regulation to subsidiary activities.
 
For
example, insurance activities would be subject to supervision and regulation
 
by state insurance authorities.
 
The BHC Act permits acquisitions of banks by bank holding companies, subject
 
to various restrictions, including that the
acquirer is “well capitalized” and “well managed”.
 
Under the Alabama Banking Code, with the prior approval of the
Alabama Superintendent, an Alabama bank may acquire and operate
 
one or more banks in other states pursuant to a
transaction in which the Alabama bank is the surviving bank.
 
In addition, one or more Alabama banks may enter into a
merger transaction with one or more out-of-state banks,
 
and an out-of-state bank resulting from such transaction may
continue to operate the acquired branches in Alabama.
 
The Dodd-Frank Act permits banks, including Alabama banks, to
branch anywhere in the United States.
8
The Company is a legal entity separate and distinct from the Bank.
 
Various
 
legal limitations restrict the Bank from lending
or otherwise supplying funds to the Company.
 
The Company and the Bank are subject to Sections 23A and 23B of the
Federal Reserve Act and Federal Reserve Regulation W thereunder.
 
Section 23A defines “covered transactions,” which
include extensions of credit, and limits a bank’s
 
covered transactions with any affiliate to 10% of such bank’s
 
capital and
surplus.
 
All covered and exempt transactions between a bank and its affiliates
 
must be on terms and conditions consistent
with safe and sound banking practices, and banks and their subsidiaries are prohibited
 
from purchasing low-quality assets
from the bank’s affiliates.
 
Finally, Section 23A requires
 
that all of a bank’s extensions of credit
 
to its affiliates be
appropriately secured by permissible collateral, generally United States government
 
or agency securities.
 
Section 23B of
the Federal Reserve Act generally requires covered and other transactions among affiliates
 
to be on terms and under
circumstances, including credit standards, that are substantially the same as or at
 
least as favorable to the bank or its
subsidiary as those prevailing at the time for similar transactions with unaffiliated
 
companies.
 
Federal Reserve policy and the Federal Deposit Insurance Act, as amended
 
by the Dodd-Frank Act, require a bank holding
company to act as a source of financial and managerial strength to its FDIC-insured
 
subsidiaries and to take measures to
preserve and protect such bank subsidiaries in situations where additional
 
investments in a bank subsidiary may not
otherwise be warranted.
 
In the event an FDIC-insured subsidiary becomes subject to a capital restoration
 
plan with its
regulators, the parent bank holding company is required to guarantee performance
 
of such plan up to 5% of the bank’s
assets, and such guarantee is given priority in bankruptcy of the bank holding company.
 
In addition, where a bank holding
company has more than one bank or thrift subsidiary,
 
each of the bank holding company’s
 
subsidiary depository institutions
may be responsible for any losses to the FDIC’s
 
Deposit Insurance Fund (“DIF”), if an affiliated depository institution
 
fails.
 
As a result, a bank holding company may be required to loan money to a bank subsidiary in the
 
form of subordinate capital
notes or other instruments which qualify as capital under bank regulatory rules.
 
However, any loans from the holding
company to such subsidiary banks likely will be unsecured and subordinated
 
to such bank’s depositors and to other
creditors of the bank.
 
See “Capital.”
As a result of legislation in 2014 and 2018, the Federal Reserve has revised its Small Bank
 
Holding Company Policy
Statement (the “Small BHC Policy”) to expand it to include thrift holding companies and
 
increase the size of “small” for
qualifying bank and thrift holding companies from $500 million to up to $3
 
billion of pro forma consolidated assets.
The Federal Reserve confirmed in 2018 that the Company is eligible for treatment as
 
a small banking holding company
under the Small BHC Policy.
 
As a result, unless and until the Company fails to qualify under the Small BHC Policy,
 
the
Company’s capital adequacy
 
will continue to be evaluated on a bank only basis.
 
See “Capital.”
Bank Regulation
The Bank is a state bank that is a member of the Federal Reserve.
 
It is subject to supervision, regulation and examination
by the Federal Reserve and the Alabama Superintendent, which monitor
 
all areas of the Bank’s operations, including
 
loans,
reserves, mortgages, issuances and redemption of capital securities, payment of dividends,
 
establishment of branches,
capital adequacy and compliance with laws.
 
The Bank is a member of the FDIC and, as such, its deposits are insured by
the FDIC to the maximum extent provided by law,
 
and is subject to various FDIC regulations.
 
See “FDIC Insurance
Assessments.”
Alabama law permits statewide branching by banks.
 
The powers granted to Alabama-chartered banks by state law include
certain provisions designed to provide such banks competitive equality with
 
national banks.
 
9
The Federal Reserve has adopted the Federal Financial Institutions Examination
 
Council’s (“FFIEC”) rating system,
 
which
assigns each financial institution a confidential composite “CAMELS” rating based
 
on an evaluation and rating of six
essential components of an institution’s
 
financial condition and operations:
 
Capital Adequacy,
 
Asset Quality, Management,
Earnings, Liquidity and Sensitivity to market risk, as well as the quality of risk
 
management practices.
 
For most
institutions, the FFIEC has indicated that market risk primarily reflects exposures
 
to changes in interest rates.
 
When
regulators evaluate this component, consideration is expected to
 
be given to: management’s ability to identify,
 
measure,
monitor and control market risk; the institution’s
 
size; the nature and complexity of its activities and its risk profile; and the
adequacy of its capital and earnings in relation to its level of market risk exposure.
 
Market risk is rated based upon, but not
limited to, an assessment of the sensitivity of the financial institution’s
 
earnings or the economic value of its capital to
adverse changes in interest rates, foreign exchange rates, commodity prices or
 
equity prices; management’s ability to
identify, measure,
 
monitor and control exposure to market risk; and the nature and complexity of interest
 
rate risk exposure
arising from non-trading positions. Composite ratings are based on evaluations of an institution’s
 
managerial, operational,
financial and compliance performance. The composite CAMELS rating is not an
 
arithmetical formula or rigid weighting of
numerical component ratings. Elements of subjectivity and examiner judgment,
 
especially as these relate to qualitative
assessments, are important elements in assigning ratings.
 
The federal bank regulatory agencies are reviewing the CAMELS
rating system and their consistency.
The GLB Act and related regulations require banks and their affiliated
 
companies to adopt and disclose privacy policies,
including policies regarding the sharing of personal information with third parties.
 
The GLB Act also permits bank
subsidiaries to engage in “financial activities” similar to those permitted to financial
 
holding companies. In December 2015,
Congress amended the GLB Act as part of the Fixing America’s
 
Surface Transportation Act. This amendment
 
provided
financial institutions that meet certain conditions an exemption to the requirement to deliver
 
an annual privacy notice. On
August 10, 2018, the federal Consumer Financial Protection Bureau (“CFPB”)
 
announced that it had finalized conforming
amendments to its implementing regulation, Regulation
P.
 
A variety of federal and state privacy laws govern the collection, safeguarding, sharing
 
and use of customer information,
and require that financial institutions have policies regarding information privacy
 
and security. Some
 
state laws also protect
the privacy of information of state residents and require adequate security of
 
such data, and certain state laws may,
 
in some
circumstances, require us to notify affected individuals of security breaches
 
of computer databases that contain their
personal information. These laws may also require us to notify law enforcement, regulators
 
or consumer reporting agencies
in the event of a data breach, as well as businesses and governmental agencies that own data.
Community Reinvestment Act and Consumer Laws
The Bank is subject to the provisions of the CRA and the Federal Reserve’s
 
regulations thereunder.
 
Under the CRA, all
FDIC-insured institutions have a continuing and affirmative obligation,
 
consistent with their safe and sound operation, to
help meet the credit needs for their entire communities, including low-
 
and moderate-income neighborhoods.
 
The CRA
requires a depository institution’s primary
 
federal regulator to periodically assess the institution’s
 
record of assessing and
meeting the credit needs of the communities served by that institution, including low
 
-
 
and moderate-income neighborhoods.
 
The bank regulatory agency’s
 
CRA assessment is publicly available.
 
Further, consideration of the CRA is required of any
FDIC-insured institution that has applied to: (i) charter a national bank; (ii) obtain deposit
 
insurance coverage for a newly-
chartered institution; (iii) establish a new branch office that accepts
 
deposits; (iv) relocate an office; or (v) merge or
consolidate with, or acquire the assets or assume the liabilities of, an FDIC-insured
 
financial institution.
 
In the case of bank
holding company applications to acquire a bank or other bank holding company,
 
the Federal Reserve will assess the records
of each subsidiary depository institution of the applicant bank holding company,
 
and such records may be the basis for
denying the application.
 
A less than satisfactory CRA rating will slow,
 
if not preclude, acquisitions, and new branches and
other expansion activities and may prevent a company from becoming a
 
financial holding company.
 
CRA agreements with private parties must be disclosed and annual
 
CRA reports must be made to a bank’s primary
 
federal
regulator.
 
A financial holding company election, and such election and financial holding company
 
activities are permitted
to be continued, only if any affiliated bank has not received less than a
 
“satisfactory” CRA rating.
 
The federal CRA
regulations require that evidence of discriminatory,
 
illegal or abusive lending practices be considered in the CRA
evaluation.
 
On December 13, 2019, the FDIC and OCC issued a joint notice of proposed rulemaking
 
seeking comment on modernizing
the agencies’ CRA regulations. The OCC issued final revised CRA Rules effective
 
October 1, 2020, which were repealed
in 2021.
 
The Federal bank regulators are cooperating and working on new CRA regulations,
 
which are expected to be
proposed around the end of March 2022.
10
The Bank is also subject to, among other things, the Equal Credit Opportunity Act (the
 
“ECOA”) and the Fair Housing Act
and other fair lending laws, which prohibit discrimination based on race or
 
color, religion, national origin, sex and familial
status in any aspect of a consumer or commercial credit or residential real estate transaction.
 
The Department of Justice
(the “DOJ”), and the federal bank regulatory agencies have issued an Interagency
 
Policy Statement on Discrimination in
Lending to provide guidance to financial institutions in determining whether discrimination
 
exists, how the agencies will
respond to lending discrimination, and what steps lenders might take to prevent
 
discriminatory lending practices.
 
The DOJ
has prosecuted what it regards as violations of the ECOA, the Fair Housing Act,
 
and the fair lending laws, generally.
The federal bank regulators have updated their guidance several times on overdrafts, including overdrafts
 
incurred at
automated teller machines and point of sale terminals.
 
Overdrafts also have been a CFPB concern, and in 2021 began
refocusing on this issue with a view to “insure that banks continue to evolve their
 
businesses to reduce reliance on overdraft
and not sufficient funds fees.”
 
Among other things, the federal regulators require banks to monitor accounts and
 
to limit
the use of overdrafts by customers as a form of short-term, high-cost credit,
 
including, for example, giving customers who
overdraw their accounts on more than six occasions where a fee is charged
 
in a rolling 12 month period a reasonable
opportunity to choose a less costly alternative and decide whether to continue
 
with fee-based overdraft coverage.
 
It also
encourages placing appropriate daily limits on overdraft fees, and asks banks to
 
consider eliminating overdraft fees for
transactions that overdraw an account by a
de minimis
 
amount.
 
Overdraft
 
policies, processes, fees and disclosures are
frequently the subject of litigation against banks in various jurisdictions. The
 
federal bank regulators continue to consider
responsible small dollar lending, including overdrafts and related fee issues and
 
issued principals for offering small-dollar
loans in a responsible manner on May 20, 2020.
 
The CFPB proposed on February 6, 2019 to rescind its mandatory
underwriting standards for loans covered by its 2017 Payday,
 
Vehicle
 
Title and Certain High-Cost Installment Loans rule,
and has separately proposed delaying the effectiveness of such 2017
 
rule.
The CFPB has a broad mandate to regulate consumer financial products and
 
services, whether or not offered by banks or
their affiliates.
 
The CFPB has the authority to adopt regulations and enforce various laws,
 
including fair lending laws, the
Truth in Lending Act, the Electronic Funds Transfer
 
Act, mortgage lending rules, the Truth in Savings Act, the Fair
 
Credit
Reporting Act and Privacy of Consumer Financial Information rules.
 
Although the CFPB does not examine or supervise
banks with less than $10 billion in assets,
 
banks of all sizes are affected by the CFPB’s
 
regulations, and the precedents set
in CFPB enforcement actions and interpretations.
 
Residential Mortgages
CFPB regulations require that lenders determine whether a consumer
 
has the ability to repay a mortgage loan.
 
These
regulations establish certain minimum requirements for creditors
 
when making ability to repay determinations, and provide
certain safe harbors from liability for mortgages that are "qualified mortgages"
 
and are not “higher-priced.”
 
Generally,
these CFPB regulations apply to all consumer,
 
closed-end loans secured by a dwelling including home-purchase loans,
refinancing and home equity loans—whether first or subordinate lien. Qualified
 
mortgages must generally satisfy detailed
requirements related to product features, underwriting standards,
 
and requirements where the total points and fees on a
mortgage loan cannot exceed specified amounts or percentages of the total loan amount.
 
Qualified mortgages must have:
(1) a term not exceeding 30 years; (2) regular periodic payments that do not result in
 
negative amortization, deferral of
principal repayment, or a balloon payment; (3) and be supported with documentation of
 
the borrower and its credit. On
December 10, 2020, the CFPB issued final rules related to “qualified mortgage” loans.
 
Lenders are required under the law
to determine that consumers have the ability to repay mortgage loans before
 
lenders make those loans. Loans that meet
standards for QM loans are presumed to be loans for which consumers have the ability to
 
repay.
We focus our residential
 
mortgage origination on qualified mortgages and those that meet our investors’ requirements,
 
but
we may make loans that do not meet the safe harbor requirements for
 
“qualified mortgages.”
The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018
 
(the “2018 Growth Act”) provides that
certain residential mortgages held in portfolio by banks with less than $10 billion
 
in consolidated assets automatically are
deemed “qualified mortgages.” This relieves smaller institutions from
 
many of the requirements to satisfy the criteria listed
above for “qualified mortgages.” Mortgages meeting the “qualified
 
mortgage” safe harbor may not have negative
amortization, must follow prepayment penalty limitations included
 
in the Truth in Lending Act, and may not have
 
fees
greater than 3% of the total value of the loan.
11
The Bank generally services the loans it originates, including those it sells.
 
The CFPB’s mortgage servicing standards
include requirements regarding force-placed insurance, certain notices
 
prior to rate adjustments on adjustable rate
mortgages, and periodic disclosures to borrowers. Servicers are prohibited
 
from processing foreclosures when a loan
modification is pending, and must wait until a loan is more than 120 days delinquent
 
before initiating a foreclosure action.
Servicers must provide borrowers with direct and ongoing access to its personnel,
 
and provide prompt review of any loss
mitigation application. Servicers must maintain accurate and accessible
 
mortgage records for the life of a loan and until one
year after the loan is paid off or transferred. These standards increase the cost and compliance
 
risks of servicing mortgage
loans, and the mandatory delays in foreclosures could result in loss of value on collateral
 
or the proceeds we may realize
from a sale of foreclosed property.
 
The Federal Housing Finance Authority (“FHFA”)
 
updated, effective January 1, 2016, The Federal National
 
Mortgage
Association’s (“Fannie Mae’s”)
 
and the Federal Home Loan Mortgage Corporation (“Freddie Mac’s”)
 
(individually and
collectively, “GSE”) repurchase
 
rules, including the kinds of loan defects that could lead to a repurchase request to, or
alternative remedies with, the mortgage loan originator or seller.
 
These rules became effective January 1, 2016.
 
FHFA also
has updated these GSEs’ representations and warranties framework and
 
provided an independent dispute resolution
(“IDR”) process to allow a neutral third party to resolve demands after the GSEs’ quality
 
control and appeal processes have
been exhausted.
The Bank is subject to the CFPB’s
 
integrated disclosure rules under the Truth in Lending
 
Act and the Real Estate
Settlement Procedures Act, referred to as “TRID”, for credit transactions secured
 
by real property. Our residential
 
mortgage
strategy, product offerings,
 
and profitability may change as these regulations are interpreted and applied
 
in practice, and
may also change due to any restructuring of Fannie Mae and Freddie Mac
 
as part of the resolution of their conservatorships.
The 2018 Growth Act reduced the scope of TRID rules by eliminating the wait time
 
for a mortgage, if an additional creditor
offers a consumer a second offer with a lower annual percentage
 
rate. Congress encouraged federal regulators to provide
better guidance on TRID in an effort to provide a clearer understanding
 
for consumers and bankers alike. The law also
provides partial exemptions from the collection, recording and reporting requirements
 
under Sections 304(b)(5) and (6) of
the Home Mortgage Disclosure Act (“HMDA”), for those banks with fewer than 500
 
closed-end mortgages or less than
500 open-end lines of credit in both of the preceding two years, provided
 
the bank’s rating under the CRA for the previous
two years has been at least “satisfactory.”
 
On August 31, 2018, the CFPB issued an interpretive and procedural rule to
implement and clarify these requirements under the 2018 Growth
 
Act.
 
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”)
 
was enacted on March 27, 2020. Section 4013 of
the CARES Act, “Temporary
 
Relief From Troubled Debt Restructurings,” provides banks
 
the option to temporarily
suspend certain requirements under ASC 340-10 TDR classifications
 
for a limited period of time to account for the effects
of COVID-19. On April 7, 2020, the Federal Reserve and the other banking agencies and
 
regulators issued a statement,
“Interagency Statement on Loan Modifications and Reporting for Financial Institutions
 
Working With
 
Customers Affected
by the Coronavirus (Revised)” (the “Interagency Statement on COVID-19
 
Loan Modifications”), to encourage banks to
work prudently with borrowers and to describe the agencies’ interpretation of
 
how accounting rules under ASC 310-40,
“Troubled Debt Restructurings by Creditors,”
 
apply to covered modifications. The Interagency Statement on COVID-19
Loan Modifications was supplemented on June 23, 2020 by the Interagency Examiner
 
Guidance for Assessing Safety and
Soundness Considering the Effect of the COVID-19 Pandemic on Institutions.
 
If a loan modification is eligible, a bank may
elect to account for the loan under section 4013 of the CARES Act. If a loan modification is not eligible
 
under section
4013, or if the bank elects not to account for the loan modification under section 4013,
 
the Revised Statement includes
criteria when a bank may presume a loan modification is not a TDR in accordance
 
with ASC 310-40.
Section 4021 of the CARES Act allows borrowers under 1-to-4 family residential
 
mortgage loans sold to Fannie Mae to
request forbearance to the servicer after affirming that such borrower
 
is experiencing financial hardships during the
COVID-19 emergency.
 
Such forbearance will be up to 180 days, subject to up to a 180 day extension. During
 
forbearance,
no fees, penalties or interest shall be charged beyond those applicable
 
if all contractual payments were fully and timely
paid. Except for vacant or abandoned properties, Fannie Mae servicers
 
may not initiate foreclosures on similar procedures
or related evictions or sales until December 31, 2020. On February 9. 2021,
 
the forbearance period was extended to March
31, 2021 after being extended to February 28, 2021. Borrowers
 
who are on a COVID-19 forbearance plan as of February
28, 2021 may apply for an additional forbearance extension of up to three additional
 
months. The Bank sells mortgage
loans to Fannie Mae and services these on an actual/actual basis. As a result, the Bank is
 
not obligated to make any
advances to Fannie Mae on principal and interest on such mortgage loans
 
where the borrower is entitled to forbearance.
FinCEN published a request for information and comment on December 15,
 
2021 seeking ways to streamline, modernize
the United States AML and countering the financing of terrorists.
12
Anti-Money Laundering and Sanctions
The International Money Laundering Abatement and Anti-Terr
 
orism Funding Act of 2001 specifies “know your customer”
requirements that obligate financial institutions to take actions to verify the
 
identity of the account holders in connection
with opening an account at any U.S. financial institution.
 
Bank regulators are required to consider compliance with anti-
money laundering laws in acting upon merger and acquisition and
 
other expansion proposals under the BHC Act and the
Bank Merger Act, and sanctions for violations of this Act can be imposed
 
in an amount equal to twice the sum involved in
the violating transaction, up to $1 million.
 
Under the Uniting and Strengthening America by Providing Appropriate Tools
 
Required to Intercept and Obstruct
Terrorism Act of 2001
 
(the “USA PATRIOT
 
Act”), financial institutions are subject to prohibitions against specified
financial transactions and account relationships as well as to enhanced due diligence
 
and “know your customer” standards
in their dealings with foreign financial institutions and foreign customers.
 
The USA PATRIOT
 
Act requires financial institutions to establish anti-money laundering programs,
 
and sets forth
minimum standards, or “pillars” for these programs, including:
 
the development of internal policies, procedures, and controls;
the designation of a compliance officer;
 
an ongoing employee training program;
 
an independent audit function to test the programs; and
ongoing customer due diligence and monitoring.
Federal Financial Crimes Enforcement Network (“FinCEN”) rules effective
 
May 2018 require banks to know the beneficial
owners of customers that are not natural persons, update customer information
 
in order to develop a customer risk profile,
and generally monitor such matters.
 
On August 13, 2020, the federal bank regulators issued a joint statement clarifying that
 
isolated or technical violations or
deficiencies are generally not considered the kinds of problems that
 
would result in an enforcement action. The statement
addresses how the agencies evaluate violations of individual pillars of the Bank Secrecy
 
Act and anti-money laundering
(“AML/BSA”) compliance program. It describes how the agencies incorporate
 
the customer due diligence regulations and
recordkeeping requirements issued by the U.S. Department of the Treasury
 
(“Treasury”) as part of the internal controls
pillar of a financial institution's AML/BSA compliance program.
On September 16, 2020, FinCEN issued an advanced notice of proposed
 
rulemaking seeking public comment on a wide
range of potential regulatory amendments under the Bank Secrecy Act. The
 
proposal seeks comment on incorporating an
“effective and reasonably designed” AML/BSA program component
 
to empower financial institutions to allocate resources
more effectively.
 
This component also would seek to implement a common understanding
 
between supervisory
 
agencies
and financial institutions regarding the necessary AML/BSA program elements,
 
and would seek to impose minimal
additional obligations on AML programs that already comply under the existing supervisory
 
framework.
 
On October 23, 2020, FinCEN and the Federal Reserve invited comment on a proposed
 
rule that would amend the
recordkeeping and travel rules under the Bank Secrecy Act, which would lower the applicable
 
threshold from $3,000 to
$250 for international transactions and apply these to transactions using
 
convertible virtual currencies and digital assets
with legal tender status.
On January 1, 2021, Congress enacted the Anti-Money Laundering
 
Act of 2020 and the Corporate Transparency Act
(collectively, the “AML
 
Act”), to strengthen anti-money laundering and countering terrorism
 
financing programs. Among
other things, the AML Act:
 
specifies uniform disclosure of beneficial ownership information for all U.S. and
 
foreign entities conducting business
in the U.S.;
 
increases potential fines and penalties for BSA violations and improves
 
whistleblower incentives;
13
 
codifies the risk-based approach to AML compliance;
 
modernizes AML systems;
 
expands the duties and powers FinCEN; and
 
emphasizes coordination and information-sharing among financial institutions, U.S.
 
financial regulators and foreign
financial regulators.
The United States has imposed various sanctions upon various foreign countries,
 
such as China, Iran, North Korea, Russia
and Venezuela,
 
and their certain government officials and persons.
 
Banks are required to comply with these sanctions,
which require additional customer screening and transaction monitoring.
Other Laws and Regulations
The Company is also required to comply with various corporate governance and
 
financial reporting requirements under the
Sarbanes-Oxley Act of 2002, as well as related rules and regulations adopted
 
by the SEC, the Public Company Accounting
Oversight Board and Nasdaq. In particular,
 
the Company is required to report annually on internal controls as part of its
annual report pursuant to Section 404 of the Sarbanes-Oxley Act.
 
The Company has evaluated its controls, including compliance
 
with the SEC rules on internal controls, and expects to
continue to spend significant amounts of time and money on compliance with these rules.
 
If the Company fails to comply
with these internal control rules in the future, it may materially adversely affect
 
its reputation, its ability to obtain the
necessary certifications to its financial statements, its relations
 
with its regulators and other financial institutions with which
it deals, and its ability to access the capital markets and offer
 
and sell Company securities on terms and conditions
acceptable to the Company. The Company’s
 
assessment of its financial reporting controls as of December 31, 2021 are
included in this report with no material weaknesses reported.
Payment of Dividends and Repurchases of Capital
 
Instruments
The Company is a legal entity separate and distinct from the Bank. The Company’s
 
primary source of cash is dividends
from the Bank. Prior regulatory approval is required if the total of all dividends declared
 
by a state member bank (such as
the Bank) in any calendar year will
 
exceed the sum of such bank’s
 
net profits for the year and its retained net profits for the
preceding two calendar years, less any required transfers to surplus. During 2021,
 
the Bank paid total cash dividends of
approximately $3.7 million to the Company.
 
At December 31, 2021, the Bank could have declared and paid additional
dividends of approximately $8.3 million without prior regulatory approval.
In addition, the Company and the Bank are subject to various general regulatory policies
 
and requirements relating to the
payment of dividends, including requirements to maintain capital above regulatory
 
minimums. The appropriate federal and
state regulatory authorities are authorized to determine when the payment of dividends
 
would be an unsafe or unsound
practice, and may prohibit such dividends. The Federal Reserve has indicated that paying
 
dividends that deplete a state
member bank’s capital base to an inadequate
 
level would be an unsafe and unsound banking practice. The
 
Federal Reserve
has indicated that depository institutions and their holding companies should
 
generally pay dividends only out of current
year’s operating earnings.
 
Federal Reserve Supervisory Letter SR-09-4 (February 24, 2009),
 
as revised December 21, 2015, applies to dividend
payments, stock redemptions and stock repurchases.
 
Prior consultation with the Federal Reserve supervisory staff is
required before:
redemptions or repurchases of capital instruments when the bank
 
holding company is experiencing financial
weakness; and
redemptions and purchases of common or perpetual preferred stock
 
which would reduce such Tier 1 capital at
end of the period compared to the beginning of the period.
 
 
14
Bank holding company directors must consider different factors
 
to ensure that its dividend level is prudent relative to
maintaining a strong financial position, and is not based on overly optimistic earnings
 
scenarios, such as potential events
that could affect its ability to pay,
 
while still maintaining a strong financial position. As a general matter,
 
the Federal
Reserve has indicated that the board of directors of a bank holding company
 
should consult with the Federal Reserve and
eliminate, defer or significantly reduce the bank holding company’s
 
dividends if:
 
its net income available to shareholders for the past four quarters, net of dividends previously
 
paid during that
period, is not sufficient to fully fund the dividends;
 
its prospective rate of earnings retention is not consistent with its capital needs and overall
 
current and
prospective financial condition; or
 
It will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy
 
ratios.
 
The Basel III Capital Rules further limit permissible dividends, stock repurchases and discretionary
 
bonuses by the
Company and the Bank, respectively,
 
unless the Company and the Bank meet capital conservation buffer
 
requirement
effective January 1, 2019.
 
See "Basel III Capital Rules."
Under a new provision of the capital rules, effective January 1,
 
2021, if a bank’s capital ratios are
 
within its buffer
requirements, the maximum amount of capital distributions it can
 
make is based on its eligible retained income. Eligible
retained income equals the greater of:
net income for the four preceding calendar quarters, net of any distributions and associated
 
tax effects not
already reflected in net income; or
the average net income over the preceding four quarters.
Regulatory Capital Changes
 
Simplification
The federal bank regulators issued final rules on July 22, 2019 simplifying their capital rules.
 
The last of these changes
become effective on April 1, 2020.
 
The principal changes for standardized approaches institutions, such the
 
Company and
the Bank are:
Deductions from capital for certain items, such as temporary difference
 
DTAs, MSAs and investments
 
in
unconsolidated were decreased to those amounts that individually exceed 25%
 
of CET1;
Institutions can elect to deduct investments in unconsolidated subsidiaries or subject
 
them to capital requirements;
and
Minority interests would be includable up to 10% of (i) CET1 capital, (ii) Tier
 
1 capital and (iii) total capital.
 
HVCRE
In December 2019, the federal banking regulators published a final rule, effective
 
April 1, 2020, to implement the “high
volatility commercial real estate,” or “HVCRE” changes in Section 214 of the 2018
 
Growth Act.
 
The new rules define
HVCRE loans as loans secured by land or improved real property that:
finance or refinance the acquisition, development, or construction of real property;
the purpose of such loans must be to acquire, develop, or improve such real property into
 
income producing
property; and
the repayment of the loan must depend on the future income or sales proceeds
 
from, or refinancing of, such real
property.
 
15
Various
 
exclusions from HVCRE are specified.
 
Banking institutions and their holding companies are required to assign
150% risk weight to HVCRE loans.
 
Community Capital Rule
On October 29, 2019, the federal banking regulators adopted, effective January
 
1, 2020, an optional community banking
leverage ratio framework applicable to depository institutions and their
 
holding companies intended to reduce regulatory
burdens for qualifying community banking organizations that do
 
not use advanced approaches capital measures, and that
have:
less than $10 billion of assets;
a leverage ratio greater than 9%;
off-balance sheet exposures of 25% or less of total consolidated
 
assets; and
trading assets plus trading liabilities of less than 5% of total consolidated assets.
The leverage ratio would be Tier 1 capital
 
divided by average total consolidated assets, taking into account the capital
simplification discussed above and the CECL related capital transitions.
The community bank leverage ratio will be the sole capital measure, and electing institutions
 
will not have to calculate or
use any other capital measure.
 
It is estimated that 85% of depository institutions will be eligible to use this rule.
 
The
Company expects it would be eligible to make such election, if the Company determined
 
it desirable.
 
After preliminary
consideration, the Company believes that it would still need to calculate the regulatory
 
capital ratios, which investors would
find helpful in comparing the Company to others.
Capital
The Federal Reserve has risk-based capital guidelines for bank holding companies
 
and state member banks, respectively.
 
These guidelines required at year end 2019 a minimum ratio of capital to risk-weighted
 
assets (including certain off-balance
sheet activities, such as standby letters of credit) and capital conservation buffer
 
of 10.5%.
 
Tier 1 capital includes common
equity and related retained earnings and a limited amount of qualifying preferred
 
stock, less goodwill and certain core
deposit intangibles.
 
Voting
 
common equity must be the predominant form of capital.
 
Tier 2 capital consists of non–
qualifying preferred stock, qualifying subordinated, perpetual, and/or mandatory convertible
 
debt, term subordinated debt
and intermediate term preferred stock, up to 45% of pretax unrealized holding
 
gains on available for sale equity securities
with readily determinable market values that are prudently valued,
 
and a limited amount of general loan loss allowance.
Tier 1 and Tier
 
2 capital equals total capital.
 
In addition, the Federal Reserve has established minimum leverage ratio guidelines
 
for bank holding companies not subject
to the Small BHC Policy, and
 
state member banks, which provide for a minimum leverage ratio of Tier
 
1 capital to adjusted
average quarterly assets (“leverage ratio”) equal to 4%.
 
However, bank regulators expect banks and bank holding
companies to operate with a higher leverage ratio.
 
The guidelines also provide that institutions experiencing internal
growth or making acquisitions will be expected to maintain strong capital positions
 
substantially above the minimum
supervisory levels without significant reliance on intangible assets.
 
Higher capital may be required in individual cases and
depending upon a bank holding company’s
 
risk profile.
 
All bank holding companies and banks are expected to hold capital
commensurate with the level and nature of their risks including the volume and severity of
 
their problem loans.
 
Lastly, the
Federal Reserve’s guidelines indicate
 
that the Federal Reserve will continue to consider a “tangible Tier
 
1 leverage ratio”
(deducting all intangibles) in evaluating proposals for expansion or new activity.
 
The level of Tier 1 capital to risk-adjusted
assets is becoming more widely used by the bank regulators to measure capital adequacy.
 
The Federal Reserve has not
advised the Company or the Bank of any specific minimum leverage ratio or
 
tangible Tier 1 leverage ratio applicable to
them. Under Federal Reserve policies, bank holding companies are generally expected
 
to operate with capital positions well
above the minimum ratios. The Federal Reserve believes the risk-based
 
ratios do not fully take into account the quality of
capital and interest rate, liquidity,
 
market and operational risks. Accordingly,
 
supervisory assessments of capital adequacy
may differ significantly from conclusions based solely on the
 
level of an organization’s risk
 
-based capital ratio.
16
The Federal Deposit Insurance Corporation Improvement Act of 1991
 
(“FDICIA”), among other things, requires the federal
banking agencies to take “prompt corrective action” regarding depository
 
institutions that do not meet minimum capital
requirements.
 
FDICIA establishes five capital tiers: “well capitalized,” “adequately capitalized,”
 
“undercapitalized,”
“significantly undercapitalized” and “critically undercapitalized.”
 
A depository institution’s capital tier
 
will depend upon
how its capital levels compare to various relevant capital measures and certain
 
other factors, as established by regulation.
 
See
 
“Prompt Corrective Action Rules.”
Basel III Capital Rules
The Federal Reserve and the other bank regulators adopted in June 2013 final capital rules
 
for bank holding companies and
banks implementing the Basel Committee on Banking Supervision’s
 
“Basel III: A Global Regulatory Framework for more
Resilient Banks and Banking Systems.”
 
These new U.S. capital rules are called the “Basel III Capital Rules,” and generally
were fully phased-in on January 1, 2019.
 
The Basel III Capital Rules limit Tier 1 capital
 
to common stock and noncumulative perpetual preferred stock, as well as
certain qualifying trust preferred securities and cumulative perpetual preferred
 
stock issued before May 19, 2010, each of
which were grandfathered in Tier 1 capital
 
for bank holding companies with less than $15 billion in assets.
 
The Company
had no qualifying trust preferred securities or cumulative preferred stock outstanding at December
 
31, 2020.
 
The Basel III
Capital Rules also introduced a new capital measure, “Common Equity Tier
 
I Capital” or “CET1.”
 
CET1 includes common
stock and related surplus, retained earnings and, subject to certain adjustments,
 
minority common equity interests in
subsidiaries.
 
CET1 is reduced by deductions for:
Goodwill and other intangibles, other than mortgage servicing assets (“MSRs”),
 
which are treated separately, net
of associated deferred tax liabilities (“DTLs”);
 
Deferred tax assets (“DTAs”)
 
arising from operating losses and tax credit carryforwards net of allowances and
DTLs;
 
Gains on sale from any securitization exposure; and
 
Defined benefit pension fund net assets (i.e., excess plan assets), net of associated DTLs.
The Company made a one-time election in 2015 and, as a result, CET1
 
will not be adjusted for certain accumulated other
comprehensive income (“AOCI”).
Additional “threshold deductions” of the following that are individually
 
greater than 10% of CET1 or collectively greater
than 15% of CET1 (after the above deductions are also made):
MSAs, net of associated DTLs;
DTAs arising from temporary
 
differences that could not be realized through net operating loss carrybacks,
 
net of
any valuation allowances and DTLs; and
Significant common stock investments in unconsolidated financial institutions,
 
net of associated DTLs.
As discussed below, recent regulations
 
change these items to simplify and improve their capital treatment.
Noncumulative perpetual preferred stock and Tier
 
1 minority interest not included in CET1, subject to limits, will qualify as
additional Tier I capital.
 
All other qualifying preferred stock, subordinated debt and qualifying minority interests
 
will be
included in Tier 2 capital.
In addition to the minimum risk-based capital requirements, a new “capital
 
conservation buffer” of CET1 capital of at least
2.5% of total risk weighted assets, will be required.
 
The capital conservation buffer will be calculated as the
lowest
 
of:
the banking organization’s
 
CET1 capital ratio minus 4.5%;
 
the banking organization’s
 
tier 1 risk-based capital ratio minus 6.0%; and
 
17
the banking organization’s
 
total risk-based capital ratio minus 8.0%.
Full compliance with the capital conservation buffer was required
 
by January 1, 2019. At such time, permissible dividends,
stock repurchases and discretionary bonuses will be limited to the following percentages
 
based on the capital conservation
buffer as calculated above, subject to any further regulatory
 
limitations, including those based on risk assessments and
enforcement actions:
Buffer %
Buffer % Limit
More than 2.50%
None
> 1.875% - 2.50%
60.0%
> 1.250% - 1.875%
40.0%
> 0.625% - 1.250%
20.0%
≤ 0.625
- 0 -
Effective March 20, 2020, the Federal Reserve and the other
 
federal banking regulators adopted an interim final rule that
amended the capital conservation buffer in light of the disruptive
 
effects of the COVID-19 pandemic. The interim final rule
was adopted as a final rule on August 26, 2020. The new rule revises the definition of
 
“eligible retained income” for
purposes of the maximum payout ratio to allow banking organizations
 
to more freely use their capital buffers to promote
lending and other financial intermediation activities, by making the limitations on
 
capital distributions more gradual. The
eligible retained income is now the greater of (i) net income for the four preceding quarters,
 
net of distributions and
associated tax effects not reflected in net income; and (ii) the average
 
of all net income over the preceding four quarters.
The interim final rule only affects the capital buffers, and banking
 
organizations were encouraged to make prudent capital
distribution decisions.
The various capital elements and total capital under the Basel III Capital Rules, as fully phased
 
in on January 1, 2019 are:
Fully Phased In
January 1, 2019
Minimum CET1
 
4.50%
CET1 Conservation Buffer
 
2.50%
Total CET1
 
7.0%
Deductions from CET1
100%
Minimum Tier 1 Capital
 
6.0%
Minimum Tier 1 Capital
plus
conservation buffer
8.5%
Minimum Total Capital
 
8.0%
Minimum Total Capital
plus
conservation buffer
10.5%
Changes in Risk-Weightings
The Basel III Capital Rules significantly change the risk weightings used to determine risk
 
weighted capital adequacy.
 
Among various other changes, the Basel III Capital Rules apply a 250% risk-weighting
 
to MSRs, DTAs that
 
cannot be
realized through net operating loss carry-backs and significant (greater
 
than 10%) investments in other financial
institutions.
 
A 150% risk-weighted category applies to “high volatility commercial real estate
 
loans,” or “HVCRE,” which
are credit facilities for the acquisition, construction or development of real property,
 
excluding one-to-four family
residential properties or commercial real estate projects where: (i) the loan-to-value ratio
 
is not in excess of interagency real
estate lending standards; and (ii) the borrower has contributed capital
 
equal to not less than 15% of the real estate’s
 
“as
completed” value before the loan was made.
18
The Basel III Capital Rules also changed some of the risk weightings used to determine
 
risk-weighted capital adequacy.
Among other things, the Basel III Capital Rules:
Assigned a 250% risk weight to MSRs;
Assigned up to a 1,250% risk weight to structured securities, including private label
 
mortgage securities, trust
preferred CDOs and asset backed securities;
Retained existing risk weights for residential mortgages, but assign a 100%
 
risk weight to most commercial real
estate loans and a 150% risk-weight for HVCRE;
Assigned a 150% risk weight to past due exposures (other than sovereign exposures
 
and residential mortgages);
 
Assigned a 250% risk weight to DTAs,
 
to the extent not deducted from capital (subject to certain maximums);
Retained the existing 100% risk weight for corporate and retail loans; and
Increased the risk weight for exposures to qualifying securities firms from 20% to
 
100%.
HVCRE loans currently have a risk weight of 150%. Section 214 of the 2018
 
Growth Act, restricts the federal bank
regulators from applying this risk weight except to certain ADC loans. The federal
 
bank regulators issued a notice of a
proposed rule on September 18, 2018 to implement Section 214
 
of the 2018 Growth Act, by revising the definition
HVCRE. If this proposal is adopted, it is expected that this proposal could
 
reduce the Company’s risk weighted assets
 
and
thereby may increase the Company’s
 
risk-weighted capital.
 
The Financial Accounting Standards Board’s
 
(the “FASB”) Accounting Standards
 
Update (“ASU”) No. 2016-13 “Financial
Instruments – Credit Losses (Topic
 
326): Measurement of Credit Losses on Financial Instruments” on June 16, 2016,
 
which
changed the loss model to take into account current expected credit losses (“CECL”)
 
in place of the incurred loss method.
The Federal Reserve and the other federal banking agencies adopted
 
rules effective on April 1, 2019 that allows banking
organizations to phase in the regulatory capital effect of a reduction
 
in retained earnings upon adoption of CECL over a
three year period.
 
On May 8, 2020, the agencies issued a statement describing the measurement of expected
 
credit losses
using the CECL methodology,
 
and updated concepts and practices in existing supervisory guidance that
 
remain applicable.
CECL is effective for the Company beginning January 1, 2023
 
and has not been adopted early. CECL’s
 
effects upon the
Company have not yet been determined.
 
Prompt Corrective Action Rules
All of the federal bank regulatory agencies’ regulations establish risk-adjusted
 
measures and relevant capital levels that
implement the “prompt corrective action” standards.
 
The relevant capital measures are the total risk-based capital ratio,
Tier 1 risk-based capital ratio, Common equity tier
 
1 capital ratio, as well as, the leverage capital ratio.
 
Under the
regulations, a state member bank will be:
well capitalized if it has a total risk-based capital ratio of 10% or greater,
 
a Tier 1 risk-based capital ratio of 8% or
greater, a Common equity tier 1 capital ratio
 
of 6.5% or greater, a leverage capital ratio of 5% or
 
greater and is not
subject to any written agreement, order,
 
capital directive or prompt corrective action directive by a federal bank
regulatory agency to maintain a specific capital level for any capital
 
measure;
“adequately capitalized” if it has a total risk-based capital ratio of 8% or greater,
 
a Tier 1 risk-based capital ratio of
6% or greater, a Common Equity Tier
 
1 capital ratio of 4.5% or greater, and generally has a leverage capital
 
ratio
of 4% or greater;
“undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier
 
1 risk-based capital ratio of less
than 6%, a Common Equity Tier 1 capital ratio of less than 4.5%
 
or generally has a leverage capital ratio of less
than 4%;
19
“significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a
 
Tier 1 risk-based capital
ratio of less than 4%, a Common Equity Tier 1 capital ratio
 
of less than 3%, or a leverage capital ratio of less than
3%; or
“critically undercapitalized” if its tangible equity is equal to or less than 2% to total assets.
The federal bank regulatory agencies have authority to require additional capital,
 
and have indicated that higher capital
levels may be required in light of market conditions and risk.
Depository institutions that are “adequately capitalized” for bank regulatory purposes
 
must receive a waiver from the FDIC
prior to accepting or renewing brokered deposits, and cannot pay interest rates or brokered
 
deposits that exceeds market
rates by more than 75 basis points.
 
Banks that are less than “adequately capitalized” cannot accept
 
or renew brokered
deposits.
 
FDICIA generally prohibits a depository institution from making any capital distribution
 
(including paying
dividends) or paying any management fee to its holding company,
 
if the depository institution thereafter would be
“undercapitalized”.
 
Institutions that are “undercapitalized” are subject to growth limitations and are
 
required to submit a
capital restoration plan for approval.
A depository institution’s parent holding company
 
must guarantee that the institution will comply with such capital
restoration plan.
 
The aggregate liability of the parent holding company is limited to the lesser
 
of 5% of the depository
institution’s total assets at the time it became
 
undercapitalized and the amount necessary to bring the institution into
compliance with applicable capital standards.
 
If a depository institution fails to submit an acceptable plan, it is treated
 
as if
it is “significantly undercapitalized”.
 
If the controlling holding company fails to fulfill its obligations under FDICIA and
files (or has filed against it) a petition under the federal Bankruptcy Code, the claim against
 
the holding company’s capital
restoration obligation would be entitled to a priority in such bankruptcy proceeding
 
over third party creditors of the bank
holding company.
Significantly undercapitalized
 
depository institutions may be subject to a number of requirements and restrictions,
including orders to sell sufficient voting stock to become “adequately
 
capitalized”, requirements to reduce total assets, and
cessation of receipt of deposits from correspondent banks.
 
“Critically undercapitalized” institutions are subject to the
appointment of a receiver or conservator.
 
Because the Company and the Bank exceed applicable capital requirements,
Company and Bank management do not believe that the provisions
 
of FDICIA have had or are expected to have any
material effect on the Company and the Bank or their respective operations.
 
Section 201 of the 2018 Growth Act provides that banks and bank holding companies
 
with consolidated assets of less than
$10 billion that meet a “community bank leverage ratio,” established by the federal
 
bank regulators between 8% and 10%,
are deemed to satisfy applicable risk-based capital requirements necessary to
 
be considered “well capitalized.” The federal
banking agencies have the discretion to determine that an institution does not qualify
 
for such treatment due to its risk
profile. An institution’s risk profile
 
may be assessed by its off-balance sheet exposure, trading of assets and liabilities,
notional derivatives’ exposure, and other methods.
 
The federal bank regulators implemented a CARES Act provision by replacing
 
interim final rules adopted in March 2020,
temporarily reducing the community bank leverage ratio threshold. The threshold is 8% through
 
the end of 2020, 8.5% for
2021, and 9% beginning January 1, 2022. Two
 
quarter grace periods are allowed to permit banks that temporarily fall
below these thresholds to remain well-capitalized for regulatory purposes.
FDICIA
FDICIA directs that each federal bank regulatory agency prescribe standards for depository
 
institutions and depository
institution holding companies relating to internal controls, information systems,
 
internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth composition,
 
a maximum ratio of classified assets to capital,
minimum earnings sufficient to absorb losses, a minimum ratio
 
of market value to book value for publicly traded shares,
safety and soundness, and such other standards as the federal bank regulatory agencies
 
deem appropriate.
 
20
Enforcement Policies and Actions
The Federal Reserve and the Alabama Superintendent monitor compliance
 
with laws and regulations.
 
The CFPB monitors
compliance with laws and regulations applicable to consumer financial products
 
and services.
 
Violations of laws and
regulations, or other unsafe and unsound practices, may result in these agencies imposing
 
fines, penalties and/or restitution,
cease and desist orders, or taking other formal or informal enforcement actions.
 
Under certain circumstances, these
agencies may enforce these remedies directly against officers,
 
directors, employees and others participating in the affairs
 
of
a bank or bank holding company, in the
 
form of fines, penalties, or the recovery,
 
or claw-back, of compensation.
 
The
federal prudential banking regulators have been bringing more
 
enforcement actions recently.
Fiscal and Monetary Policy
Banking is a business that depends on interest rate differentials.
 
In general, the difference between the interest paid by a
bank on its deposits and its other borrowings, and the interest received by a bank on its loans and
 
securities holdings,
constitutes the major portion of a bank’s earnings.
 
Thus, the earnings and growth of the Company and the Bank, as well as
the values of, and earnings on, its assets and the costs of its deposits and other liabilities are
 
subject to the influence of
economic conditions generally,
 
both domestic and foreign, and also to the monetary and fiscal policies of the United States
and its agencies, particularly the Federal Reserve.
 
The Federal Reserve regulates the supply of money through various
means, including open market dealings in United States government securities,
 
the setting of discount rate at which banks
may borrow from the Federal Reserve, and the reserve requirements on deposits.
 
The Federal Reserve has been paying interest on depository institutions’ required and
 
excess reserve balances since October
2008.
 
The payment of interest on excess reserve balances was expected to give the Federal
 
Reserve greater scope to use its
lending programs to address conditions in credit markets while also
 
maintaining the federal funds rate close to the target
rate established by the Federal Open Market Committee.
 
The Federal Reserve has indicated that it may use this authority to
implement a mandatory policy to reduce excess liquidity,
 
in the
 
event of inflation or the threat of inflation.
 
In April 2010, the Federal Reserve Board amended Regulation D (Reserve
 
Requirements of Depository Institutions)
authorizing the Reserve Banks to offer term deposits to certain institutions.
 
Term deposits,
 
which are deposits with
specified maturity dates, will be offered through a Term
 
Deposit Facility.
 
Term deposits will be
 
one of several tools that
the Federal Reserve could employ to drain reserves when policymakers judge that
 
it is appropriate to begin moving to a less
accommodative stance of monetary policy.
 
In 2011, the Federal Reserve repealed its historical Regulation
 
Q to permit banks to pay interest on demand deposits.
On March 3, 2020, the Federal Reserve reduced the Federal Funds rate target by 50
 
basis points to 1.00-1.25%. The Federal
Reserve further reduced the Federal Funds Rate target by an additional
 
100 basis points to 0-0.25% on March 16, 2020. The
Federal Reserve established various liquidity facilities pursuant to section 13(3)
 
of the Federal Reserve Act to help stabilize
the financial system.
 
As a result of inflation, the decline in serious COVID-19 cases, and the strengthening of
 
the economy
following the March 2020 outbreak of the COVID-19 pandemic, the Federal
 
Reserve is considering increasing the discount
rate and reducing its holdings of securities.
In light of disruptions in economic conditions caused by the outbreak of COVID-19 and the
 
stress in U.S. financial markets,
the Federal Reserve, Congress and the Department of the Treasury
 
took a host of fiscal and monetary measures to minimize
the economic effect of COVID-19.
 
The CARES Act provided a $2 trillion stimulus package and various
 
measures to provide relief from the COVID-19
pandemic, including:
The Paycheck Protection Program (“PPP”), which expands eligibility for special new SBA
 
guaranteed loans,
forgivable loans and other relief to small businesses affected
 
by COVID-19.
 
A new $500 billion federal stimulus program for air carriers and other companies in severely
 
distressed sectors of
the American economy. The lending
 
programs impose stock buyback, dividend, executive compensation, and
other restrictions on direct loan recipients.
 
Optional temporary suspension of certain requirements under ASC 340-10 TDR
 
classifications for a limited period
of time to account for the effects of COVID-19.
The creation of rapid tax rebates and expansion of unemployment benefits to
 
provide relief to individuals.
 
 
 
 
 
 
 
 
 
 
 
 
21
Substantial federal spending and significant changes for health care companies,
 
providers, and patients.
 
Over $525 billion of PPP loans were made in 2020.
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits,
 
and Venues
 
Act (the “Economic Aid
Act”) was signed into law. The
 
Economic Aid Act provides a second $900 billion stimulus package, including
 
$325 billion
in additional PPP loans, changed the eligibility rules to focus more on smaller business,
 
further enhances other Small
Business Association programs.
 
The nature and timing of any changes in monetary policies and their effect
 
on the Company and the Bank cannot be
predicted. The turnover of a majority of the Federal Reserve Board and
 
the members of its FOMC and the appointment of a
new Federal Reserve Chairman may result in changes in policy and the timing and amount
 
of monetary policy
normalization.
FDIC Insurance Assessments
The Bank’s deposits are insured
 
by the FDIC’s DIF,
 
and the Bank is subject to FDIC assessments for its deposit insurance.
 
Assessments by the FDIC to pay interest on Financing Corporation (“FICO”)
 
bonds ended in September 2019.
Since 2011, and as discussed above under “Recent Regulatory
 
Developments”, the FDIC has been calculating assessments
based on an institution’s average consolidated
 
total assets less its average tangible equity (the
 
“FDIC Assessment Base”) in
accordance with changes mandated by the Dodd-Frank Act.
 
The FDIC changed its assessment rates which shifted part of
the burden of deposit insurance premiums toward depository institutions relying on
 
funding sources other than deposits.
In 2016, the FDIC again changed its deposit insurance pricing and eliminated all risk categories
 
and now uses “financial
ratios method” based on CAMELS composite ratings to determine assessment
 
rates for small established institutions with
less than $10 billion in assets (“Small Banks”).
 
The financial ratios method sets a maximum assessment for CAMELS 1
and 2 rated banks, and set minimum assessments for lower rated institutions.
 
All basis points are annual amounts.
 
The following table shows the FDIC assessment schedule for 2020
 
applicable to Small Banks, such as the Bank.
 
Established Small Institution
CAMELS Composite
1 or 2
3
4 or 5
Initial Base Assessment Rule
3 to 16 basis points
6 to 30 basis points
16 to 30 basis points
Unsecured Debt Adjustment
-5 to 0 basis points
-5 to 0 basis points
-5 to 0 basis points
Total Base Assessment
 
Rate
1.5 to 16 basis points
3 to 30 basis points
11 to 30 basis points
On March 15, 2016 the FDIC implemented Dodd-Frank Act provisions by raising the DIF’s
 
minimum Reserve Ratio from
1.15% to 1.35%.
 
The FDIC imposed a 4.5 basis point annual surcharge on insured depository
 
institutions with total
consolidated assets of $10 billion or more (“Large Banks”).
 
The new rules grant credits to smaller banks for the portion of
their regular assessments that contribute to increasing the reserve ratio from 1.15%
 
to 1.35%.
The FDIC’s reserve ratio reached 1.36%
 
on September 30, 2018, exceeding the minimum requirement.
 
As a result, deposit
insurance surcharges on Large Banks ceased, and smaller
 
banks will receive credits against their deposit assessments from
the FDIC for their portion of assessments that contributed to the growth in the reserve ratio
 
from 1.15% to 1.35%.
 
The
Bank’s credit was $0.2 million, and
 
was received and applied against the Bank’s deposit
 
insurance assessments during 2019
and 2020.
 
Given the extraordinary growth in deposits in the first six months of 2020 due
 
to the pandemic and government
stimulus, the reserve ratio declined below 1.35% to 1.30%. The FDIC issued a restoration
 
plan on September 15, 2020
designed to restore the reserve ratio to at least the statutory minimum of 1.35%
 
within 8 years. Although the FDIC
maintained current assessment rates, the FDIC may increase deposit assessment rates
 
by up to two basis points without
notice, or more following notice and a comment period, to meet the required reserve
 
ratio.
 
22
On June 22, 2020, the FDIC issued a final rule designed to mitigate the deposit insurance
 
assessment effect of the PPP and
the related liquidity programs established by the Federal Reserve. Specifically
 
,
 
the rule removes the effects of participating
in PPP and liquidity facilities from the various risk measures used to calculate
 
assessment rates and provides an offset to
assessments for the increase in assessment base rates attributed to participation
 
in the PPP and liquidity facilities.
 
Prior to June 30, 2016, when the new assessment system became effective,
 
the Bank’s overall rate for assessment
calculations was 9 basis points or less, which was within the range of assessment
 
rates for the lowest “risk category” under
the former FDIC assessment rules.
 
The Company recorded FDIC insurance premiums expenses of $0.3
 
and $0.1 million in
2021 and 2020, respectively.
Lending Practices
The federal bank regulatory agencies released guidance in 2006
 
on “Concentrations in Commercial Real Estate Lending”
(the “Guidance”).
 
The Guidance defines CRE loans as exposures secured by raw land, land development
 
and construction
(including 1-4 family residential construction), multi-family property,
 
and non-farm nonresidential property where the
primary or a significant source of repayment is derived from rental income associated
 
with the property (that is, loans for
which 50% or more of the source of repayment comes from third party,
 
non-affiliated, rental income) or the proceeds of the
sale, refinancing, or permanent financing of this property.
 
Loans to REITs and unsecured
 
loans to developers that closely
correlate to the inherent risks in CRE markets would also be considered
 
CRE loans under the Guidance.
 
Loans on owner
occupied CRE are generally excluded.
 
In December 2015, the Federal Reserve and other bank regulators issued an
interagency statement to highlight prudent risk management practices
 
from existing guidance that regulated financial
institutions and made recommendations regarding maintaining capital levels
 
commensurate with the level and nature of
their CRE concentration risk.
The Guidance requires that appropriate processes be in place to identify,
 
monitor and control risks associated with real
estate lending concentrations.
 
This could include enhanced strategic planning, CRE underwriting policies, risk
management, internal controls, portfolio stress testing and risk exposure limits as
 
well as appropriately designed
compensation and incentive programs.
 
Higher allowances for loan losses and capital levels may also be required.
 
The
Guidance is triggered when either:
Total reported
 
loans for construction, land development, and other land of 100% or more of a bank’s
 
total capital; or
Total reported
 
loans secured by multifamily and nonfarm nonresidential properties and
 
loans for construction, land
development, and other land are 300% or more of a bank’s
 
total risk-based capital.
 
This Guidance was supplemented by the Interagency Statement on Prudent
 
Risk Management for Commercial Real Estate
Lending (December 18, 2015).
 
The Guidance also applies when a bank has a sharp increase in CRE loans or
 
has significant
concentrations of CRE secured by a particular property type.
 
The Guidance did not apply to the Bank’s
 
CRE lending activities during 2020 or 2021.
 
At December 31, 2021, the Bank
had outstanding $32.4 million in construction and land development loans and $229.8
 
million in total CRE loans (excluding
owner occupied), which represent approximately 30.8% and 218.5%,
 
respectively, of the Bank’s
 
total risk-based capital at
December 31, 2021.
 
The Company has always had significant exposures to loans secured
 
by commercial real estate due to
the nature of its markets and the loan needs of both its retail and commercial customers.
 
The Company believes its long
term experience in CRE lending, underwriting policies, internal controls, and other policies
 
currently in place, as well as its
loan and credit monitoring and administration procedures, are generally appropriate
 
to manage its concentrations as
required under the Guidance.
 
In 2013, the Federal Reserve and other banking regulators issued their “Interagency Guidance
 
on Leveraged Lending”
highlighting standards for originating leveraged transactions and
 
managing leveraged portfolios, as well as requiring banks
to identify their highly leveraged transactions, or HLTs.
 
The Government Accountability Office issued a statement
 
on
October 23, 2017 that this guidance constituted a “rule” for purposes of the Congressional
 
Review Act, which provides
Congress with the right to review the guidance and issue a joint resolution for
 
signature by the President disapproving it.
 
No such action was taken, and instead, the federal bank regulators issued a September
 
11, 2018 “Statement Reaffirming
 
the
Role of Supervisory Guidance.”
 
This Statement indicated that guidance does not have the force or effect
 
of law or provide
the basis for enforcement actions, but this guidance can outline supervisory agencies’
 
views of supervisory expectations and
priorities, and appropriate practices.
 
The federal bank regulators continue to identify elevated risks in leveraged loans and
shared national credits.
23
The Bank did not have any
 
loans at year-end 2021 or 2020 that were leveraged loans
 
subject to the Interagency Guidance
on Leveraged Lending or that were shared national credits.
Other Dodd-Frank Act Provisions
In addition to the capital, liquidity and FDIC deposit insurance changes discussed above,
 
some of the provisions of the
Dodd-Frank Act we believe may affect us are set forth below.
Executive Compensation
The Dodd-Frank Act provides shareholders of all public companies with a say on executive
 
compensation.
 
Under the
Dodd-Frank Act, each company must give its shareholders the opportunity to
 
vote on the compensation of its executives, on
a non-binding advisory basis, at least once every three years.
 
The Dodd-Frank Act also adds disclosure and voting
requirements for golden parachute compensation that is payable to
 
named executive officers in connection with sale
transactions.
 
The SEC is required under the Dodd-Frank Act to issue rules obligating companies to disclose
 
in proxy materials for annual
shareholders meetings, information that shows the relationship between executive
 
compensation actually paid to their
named executive officers and their financial performance,
 
taking into account any change in the value of the shares of a
company’s stock and dividends or
 
distributions.
 
The Dodd-Frank Act also provides that a company’s
 
compensation
committee may only select a consultant, legal counsel or other advisor on
 
methods of compensation after taking into
consideration factors to be identified by the SEC that affect the independence
 
of a compensation consultant, legal counsel
or other advisor.
Section 954 of the Dodd-Frank Act added section 10D to the Exchange Act.
 
Section 10D directs the SEC to adopt rules
prohibiting a national securities exchange or association from listing a company
 
unless it develops, implements, and
discloses a policy regarding the recovery or “claw-back” of executive compensation
 
in certain circumstances.
 
The policy
must require that, in the event an accounting restatement due to material noncompliance
 
with a financial reporting
requirement under the federal securities laws, the company will recover
 
from any current or former executive officer any
incentive-based compensation (including stock options) received
 
during the three year period preceding the date of the
restatement, which is in excess of what would have been paid based
 
on the restated financial statements.
 
There is no
requirement of wrongdoing by the executive, and the claw-back is
 
mandatory and applies to all executive officers.
 
Section
954 augments section 304 of the Sarbanes-Oxley Act, which requires the CEO and
 
CFO to return any bonus or other
incentive or equity-based compensation received during the 12
 
months following the date of similarly inaccurate financial
statements, as well as any profit received from the sale of employer securities during the period,
 
if the restatement was due
to misconduct.
 
Unlike section 304, under which only the SEC may seek recoupment, the Dodd
 
-Frank Act requires the
Company to seek the return of compensation.
 
The SEC adopted rules in September 2013 to implement pay ratios pursuant to Section 953
 
of the Dodd-Frank Act, which
apply to fiscal year 2017 annual reports and proxy statements.
 
The SEC proposed Rule 10D-1 under Section 954 on July
1, 2015 which would direct Nasdaq and the other national securities exchanges to adopt
 
listing standards requiring
companies to adopt policies requiring executive officers to pay back erroneously
 
awarded incentive-based compensation.
 
In February 2017, the acting SEC Chairman indicated interest in reconsidering
 
the pay ratio rule.
 
The Dodd-Frank Act, Section 955, requires the SEC, by rule, to require that each company
 
disclose in the proxy
 
materials
for its annual meetings whether an employee or board member is permitted to
 
purchase financial instruments designed to
hedge or offset decreases in the market value of equity securities granted
 
as compensation or otherwise held by the
employee or board member.
 
The SEC proposed implementing rules in February 2015, though the rules
 
have not been
implemented to date.
Section 956 of the Dodd-Frank Act prohibits incentive-based compensation arrangements
 
that encourage inappropriate risk
taking by covered financial institutions, are deemed to be excessive, or that
 
may lead to material losses.
 
In June 2010, the
federal bank regulators adopted Guidance on Sound Incentive Compensation Policies,
 
which, although targeted to larger,
more complex organizations than the Company,
 
includes principles that have been applied to smaller organizations
 
similar
to the Company.
 
This Guidance applies to incentive compensation to executives as well as employees,
 
who, “individually
or a part of a group, have the ability to expose the relevant banking organization to
 
material amounts of risk.”
 
Incentive
compensation should:
Provide employees incentives that appropriately balance risk and reward;
24
Be compatible with effective controls and risk-management;
 
and
Be supported by strong corporate governance, including active and effective
 
oversight by the organization’s
 
board
of directors.
The federal bank regulators, the SEC and other regulators proposed regulations implementing
 
Section 956 in April 2011,
which would have been applicable to, among others, depository institutions and
 
their holding companies with $1 billion or
more in assets.
 
An advance notice of a revised proposed joint rulemaking under Section 956
 
was published by the financial
services regulators in May 2016, but these rules have not been adopted.
Debit Card Interchange
 
Fees
The “Durbin Amendment” to the Dodd-Frank Act and implementing Federal Reserve
 
regulations provide that interchanged
transaction fees for electronic debit transactions be “reasonable” and proportional
 
to certain costs associated with
processing the transactions.
 
The Durbin Amendment and the Federal Reserve rules thereunder are not
 
applicable to banks
with assets less than $10 billion.
 
Other Legislative and Regulatory Changes
Various
 
legislative and regulatory proposals, including substantial changes in banking,
 
and the regulation of banks, thrifts
and other financial institutions, compensation, and the regulation of financial
 
markets and their participants and financial
instruments, and the regulators of all of these, as well as the taxation of these entities, are being considered
 
by the executive
branch of the federal government, Congress and various state governments, including
 
Alabama.
 
President Biden has frozen new rulemaking generally,
 
and has rescinded various of his predecessor’s executive orders,
including the February 3, 2017 executive order containing “Core Principles
 
for Regulating the United States Financial
System” (“Core Principles”).
 
The Core Principles directed the Secretary of the Treasury
 
to consult with the heads of
Financial Stability Oversight Council’s
 
members and report to the President periodically thereafter on how laws and
government policies promote the Core Principles and to identify laws, regulations,
 
guidance and reporting that inhibit
financial services regulation.
 
The President has also issued an Executive Order 14036 on Promoting Competition
 
in the
American Economy (July 9, 2021), which may affect the federal
 
bank regulators’ reviews of bank and bank holding
company mergers.
 
The OCC, the FDIC and the CFPB have made proposals to further scrutinize
 
mergers, especially where
the confirming institutions have assets greater than $100 million.
 
The President’s Working
 
Group and various agencies
have also been working on the regulation of crypto assets, including stable coin, and access
 
to the payments system.
25
The 2018 Growth Act, which, was enacted on May 24, 2018, amends the Dodd
 
-Frank Act, the BHC Act, the Federal
Deposit Insurance Act and other federal banking and securities laws to provide
 
regulatory relief in these areas:
 
consumer credit and mortgage lending;
 
capital requirements;
 
Volcker
 
Rule compliance;
stress testing and enhanced prudential standards;
increased the asset threshold under the Federal Reserve’s
 
Small BHC Policy from $1 billion to $3 billion; and
 
capital formation.
We believe the 2018
 
Growth Act has positively affected our business.
 
The following provisions of the 2018 Growth Act
may be especially helpful to banks of our size as regulations adopted in 2019
 
became effective:
 
“qualifying community banks,” defined as institutions with total consolidated
 
assets of less than $10 billion, which
meet a “community bank leverage ratio” of 8.00% to 10.00%, may be deemed to
 
have satisfied applicable risk
based capital requirements as well as the capital ratio requirements;
 
section 13(h) of the BHC Act, or the “Volcker
 
Rule,” is amended to exempt from the Volcker
 
Rule, banks with
total consolidated assets valued at less than $10 billion (“community banking organizations”),
 
and trading assets
and liabilities comprising not more than 5.00% of total assets;
 
“reciprocal deposits” will not be considered “brokered deposits” for
 
FDIC purposes, provided such deposits
 
do not
exceed the lesser of $5 billion or 20% of the bank’s total
 
liabilities; and
The Volcker
 
Rule change may enable us to invest in certain collateralized loan obligations that are treated
 
as “covered
funds” prohibited to banking entities by the Volcker
 
Rule. Reciprocal deposits, such as CDARs, may expand our funding
sources without being subjected to FDIC limitations and potential insurance assessments
 
increases for brokered deposits.
 
On July 9, 2019, the federal banking agencies, together with the SEC and the
 
Commodities Futures Trading Commission
(“CFTC”), issued a final rule excluding qualifying community banking organizations
 
from the Volcker
 
Rule pursuant to the
2018 Growth Act. The Volcker
 
Rule change may enable us to invest in certain collateralized loan obligations that are
treated as “covered funds” and other investments prohibited to banking entities by the Volcker
 
Rule.
The applicable agencies also issued final rules simplifying the Volcker
 
Rule proprietary trading restrictions effective
January 1, 2020. On June 25, 2020, the agencies adopted a final rule simplifying
 
the Volcker
 
Rule’s covered fund
provisions effective October 1, 2020.
The FDIC announced on December 19, 2018 a final rule allows reciprocal deposits to be
 
excluded from “brokered
deposits” up to the lesser of $5 billion or 20% of their total liabilities.
 
Institutions that are not both well capitalized and
well rated are permitted to exclude reciprocal deposits from brokered
 
deposits in certain circumstances.
The FDIC issued comprehensive changes to its brokered deposit rules effective
 
April 1, 2021. The revised rules establishes
new standards for determining whether an entity meets the statutory definition of
 
“deposit broker,” and identifies a number
of business that automatically meet the “primary purpose exception” from a
 
“deposit broker.”
 
The revisions also provide
an application process for entities that seek a “primary purpose exception,” but do
 
not meet one of the designated
exceptions.”
 
The new rules may provide us greater future flexibility,
 
but we had no brokered deposits at December 31,
2020 or 2021, and historically have not relied on brokered deposits.
26
On November 20, 2020, the Federal Reserve and the other federal bank regulators
 
issued temporary relief for community
banks with less than $10 billion in total assets as of December 31, 2019
 
related to certain regulations and reporting
requirements that largely result from growth due to the various relief and stimulus
 
actions in response to the COVID-19
pandemic. In particular, the interim final rule permits these
 
institutions to use asset data as of December 31, 2019, to
determine the applicability of various regulatory asset thresholds during calendar
 
years 2020 and 2021. For the same
reasons, the Federal Reserve temporarily revised the instructions to a number of its regulatory
 
reports to provide that
community banking organizations may use asset data as of December
 
31, 2019, in order to determine reporting
requirements for reports due in calendar years 2020 or 2021.
 
On November 30, 2020, the bank regulators issued a statement urging banks
 
to cease entering into new contracts using U.S.
dollar LIBOR rates as soon as practicable and in any event by December 31, 2021,
 
to effect orderly, and safe and sound
LIBOR transition. Banks were reminded that operating with insufficient
 
fallback interest rates could undermine financial
stability and banks’ safety and soundness.
 
Any alternative reference rate may be used that a bank determines is appropriate
for its funding and customer needs.
 
Alabama passed the LIBOR Discontinuance and Replacement Act of 2021
 
in April 202
to deal with the LIBOR transition.
 
Congress is also considering LIBOR transition legislation.
Certain of these new rules, and proposals, if adopted, these proposals could significantly
 
change the regulation or
operations of banks and the financial services industry.
 
New regulations and statutes are regularly proposed
 
that contain
wide-ranging proposals for altering the structures, regulations and competitive
 
relationships of the nation’s financial
institutions.
 
ITEM 1A. RISK FACTORS
Any of the following risks could harm our business, results of operations and financial
 
condition and an investment in our
stock.
 
The risks discussed below also include forward-looking statements, and our
 
actual results may differ substantially
from those discussed in these forward-looking statements.
 
Operational Risks
Market conditions and economic cyclicality may adversely affect our industry.
 
We believe the following,
 
among other things, may affect us in 2022:
The COVID-19 pandemic disrupted the economy beginning late in the first quarter
 
of 2020, and continues.
 
Auburn University, government
 
agencies and businesses were limited to remote work and gatherings
 
were limited.
 
Supply chains continue to be disrupted and unemployment spiked and remains
 
high.
 
Hotels, motels, restaurants,
retail and shopping centers were especially affected.
Extraordinary monetary and fiscal stimulus in 2020 and in early 2021
 
have offset certain of the pandemic’s
adverse economic effects.
 
Inflation is running at levels unseen in decades and the Federal Reserve is
contemplating raising target interest rates and reducing its securities
 
holdings.
 
The nature and timing of any future
changes in monetary and fiscal policies and their effect on us cannot be
 
predicted.
Market developments, including unemployment, price levels, stock and
 
bond market volatility, and changes,
including those resulting from COVID-19 and the pace of vaccination and expected
 
declines in serious COVID-19
cases, and Russia’s invasion of Ukraine affect
 
consumer confidence levels, economic activity and inflation.
 
Changes in payment behaviors and payment rates may increase in delinquencies and
 
default rates, which could
affect our earnings and credit quality.
Our ability to assess the creditworthiness of our customers and those we do business
 
with, and the values of our
assets and loan collateral may be adversely affected and less
 
predictable as a result of the pandemic and
government responses.
 
The accounting for loan modifications and deferrals may provide only temporary
 
relief.
 
The process we use to estimate losses inherent in our credit exposure or estimate the
 
value of certain assets
requires difficult, subjective, and complex judgments, including
 
forecasts of economic conditions and how those
economic predictions might affect the ability of our borrowers
 
to repay their loans or the value of assets.
27
The end of the LIBOR reference rate is currently scheduled for most tenors by June 30, 2023,
 
although U.S. bank
regulators informed banks November 30, 2020 that they should stop using LIBOR
 
for new loans and contracts and
derivatives, including hedging, and involves risks of potential marked disruption and costs
 
of compliance and
conversion.
 
New hedges may not be as effective as hedges based on LIBOR.
Nonperforming and similar assets take significant time to resolve
 
and may adversely affect our results of operations
 
and
financial condition.
Our nonperforming loans were 0.10% of total loans as of December 31,
 
2021, and we had $0.4 million in other real estate
owned (“OREO”).
 
Non-performing assets may adversely affect our net income in various
 
ways.
 
We do
 
not record interest
income on nonaccrual loans or OREO and these assets require higher loan administration
 
and other costs, thereby adversely
affecting our income.
 
Decreases in the value of these assets, or the underlying collateral, or
 
in the related borrowers’
performance or financial condition, whether or not due to economic and
 
market conditions beyond our control, could
adversely affect our business, results of operations and
 
financial condition.
 
In addition, the resolution of nonperforming
assets requires commitments of time from management, which can be detrimental
 
to the performance of their other
responsibilities. Our non-performing assets may be adversely affected
 
by loan deferrals and modifications made in response
to the pandemic and the moratoria on foreclosures and evictions.
 
There can be no assurance that we will not experience
increases in nonperforming loans in the future, much of which is affected
 
by the economy and the levels of interest rates,
generally.
Our allowance for loan losses may prove
 
inadequate or we may be negatively affected by credit risk exposures.
We periodically review
 
our allowance for loan losses for adequacy considering economic conditions and
 
trends, collateral
values and credit quality indicators, including past charge-off experience
 
and levels of past due loans and nonperforming
assets.
 
We cannot be
 
certain that our allowance for loan losses will be adequate over time to
 
cover credit losses in our
portfolio because of unanticipated adverse changes in the economy,
 
including the continuing effects of the pandemic and
fiscal and monetary response to COVID-19, loan modifications and deferrals,
 
market conditions or events adversely
affecting specific customers, industries or markets, including
 
disruptions of supply chains and war, and changes
 
in
borrower behaviors.
 
Certain borrowers may not recover fully or may fail as a result of COVID
 
-19 effects.
 
If the credit
quality of our customer base materially decreases, if the risk profile of the
 
market, industry or group of customers changes
materially or weaknesses in the real estate markets worsen, borrower payment
 
behaviors change, or if our allowance for
loan losses is not adequate, our business, financial condition, including our liquidity
 
and capital, and results of operations
could be materially adversely affected.
 
CECL, a new accounting standard for estimating loan losses, is effective
 
for the
Company beginning January 1, 2023, and its effects upon the Company
 
have not yet been determined.
Changes in the real estate markets, including
 
the secondary market for residential mortgage loans,
 
may continue to
adversely affect us.
 
The CFPB’s mortgage and servicing rules,
 
including TRID rules for closed end credit transactions, enforcement actions,
reviews and settlements, affect the mortgage markets and our
 
mortgage operations.
 
The CFPB requires that lenders
determine whether a consumer has the ability to repay a mortgage loan have limited
 
the secondary market for and liquidity
of many mortgage loans that are not “qualified mortgages.”
 
Recently adopted changes to the CFPB’s
 
qualified mortgage
rules are reportedly being reconsidered.
The Tax Cuts and Jobs
 
Act’s (the “2017 Tax
 
Act”) limitations on the deductibility of residential mortgage interest and state
and local property and other taxes and federal moratoria on single-family
 
foreclosures and rental evictions could adversely
affect consumer behaviors and the volumes of housing sales,
 
mortgage and home equity loan originations, as well as the
value and liquidity of residential property held as collateral by lenders such as the Bank, and
 
the secondary markets for
single and multi-family loans.
 
Acquisition, construction and development loans for residential development
 
may be
similarly adversely affected.
Fannie Mae and Freddie Mac (“GSEs”), have been in conservatorship since September
 
2008.
 
Since Fannie Mae and
Freddie Mac dominate the residential mortgage markets, any changes in their
 
operations and requirements, as well as their
respective restructurings and capital, could adversely affect the
 
primary and secondary mortgage markets, and our
residential mortgage businesses, our results of operations and the returns on capital
 
deployed in these businesses.
 
The
timing and effects of resolution of these government sponsored
 
enterprises cannot be predicted.
Weaknesses in real estate
 
markets the FHFA’s
 
moratoria on foreclosures and real estate owned evictions may adversely
affect the length of time and costs required to manage and dispose
 
of, and the values realized from the sale of our OREO.
28
We may be contractually
 
obligated to repurchase
 
mortgage loans we sold to third parties on terms unfavorable
 
to us.
As part of its routine business, the Company originates mortgage loans that it subsequently
 
sells in the secondary market,
including to governmental agencies and GSEs.
 
In connection with the sale of these loans, the Company makes customary
representations and warranties, the breach of which may result in the Company
 
being required to repurchase the loan or
loans.
 
Furthermore, the amount paid may be greater than the fair value of the loan or loans at the time
 
of the repurchase.
 
Although mortgage loan repurchase requests made to us have been limited, if these increased,
 
we may have to establish
reserves for possible repurchases and adversely affect our results of operation
 
and financial condition.
Mortgage servicing rights requirements
 
may change and require
 
us to incur additional costs and risks.
The CFPB’s residential mortgage servicing
 
standards may adversely affect our costs to service residential
 
mortgage loans,
and together with the Basel III Rules and the effects of lower interest rates
 
from COVID-19 stimulus, may decrease the
returns on, and values of, our MSRs.
 
This could reduce our income from servicing these types of loans and
 
make it more
difficult and costly to timely realize the value of collateral securing
 
such loans upon a borrower default.
 
In contrast, rising
interest rates would be expected to reduce mortgage refinancings and extend the duration
 
of our MSRs.
The soundness of other financial institutions could adversely affect us.
We routinely execute
 
transactions with counterparties in the financial services industry,
 
including brokers and dealers,
central clearinghouses, banks, including our correspondent banks and other
 
financial institutions.
 
Our ability to engage in
routine investment and banking transactions, as well as the quality and values of our investments
 
in holdings of other
obligations of other financial institutions such as the FHLB, could be adversely affected
 
by the actions, financial condition,
and profitability of such other financial institutions, including the FHLB
 
and our correspondent banks.
 
Financial services
institutions are interrelated as a result of shared credits, trading, clearing, counterparty and
 
other relationships.
 
Any losses,
defaults by, or failures of, the institutions
 
we do business with could adversely affect our holdings of the equity in
 
such
other institutions, our participation interests in loans originated by other institutions,
 
and our business, including our
liquidity, financial condition and
 
earnings.
Our concentration of commercial real
 
estate loans could result in further increased
 
loan losses, and adversely affect our
business, earnings, and financial condition.
Commercial real estate, or CRE, is cyclical and poses risks of possible loss due to concentration
 
levels and risks of the
assets being financed, which include loans for the acquisition and development of land and
 
residential construction.
 
The
federal bank regulatory agencies released guidance in 2006 on “Concentrations
 
in Commercial Real Estate Lending.”
 
The
guidance defines CRE loans as exposures secured by raw land, land development
 
and construction loans (including 1-4
family residential construction loans), multi-family property,
 
and non-farm non-residential property,
 
where the primary or a
significant source of repayment is derived from rental income associated
 
with the property (that is, loans for which 50% or
more of the source of repayment comes from third party,
 
non-affiliated, rental income) or the proceeds of the sale,
refinancing, or permanent financing of the property.
 
Loans to REITs
 
and unsecured loans to developers that closely
correlate to the inherent risks in CRE markets are also CRE loans.
 
Loans on owner occupied commercial real estate are
generally excluded from CRE for purposes of this guidance.
 
Excluding owner occupied commercial real estate, we had
50.0% of our portfolio in CRE loans at year-end 2021 compared to 43.6% at year-end 2020.
 
The banking regulators
continue to give CRE lending scrutiny and require banks with higher levels
 
of CRE loans to implement improved
underwriting, internal controls, risk management policies and portfolio
 
stress testing, as well as higher levels of allowances
for possible losses and capital levels as a result of CRE lending growth and exposures.
 
Lower demand for CRE, and
reduced availability of, and higher interest rates and costs for,
 
CRE lending could adversely affect our CRE loans and sales
of our OREO, and therefore our earnings and financial condition, including our capital and
 
liquidity.
At year-end 2021, 21% of our total loans were CRE loans to
 
hotels/motels, retail and shopping centers and restaurants,
businesses that were severely affected
 
by the effects of COVID-19.
29
Our future success is dependent on our ability
 
to compete effectively in highly competitive markets.
The East Alabama banking markets which we operate are
 
highly competitive and our future growth and success will
depend on our ability to compete effectively in these markets.
 
We compete for loans, deposits
 
and other financial services
with other local, regional and national commercial banks, thrifts, credit unions,
 
mortgage lenders, and securities and
insurance brokerage firms.
 
Lenders operating nationwide over the internet are growing rapidly.
 
Many of our competitors
offer products and services different from us, and
 
have substantially greater resources, name recognition and market
presence than we do, which benefits them in attracting business.
 
In addition, larger competitors may be able to price loans
and deposits more aggressively than we are able to and have broader and more diverse customer
 
and geographic bases to
draw upon.
 
Out of state banks may branch into our markets.
 
Fintech and other non-bank competitors also complete for our
customers, and may partner with other banks and/or seek to enter the payments system.
 
Failures of other banks with offices
in our markets could also lead to the entrance of new,
 
stronger competitors in our markets.
Our success depends on local economic conditions.
Our success depends on the general economic conditions in the geographic
 
markets we serve in Alabama.
 
The local
economic conditions in our markets have a significant effect on our
 
commercial, real estate and construction loans, the
ability of borrowers to repay these loans and the value of the collateral securing these loans.
 
Adverse changes in the
economic conditions of the Southeastern United States in general, or in one or
 
more of our local markets, including the
continuous effects from COVID-19 and the timing, strength
 
and breadth of the recovery from the pandemic, could
negatively affect our results of operations and our profitability.
 
Our local economy is also affected by the growth of
automobile manufacturing and related suppliers located in our markets and
 
nearby.
 
Auto sales are cyclical and are affected
adversely by higher interest rates.
Attractive acquisition opportunities may not be available to us in
 
the future.
 
 
While we seek continued organic growth, we also may consider
 
the acquisition of other businesses.
 
We expect that other
banking and financial companies, many of which have significantly
 
greater resources, will compete with us to acquire
financial services businesses.
 
This competition could increase prices for potential acquisitions that we believe are
attractive.
 
Also, acquisitions are subject to various regulatory approvals.
 
If we fail to receive the appropriate regulatory
approvals, we will not be able to consummate an acquisition that
 
we believe is in our best interests, and regulatory
approvals could contain conditions that reduce the anticipated benefits of any transaction.
 
Among other things, our
regulators consider our capital, liquidity,
 
profitability, regulatory compliance
 
and levels of goodwill and intangibles when
considering acquisition and expansion proposals.
 
Any acquisition could be dilutive to our earnings and shareholders’
equity per share of our common stock.
 
Future acquisitions and expansion activities may
 
disrupt our business, dilute shareholder
 
value and adversely affect our
operating results.
We regularly evaluate
 
potential acquisitions and expansion opportunities, including new branches and
 
other offices.
 
To the
extent that we grow through acquisitions, we cannot assure you that
 
we will be able to adequately or profitably manage this
growth.
 
Acquiring other banks, branches, or businesses, as well as other geographic and product
 
expansion activities,
involve various risks including:
 
risks of unknown or contingent liabilities, and potential asset quality issues;
unanticipated costs and delays;
risks that acquired new businesses will not perform consistent with our growth
 
and profitability expectations;
risks of entering new markets or product areas where we have limited experience;
risks that growth will strain our infrastructure, staff, internal
 
controls and management, which may require
additional personnel, time and expenditures;
difficulties, expenses and delays of integrating the operations and personnel of
 
acquired institutions;
 
potential disruptions to our business;
30
possible loss of key employees and customers of acquired institutions;
potential short-term decreases in profitability; and
diversion of our management’s
 
time and attention from our existing operations and business.
Technological
 
changes affect our business, and we may have fewer resources
 
than many competitors to invest in
technological improvements.
The financial services industry is undergoing rapid
 
technological changes with frequent introductions of new technology
driven products and services and growing demands for mobile and user-based
 
banking applications. In addition to allowing
us to analyze our customers better, the effective
 
use of technology may increase efficiency and may enable
 
financial
institutions to reduce costs, risks associated with fraud and compliance
 
with anti-money laundering and other laws, and
various operational risks. Largely unregulated “fintech” businesses
 
have increased their participation in the lending and
payments businesses, and have increased competition in these businesses. Our
 
future success will depend, in part, upon our
ability to use technology to provide products and services that meet our customers’ preferences
 
and create additional
efficiencies in operations, while avoiding cyber-attacks
 
and disruptions, data breaches and anti-money laundering
violations. The COVID-19 pandemic and increased remote work has accelerated
 
electronic banking activity and the need
for increased operational efficiencies.
 
We
 
may need to make significant additional capital investments in technology,
including cyber and data security,
 
and we may not be able to effectively implement new technology
 
-driven products and
services, or such technology may prove less effective than anticipated.
 
Many larger competitors have substantially greater
resources to invest in technological improvements and, increasingly,
 
non-banking firms are using technology to compete
with traditional lenders for loans and other banking services.
 
As a result, our competition from service providers not
located in our markets has increased.
Operational risks are inherent
 
in our businesses.
Operational risks and losses can result from internal and external fraud; gaps or
 
weaknesses in our risk management or
internal audit procedures; errors by employees or third parties, including our
 
vendors, failures to document transactions
properly or obtain proper authorizations; failure to comply with applicable regulatory requirements
 
in the various
jurisdictions where we do business or have customers; failures in our estimates
 
models that rely on; equipment failures,
including those caused by natural disasters, or by electrical, telecommunications
 
or other essential utility outages; business
continuity and data security system failures, including those caused by computer
 
viruses, cyberattacks, unforeseen
problems encountered while implementing major new computer systems or,
 
failures to timely and properly upgrade and
patch existing systems or inadequate access to data or poor response capabilities in
 
light of such business continuity and
data security system failures; or the inadequacy or failure of systems and controls,
 
including those of our vendors or
counterparties.
 
The COVID-19 pandemic presented operational challenges to
 
maintaining continuity of operations of
customer services while protecting our employees’ and customers’ safety.
 
In addition, we face certain risks inherent in the
ownership and operation
 
of our bank premises and other real-estate, including liability for accidents on our properties.
Although we have implemented risk controls and loss mitigation actions, and substantial
 
resources are devoted to
developing efficient procedures, identifying and rectifying
 
weaknesses in existing procedures and training staff and
potential environmental risks, it is not possible to be certain that such actions
 
have been or will be effective in controlling
these various operational risks that evolve continuously.
31
Potential gaps in our risk management policies and internal audit procedures
 
may leave us exposed unidentified or
unanticipated risk, which could negatively affect our business.
Our enterprise risk management and internal audit program is designed to
 
mitigate material risks and loss to us. We
 
have
developed and continue to develop risk management and internal audit policies
 
and procedures to reflect the ongoing
review of our risks and expect to continue to do so in the future. Nonetheless, our policies
 
and procedures may not be
comprehensive and may not identify timely every risk to which we are exposed,
 
and our internal audit process may fail to
detect such weaknesses or deficiencies in our risk management framework.
 
Many of our risk management models and
estimates use observed historical market behavior to model or project
 
potential future exposure.
 
Models used by our
business are based on assumptions and projections. These models
 
may not operate properly or our inputs and assumptions
may be inaccurate, or changes in economic conditions, customer behaviors
 
or regulations.
 
As a result, these methods may
not fully predict future exposures, which can be significantly greater than
 
historically.
 
Other risk management methods
depend upon the evaluation of information regarding markets, clients, or
 
other matters that are publicly available or
otherwise accessible to us. This information may not always be accurate,
 
complete, up-to-date or properly evaluated.
Furthermore, there can be no assurance that we can effectively review
 
and monitor all risks or that all of our employees will
closely follow our risk management policies and procedures, nor can there be any assurance
 
that our risk management
policies and procedures will enable us to accurately identify all risks and limit our exposures
 
based on our assessments. In
addition, we may have to implement more extensive
 
and perhaps different risk management policies and procedures
 
as our
regulation changes.
 
For example, the Federal Reserve and the OCC are in the initial stages of proposing
 
climate risk
management criteria and potential climate risk stress tests.
 
The SEC is expected to require more disclosure on climate
risks, also.
 
All of these could adversely affect our financial condition and results
 
of operations.
Any failure to protect
 
the confidentiality of customer information could adversely affect our reputation
 
and have a material
adverse effect on our business, financial condition and results
 
of operations
.
Various
 
laws enforced by the bank regulators and other agencies protect the privacy and security of
 
customers’ non-public
personal information. Many of our employees have access to, and routinely process
 
personal information of clients through
a variety of media, including information technology systems.
 
Our internal processes and controls are designed to protect
the confidentiality of client information we hold and that is accessible to us and our employees.
 
It is possible that an
employee could, intentionally or unintentionally,
 
disclose or misappropriate confidential client information or our data
could be the subject of a cybersecurity attack.
 
Such personal data could also be compromised via intrusions into our
systems or those of our service providers or persons we do business with such as credit
 
bureaus, data processors and
merchants who accept credit or debit cards for payment. If we fail to
 
maintain adequate internal controls, or if our
employees fail to comply with our policies and procedures, misappropriation
 
or inappropriate disclosure or misuse of client
information could occur. Such
 
internal control inadequacies or non-compliance could materially damage our
 
reputation,
lead to remediation costs and civil or criminal penalties.
 
These could have a material adverse effect on our business,
financial condition and results of operations.
Our information systems may experience interruptions and
 
security breaches.
We rely heavily on communications
 
and information systems, including those provided by third-party service
 
providers, to
conduct our business.
 
Any failure, interruption, or security breach of these systems could result in failures
 
or disruptions
which could affect our customers’ privacy and our customer
 
relationships, generally.
 
Our business continuity plans,
including those of our service providers, to provide back-up and restore service
 
may not be effective in the case of
widespread outages due to severe weather,
 
natural disasters, pandemics, or power, communications
 
and other failures.
Our systems and networks, as well as those of our third-party service providers,
 
are subject to security risks and could be
susceptible to cyber-attacks, such as denial of service attacks,
 
hacking, terrorist activities or identity theft.
 
Cybercrime risks
have increased as electronic and mobile banking activities increased as a result
 
of the COVID-19 pandemic, and may
increase as a result of the Russia invasion of Ukraine.
 
Other financial service institutions and their service providers have
reported material security breaches in their websites or other systems, some of
 
which have involved sophisticated and
targeted attacks, including use of stolen access credentials, malware,
 
ransomware, phishing and distributed denial-of-
service attacks, among other means.
 
Such cyber-attacks may also seek to disrupt the operations of public companies
 
or
their business partners, effect unauthorized fund transfers, obtain unauthorized
 
access to confidential information, destroy
data, disable or degrade service, or sabotage systems.
 
Denial of service attacks have been launched against a number of
financial services institutions, and we may be subject to these types of attacks in
 
the future. Hacking and identity theft risks,
in particular, could cause serious reputational harm.
32
Despite our cybersecurity policies and procedures and our Board
 
of Director’s and Management’s efforts
 
to monitor and
ensure the integrity of the system we use, we may not be able to anticipate the rapidly evolving
 
security threats, nor may we
be able to implement preventive measures effective against
 
all such threats. The techniques used by cyber criminals change
frequently, may not be recognize
 
d
 
until launched and can originate from a wide variety of sources, including outside groups
such as external service providers, organized crime affiliates,
 
terrorist organizations or hostile foreign governments. These
risks may increase in the future as the use of mobile banking and other internet
 
electronic banking continues to grow.
Security breaches or failures may have serious adverse financial and other consequences,
 
including significant legal and
remediation costs, disruptions to operations, misappropriation of confidential information,
 
damage to systems operated by
us or our third-party service providers, as well as damages to our customers and our
 
counterparties. In addition, these events
could damage our reputation, result in a loss of customer business, subject us to additional
 
regulatory scrutiny, or expose
 
us
to civil litigation and possible financial liability,
 
any of which could have a material adverse effect on
 
our financial
condition and results of operations.
 
We may be unable
 
to attract and retain key people to support our business.
Our success depends, in large part, on our ability to attract and retain key people.
 
We compete
 
with other financial services
companies for people primarily on the basis of compensation and benefits,
 
support services and financial position. Intense
competition exists for key employees with demonstrated ability,
 
and we may be unable to hire or retain such employees.
Effective succession planning is also important to our long-term
 
success. The unexpected loss of services of one or more of
our key persons and failure to ensure effective transfer of knowledge
 
and smooth transitions involving such persons could
have a material adverse effect on our business due to loss of their skills,
 
knowledge of our business, their years of industry
experience and the potential difficulty of promptly finding qualified
 
replacement employees.
Proposed rules implementing the executive compensation provisions of the
 
Dodd-Frank Act may limit the type and
structure of compensation arrangements and prohibit the payment of “excessive
 
compensation” to our executives. These
restrictions could negatively affect our ability to compete with other companies
 
in recruiting and retaining key personnel.
Severe weather and natural disasters, including
 
as a result of climate change, pandemics, epidemics,
 
acts of war or
terrorism or other external events could
 
have significant effects on our business.
Severe weather and natural disasters, including hurricanes, tornados,
 
drought and floods, epidemics and pandemics, acts of
war or terrorism or other external events could have a significant effect on our
 
ability to conduct business.
 
Such events
could affect the stability of our deposit base, impair the ability of borrowers
 
to repay outstanding loans, impair the value of
collateral securing loans, cause significant property damage, result in loss of revenue
 
and/or cause us to incur additional
expenses.
 
Although management has established disaster recovery and business continuity
 
policies and procedures, the
occurrence of any such event could have a material adverse effect
 
on our business, which, in turn, could have a material
adverse effect on our financial condition and results of operations.
 
The COVID-19 pandemic, trade wars, tariffs, and similar events and
 
disputes, domestic and international, have adversely
affected, and may continue to adversely affect economic
 
activity globally,
 
nationally and locally.
 
Market interest rates have
declined significantly during 2020, and remain low,
 
but may begin increasing in early 2022 due to inflation.
 
Such events
also may adversely affect business and consumer confidence,
 
generally.
 
We and our customers,
 
and our respective
suppliers, vendors and processors may be adversely affected
 
by rising costs and shortages of needed equipment and
supplies.
 
Any such adverse changes may adversely affect our profitability,
 
growth asset quality and financial condition.
33
Financial Risks
Our ability to realize our deferred
 
tax assets may be reduced in the future
 
if our estimates of future taxable income from
our operations and tax planning strategies do not support this amount, and the amount
 
of net operating loss carry-forwards
realizable for income tax purposes may be reduced
 
under Section 382 of the Internal Revenue Code by sales of our capital
securities.
 
We are
 
allowed to carry-back losses for two years for Federal income tax purposes.
 
As of December 31, 2022, we had a
net deferred tax asset of $0.4 million with gross deferred tax assets of $1.7
 
million.
 
These and future deferred tax assets
may be further reduced in the future if our estimates of future taxable income from our
 
operations and tax planning
strategies do not support the amount of the deferred tax asset.
 
The amount of net operating loss carry-forwards realizable
for income tax purposes potentially could be further reduced under Section 382
 
of the Internal Revenue Code by a
significant offering and/or other sales of our capital securities.
 
Current bank capital rules also reduce the regulatory capital
benefits of deferred tax assets.
Our cost of funds may increase as a result
 
of general economic conditions, interest rates, inflation
 
and competitive
pressures.
The Federal Reserve shifted to a more accommodating monetary policy in
 
Summer 2019. During 2020, the Federal Reserve
reduced its federal funds target to 0-0.25% and has made significant
 
monthly purchases of U.S. Treasury and agency
mortgage-backed securities to help stimulate the economy,
 
market interest rates have increased, possibly as a result of
increased government borrowings to finance rounds of fiscal stimulus and
 
increased inflation expectations resulting from
such stimulus and expected increases in economic growth from fiscal and
 
monetary stimulus and COVID-19 vaccinations.
 
Our costs of funds may increase as a result of general economic conditions, increasing
 
interest rates and competitive
pressures, and potential inflation resulting from continued government deficit spending
 
and monetary policies, and
anticipated changes by the Federal Reserve to a less accommodative monetary policy.
 
Traditionally,
 
we have obtained
funds principally through local deposits and borrowings from other institutional
 
lenders, which we believe are a cheaper
and more stable source of funds than borrowings.
 
Increases in interest rates may cause consumers to shift their funds to
more interest bearing instruments and to increase the competition for and costs of
 
deposits.
 
If customers move money out
of bank deposits and into other investment assets or from transaction deposits to higher interest
 
bearing time deposits, we
could lose a relatively low cost source of funds, increasing our funding costs and reducing our
 
net interest income and net
income. Additionally, any
 
such loss of funds could result in lower loan originations and growth, which could
 
materially and
adversely affect our results of operations and financial condition.
Our profitability and liquidity may be
 
affected by changes in interest rates and interest
 
rate levels, the shape of the yield
curve and economic conditions.
 
Our profitability depends upon net interest income, which is the difference
 
between interest earned on interest-earning
assets, such as loans and investments, and interest expense on interest-bearing liabilities,
 
such as deposits and borrowings.
 
Net interest income will be adversely affected if market interest
 
rates on the interest we pay on deposits and borrowings
increases faster than the interest earned on loans and investments.
 
Interest rates, and consequently our results of operations,
are affected by general economic conditions (national, international and
 
local) and fiscal and monetary policies, as well as
expectations of interest rate changes, fiscal and monetary policies and the shape of the
 
yield curve.
 
Our income is primarily
driven by the spread between these rates. As a result, a steeper yield curve,
 
meaning long-term interest rates are
significantly higher than short-term interest rates, would
 
provide the Bank with a better opportunity to increase net interest
income. Conversely, a
 
flattening yield curve could further pressure our net interest margin
 
as our cost of funds increases
relative to the spread we can earn on our assets. In addition, net interest income could
 
be affected by asymmetrical changes
in the different interest rate indexes, given that not all of our assets or liabilities
 
are priced with the same index.
 
The
interest rate reductions by the Federal Reserve and the effects of the
 
COVID-19 pandemic have reduced market rates,
which adversely affected our net interest income and our results of operations.
The production of mortgages and other loans and the value of collateral
 
securing our loans are dependent on demand within
the markets we serve, as well as interest rates.
 
Lower interest rates typically increase mortgage originations, decrease MSR
values, and facilitate pandemic-related trends to single family houses.
 
Increases in market interest rates would tend to
decrease mortgage originations, increase MSR values and potentially increase
 
net interest spread depending upon the yield
curve and the magnitude and duration of interest rate increase.
34
Liquidity risks could affect operations and jeopardize
 
our financial condition.
Liquidity is essential to our business.
 
An inability to raise funds through deposits, borrowings, proceeds from loan
repayments or sales proceeds from maturing loans and securities, and other sources
 
could have a negative effect on our
liquidity.
 
Our funding sources include federal funds purchased, securities sold under
 
repurchase agreements, core and non-
core deposits, and short- and long-term debt.
 
We
 
maintain a portfolio of securities that can be used as a source of liquidity.
 
We are
 
also members of the FHLB and the Federal Reserve Bank of Atlanta, where we can obtain advances
 
collateralized
with eligible assets.
 
There are other sources of liquidity available to the Company or the Bank
 
should they be needed,
including our ability to acquire additional
 
non-core deposits.
 
We may be able, depending
 
upon market conditions, to
otherwise borrow money or issue and sell debt and preferred or common securities in public
 
or private transactions.
 
Our
access to funding sources in amounts adequate to finance or capitalize our activities
 
on terms which are acceptable to us
could be impaired by factors that affect us specifically,
 
or the financial services industry or the economy in general.
 
General conditions that are not specific to us, such as disruptions in the financial
 
markets or negative views and
expectations about the prospects for the financial services industry could
 
adversely affect us.
The COVID-19 pandemic generally has increased our deposits and at banks, generally,
 
while reducing the interest rates
earned on loans and securities.
 
Such excess liquidity and the resulting balance sheet growth requires capital support
 
and
may reduce returns on assets and equity.
Changes in accounting and tax rules applicable to banks could adversely
 
affect our financial conditions and results of
operations.
 
From time to time, the FASB
 
and the SEC change the financial accounting and reporting standards that govern the
preparation of our financial statements.
 
These changes can be difficult to predict and can materially impact
 
how we record
and report our financial condition and results of operations.
 
In some cases, we could be required to apply a new or revised
standard retroactively, resulting
 
in us restating prior period financial statements
.
The
FASB’s
 
guidance under ASU No.
2016-13 includes significant changes to the manner in which banks’ allowance
 
for loan losses will be effective for us
beginning January 1, 2023.
 
Instead of using historical losses, the CECL model is forward-looking with respect
 
to expected
losses over the life of loans and other instruments, and could materially affect our
 
results of operations and financial
condition, including the variability of our results of operations and our regulatory
 
capital, notwithstanding a three-year
phase-in of CECL for regulatory capital purposes.
We may need
 
to raise additional capital in the future, but that capital
 
may not be available when it is needed or on
favorable terms.
We anticipate that our current
 
capital resources will satisfy our capital requirements for the foreseeable
 
future under
currently effective rules.
 
We may,
 
however, need to raise additional capital to
 
support our growth or currently
unanticipated losses, or to meet the needs of our communities, resulting from failures or
 
cutbacks by our competitors.
 
Our
ability to raise additional capital, if needed, will depend, among other things,
 
on conditions in the capital markets at that
time, which are limited by events outside our control, and on our financial performance.
 
If we cannot raise additional
capital on acceptable terms when needed, our ability to further expand our
 
operations through internal growth and
acquisitions could be limited.
 
Our associates may take excessive risks which could negatively affect our financial
 
condition and business.
Banks are in the business of accepting certain risks.
 
Our executive officers and other members of management,
 
sales
intermediaries, investment professionals, product managers, and
 
other associates, make decisions and choices that involve
exposing us to risk. We endeavor,
 
in the design and implementation of our compensation programs and practices, to avoid
giving our associates incentives to take excessive risks; however,
 
associates may nonetheless take such risks.
 
Similarly,
although we employ controls and procedures designed to prevent misconduct,
 
to monitor associates’ business decisions and
prevent them from taking excessive risks, these controls and procedures
 
may not be effective. If our associates take
excessive risks, risks to our reputation, financial condition and business operations
 
could be materially and adversely
affected.
35
Our ability to continue to pay dividends to shareholders
 
in the future is subject to our profitability,
 
capital, liquidity and
regulatory requirements
 
and these limitations may prevent or limit future
 
dividends.
Cash available to pay dividends to our shareholders is derived primarily from dividends paid
 
to the Company by the Bank.
 
The ability of the Bank to pay dividends, as well as our ability to pay dividends to our shareholders,
 
will continue to be
subject to and limited by laws limiting dividend payments by the Bank, the results of operations
 
of our subsidiaries and our
need to maintain appropriate liquidity and capital at all levels of our business consistent
 
with regulatory requirements and
the needs of our businesses.
 
See “Supervision and Regulation”.
A limited trading market exists for our common shares,
 
which could result in price volatility.
Your
 
ability to sell or purchase common shares depends upon the existence of an active trading
 
market for our common
stock.
 
Although our common stock is quoted on the Nasdaq Global Market under the trading
 
symbol “AUBN,” our historic
trading volume has been limited historically.
 
As a result, you may be unable to sell or purchase shares of our common
stock at the volume, price and time that you desire.
 
Additionally, whether the purchase
 
or sales prices of our common stock
reflects a reasonable valuation of our common stock also is affected
 
by limited trading market, and thus the price you
receive for a thinly-traded stock such as our common stock, may not reflect its true or intrinsic
 
value.
 
The limited trading
market for our common stock may cause fluctuations in the market value of our common
 
stock to be exaggerated, leading
to price volatility in excess of that which would occur in a more active trading
 
market.
Legal and Regulatory Risks
The Company is an entity separate and distinct from
 
the Bank.
The Company is an entity separate and distinct from the Bank. Company transactions
 
with the Bank are limited by Sections
23A and 23B of the Federal Reserve Act and Federal Reserve Regulation
W.
 
We depend upon the Bank’s
 
earnings and
dividends, which are limited by law and regulatory policies and actions, for cash to pay the
 
Company’s debt and corporate
obligations, and to pay dividends to our shareholders.
 
If the Bank’s ability to pay dividends to the Company
 
was
terminated or limited, the Company’s liquidity
 
and financial condition could be materially and adversely affected.
 
Legislative and regulatory changes
The Biden Administration is appointing new members to FDIC and Federal
 
Reserve Board, and has appointed an acting
Comptroller of the Currency and a new full time CFPB director.
 
This Administration and its appointees propose changes to
bank regulation and corporate tax changes that could have an adverse effect
 
on our results of operations and financial
conditions.
We are
 
subject to extensive regulation that could limit or restrict
 
our activities and adversely affect our earnings.
We and our subsidiaries are
 
regulated by several regulators, including the Federal Reserve, the
 
Alabama Superintendent,
the SEC and the FDIC.
 
Our success is affected by state and federal laws and regulations affecting
 
banks and bank holding
companies, and the securities markets, and our costs of compliance could adversely affect
 
our earnings.
 
Banking
regulations are primarily intended to protect depositors, and the FDIC Deposit Insurance
 
Fund (“DIF”), not shareholders.
 
The financial services industry also is subject to frequent legislative and regulatory
 
changes and proposed changes.
 
In
addition, the interpretations of regulations by regulators may change and statutes
 
may be enacted with retroactive impact.
From time to time, regulators raise issues during examinations of us which,
 
if not determined satisfactorily,
 
could have a
material adverse effect on us. Compliance with applicable
 
laws and regulations is time consuming and costly and may
affect our profitability. The
 
position of the President and his administration that took office
 
in January 2021 with respect to
regulation of banks and bank holding companies is not yet fully known, but
 
their views and actions could have a material
adverse effect on financial services regulation, generally.
36
Litigation and regulatory actions could harm
 
our reputation and adversely affect our results
 
of operations and financial
condition.
A substantial legal liability or a significant regulatory action against us, as well as regulatory
 
inquiries or investigations,
could harm our reputation, result in material fines or penalties, result in significant
 
legal and other costs, divert management
resources away from our business, and otherwise have a material adverse
 
effect on our ability to expand on our existing
business, financial condition and results of operations. Even if we ultimately
 
prevail in litigation, regulatory investigation or
action, our ability to attract new customers, retain our current customers and recruit and
 
retain employees could be
materially and adversely affected. Regulatory inquiries and litigation
 
may also adversely affect the prices or volatility of
our securities specifically, or the
 
securities of our industry,
 
generally.
We are
 
required to maintain
 
capital to meet regulatory requirements,
 
and if we fail to maintain sufficient capital, our
financial condition, liquidity and results of operations
 
would be adversely affected.
 
We and the Bank
 
must meet regulatory capital requirements and maintain sufficient
 
liquidity, including liquidity
 
at the
Company, as well as the Bank.
 
If we fail to meet these capital and other regulatory requirements, including
 
more rigorous
requirements arising from our regulators’ implementation of Basel III,
 
our financial condition, liquidity and results of
operations would be materially and adversely affected.
 
Our failure to remain “well capitalized” and “well managed”,
including meeting the Basel III capital conservation buffers,
 
for bank regulatory purposes, could affect customer
confidence, our ability to grow, our
 
costs of funds and FDIC insurance, our ability to raise brokered deposits,
 
our ability to
pay dividends on our common stock and our ability to make acquisitions, and
 
we may no longer meet the requirements for
becoming a financial holding company.
 
These could also affect our ability to use discretionary bonuses
 
to attract and retain
quality personnel.
 
The Basel III Capital Rules include a minimum ratio of common equity
 
tier 1 capital, or CET1, to risk-
weighted assets of 4.5% and a capital conservation buffer of 2.5% of risk-weighted
 
assets.
See
“Supervision and
Regulation—Basel III Capital Rules.”
 
Although we currently have capital ratios that exceed all these minimum levels and
a strategic plan to maintain these levels, we or the Bank may be unable to continue
 
to satisfy the capital adequacy
requirements for various reasons, which may include:
 
 
 
losses and/or increases in the Bank’s credit
 
risk assets and expected losses resulting from the deterioration in the
creditworthiness of borrowers and the issuers of equity and debt securities;
 
 
 
difficulty in refinancing or issuing instruments upon redemption or
 
at maturity of such instruments to raise capital
under acceptable terms and conditions;
 
 
 
declines in the value of our securities portfolios;
 
 
 
revisions to the regulations or their application by our regulators that increase our capital requirements;
 
 
 
reduced total earnings on our assets will reduce our internal generation of capital
 
available to support our balance
sheet growth;
 
 
 
reductions in the value of our MSRs and DTAs;
 
and other adverse developments; and
 
 
 
unexpected growth and an inability to increase capital timely.
A failure to remain “well capitalized,” for bank regulatory purposes, including
 
meeting the Basel III Capital Rule’s
conservation buffer, could adversely affect
 
customer confidence, and our:
 
 
 
ability to grow;
 
 
 
the costs of and availability of funds;
 
 
 
FDIC deposit insurance premiums;
 
 
 
ability to raise or replace brokered deposits;
 
 
 
ability to pay or increase dividends on our capital stock.
 
37
 
 
ability to make discretionary bonuses to attract and retain quality personnel;
 
 
 
ability to make acquisitions or engage in new activities;
 
 
 
flexibility if we become subject to prompt corrective action restrictions;
 
 
 
ability to make payments of principal and interest on our capital instruments; and
The Federal Reserve may require
 
us to commit capital resources
 
to support the Bank.
As a matter of policy, the Federal
 
Reserve expects a bank holding company to act as a source of financial and
 
managerial
strength to a subsidiary bank and to commit resources to support such subsidiary bank. The
 
Federal Reserve may require a
bank holding company to make capital injections into a troubled subsidiary bank.
 
In addition, the Dodd-Frank Act amended
the FDI Act to require that all companies that control a FDIC-insured depository institution
 
serve as a source of financial
strength to their depository institution subsidiaries. Under these requirements,
 
we could be required to provide financial
assistance to the Bank should it experience financial distress, even if further investment
 
was not otherwise warranted. See
“Supervision and Regulation.”
Our operations are subject to risk of loss from
 
unfavorable fiscal, monetary and political developments in the
 
U.S.
Our businesses and earnings are affected by the fiscal, monetary and other
 
policies and actions of various U.S.
governmental and regulatory authorities. Changes in these are beyond our control
 
and are difficult to predict and,
consequently, changes in these
 
policies could have negative effects on our activities and results of operations.
 
Failures of
the executive and legislative branches to agree on spending plans and budgets previously
 
have led to Federal government
shutdowns, which may adversely affect the U.S. economy.
 
Additionally, any prolonged
 
government shutdown may inhibit
our ability to evaluate the economy,
 
generally, and affect
 
government workers who are not paid during such events, and
where the absence of government services and data could adversely affect consumer
 
and business sentiment, our local
economy and our customers and therefore our business.
Litigation and regulatory investigations are
 
increasingly common in our businesses and may result
 
in significant financial
losses and/or harm to our reputation.
We face risks of litigation
 
and regulatory investigations and actions in the ordinary course of operating
 
our businesses,
including the risk of class action lawsuits. Plaintiffs in class
 
action and other lawsuits against us may seek very large and/or
indeterminate amounts, including punitive and treble damages. Due to the vagaries of litigation,
 
the ultimate outcome of
litigation and the amount or range of potential loss at particular points in time may be difficult
 
to ascertain. We
 
do not have
any material pending litigation or regulatory matters affecting
 
us.
Failures to comply with the fair lending laws, CFPB regulati
 
ons or the Community Reinvestment Act, or CRA, could
adversely affect us.
The Bank is subject to, among other things, the provisions of the Equal Credit Opportunity
 
Act, or ECOA, and the Fair
Housing Act, both of which prohibit discrimination based on race or
 
color, religion, national origin, sex and familial status
in any aspect of a consumer, commercial credit or
 
residential real estate transaction. The DOJ and the federal bank
regulatory agencies have issued an Interagency Policy Statement on Discrimination
 
in Lending have provided guidance to
financial institutions to evaluate whether discrimination exists and how the
 
agencies will respond to lending discrimination,
and what steps lenders might take to prevent discriminatory lending practices.
 
Failures to comply with ECOA, the Fair
Housing Act and other fair lending laws and regulations, including CFPB
 
regulations, could subject us to enforcement
actions or litigation, and could have a material adverse effect
 
on our business financial condition and results of operations.
Our Bank is also subject to the CRA and periodic CRA examinations. The CRA requires
 
us to serve our entire
communities, including low-
 
and moderate-income neighborhoods. Our CRA ratings could
 
be adversely affected by actual
or alleged violations of the fair lending or consumer financial protection
 
laws. Even though we have maintained an
“satisfactory” CRA rating since 2000, we cannot predict our future CRA ratings.
 
Violations of fair lending laws or if our
CRA rating falls to less than “satisfactory” could adversely affect
 
our business, including expansion through branching or
acquisitions.
38
COVID-19 Risks
The COVID-19 pandemic may continue to adversely affect our business, financial
 
condition and results of operations. The
ultimate effects of the pandemic on us will depend on the severity,
 
scope and duration of the pandemic, its cumulative
economic effects, governmental actions in response
 
to the pandemic, and the restoration of a more
 
normal economy.
 
The COVID-19 national health emergency has significantly disrupted
 
the United States and international economies and
financial markets. We
 
expect that the COVID-19 pandemic and its effects
 
will continue to adversely affect our business,
financial condition and results of operations in future periods. The spread of COVID-19
 
has caused illness, quarantines,
cancellation of events and travel, business and school shutdowns, reductions in business
 
activity and financial transactions,
supply chain interruptions and overall economic and financial market instability.
 
The State of Alabama and many other
states have taken preventative and protective actions, such as imposing a statewide
 
mask mandate, restrictions on travel,
business operations, public gatherings, social distancing, advising or requiring
 
individuals to limit or forego their time
outside of their homes, and ordering temporary closures of non-essential businesses.
 
Though various of these measures
have been relaxed or eliminated, the pandemic has moved in disruptive and unpredictable
 
waves.
 
The travel, hospitality and food and beverage industries, restaurants, retailers and auto
 
manufacturers, and their suppliers
have been severely affected. A significant number of layoffs,
 
furloughs of employees, as well as remote work have
occurred in these and other industries, including government offices, schools and
 
universities. Auburn University held
virtual classes only from March 16, 2020 through the summer session.
 
The auto industry’s production
 
and sales continue to
be adversely affected
 
by supply chain disruptions.
 
Hyundai and Kia are major direct and indirect employers in our area.
The ultimate effects of the COVID-19 pandemic on the economy,
 
generally, our markets, and on us cannot
 
be predicted.
The timing and effects of the COVID-19 pandemic on our business, results
 
of operations and financial condition may
include, among various other consequences, the following. These effects
 
depend on the severity, scope
 
and duration of the
pandemic, its cumulative economic effects, and the effectiveness
 
of healthcare, business and governmental actions
addressing the pandemic’s effects,
 
including vaccinations.
 
Employees’ health could be adversely affected, necessitating their recovery
 
away from work;
Unavailability of key personnel necessary to conduct our business activities;
Our operating effectiveness may be reduced as our employees
 
work from home or suffer from the COVID-19
virus;
Shelter in place, remote work or other restrictions and interruptions of our business and contact
 
with our
customers;
Sustained closures of our branch lobbies or the offices of our customers;
Declines in demand for loans and other banking services and products, and reduced usage
 
and interchange fees
on our payment cards;
Continuing large scale fiscal and monetary stimulus actions
 
may stabilize the economy, but
 
may increase
economic and market risks, including valuation “bubbles,” volatility in various assets and
 
inflation;
Inflation and increases in interest rates may result from fiscal stimulus and
 
monetary stimulus, and the Federal
Reserve has indicated it is willing to permit inflation to run moderately above its 2% target
 
for some time, but is
considering raising interest rates and reducing its securities holdings as a result of inflation
 
that is substantially
higher than the Federal
 
Reserve’s target range;
Increased savings and debt reduction by consumers could reduce demand for credit
 
and our earning assets;
Significant volatility in United States financial markets and our investment securities
 
portfolio, including credit
concerns in municipal securities;
Declines in the credit quality of our loan portfolio, owing to the effects
 
of the COVID-19 pandemic in the
markets we serve, leading to increased provisions for loan losses and increases in our allowance
 
for possible
credit losses;
39
Declines in the value of collateral for loans, including real estate collateral, especially in industries
 
such as
travel, hospitality, restaurants
 
and retailers;
Declines in the net worth and liquidity of borrowers, impairing their ability to pay timely their
 
loan obligations
to us;
Generally low market interest rates that reduce our net interest income and our profitability;
Loan deferrals and loan modifications, and mortgage foreclosure
 
moratoria, including those mandated by law,
 
or
which are encouraged by our regulators, may increase our expense and risks of collectability,
 
reduce our cash
flows and liquidity and adversely affect our results of operations and
 
financial condition;
The end of temporary regulatory accounting and capital relief for banks regarding the effects
 
of the COVID-19
pandemic, including loan deferrals and modifications, could increase our TDRs and require
 
additions to our
allowance for loan losses, which may adversely affect our income,
 
financial condition and capital;
Our waiver of various fees and service charges to support our customers
 
and communities will adversely affect
our results of operation and our liquidity and financial position;
The COVID-19 pandemic may change customer financial behaviors and
 
payment practices. Electronic banking
could become more popular with less customers doing business at our offices;
Certain of our assets, including loans and securities, may become impaired,
 
which would adversely affect our
results of operation and financial condition and mortgage loan foreclosure
 
moratoria may limit our ability to
timely act to protect our interests in the loan collateral;
Reductions in income or losses will adversely affect our capital and growth
 
of capital, including our capital for
bank regulatory purposes;
Losses or reductions in net income may adversely affect the growth or
 
amount of dividends we can pay on our
common stock;
The effects of government fiscal and monetary policies, including
 
changes in such policies, or the effects of
COVID-19 relief programs are discontinued, on the economy and financial stability,
 
generally, and on our
business, results of operations and financial condition cannot be predicted;
Cybercriminals may increase their attempts to compromise business and consumer
 
emails, including an increase
in phishing attempts, and fraudulent vendors or other parties may view the pandemic
 
as an opportunity to prey
upon consumers and businesses during this time.
 
The restoration of financial stability and economic growth may depend
 
on the health care system developing and
deploying COVID-19 testing and contact tracing, and delivery of COVID-19 vaccines,
 
which promote consumer
and employee health and confidence in the economy.
 
These factors, together or in combination with other events or occurrences that are unknown
 
or anticipated, may materially
and adversely affect our business, financial condition and results of operations.
 
Our stock price may reflect securities market conditions
 
The ongoing COVID-19
pandemic has resulted in substantial securities market volatility,
 
especially for bank stocks and
has, and may continue to, adversely affect the market of our common
 
stock. The spread, intensification and duration of
COVID-19 pandemic, as well as the effectiveness of governmental,
 
fiscal and monetary policies, and regulatory responses
to the pandemic, further affect the financial markets and the market prices
 
for securities generally, and the
 
market prices for
bank stocks, including our common stock.
 
The stock market’s gains due to a concentration
 
of high growth companies has
been adversely affected by inflation and expectation of higher interest rates and
 
the Russia invasion of Ukraine in February
2022.
40
The COVID-19 global pandemic could result in
 
deterioration of asset quality and an increase in credit
 
losses.
 
Many businesses have had, and may continue to have lower revenues and cash
 
flows and many consumers will have lower
income as a result of COVID-19. These could result in an inability to repay loans timely in
 
full, reduce our asset quality and
reduce our deposits. Loan modifications and payment deferrals may also increase
 
our credit risks, especially when
temporary regulatory relief for these actions expires. Our business, results of operations, liquidity
 
and financial condition
could be adversely affected.
 
As a participating lender in the PPP,
 
the Bank is subject to additional risks of litigation from the
 
Bank’s
 
customers or other
parties regarding
 
the Bank’s
 
processing of loans for the PPP and risks that the SBA may
 
not fund some or all PPP loan
guaranties.
 
The CARES Act, Paycheck Protection Program and Healthcare Enhancement
 
Act and Economic Aid Act appropriated
more than $1 trillion in funding for PPP loans administered through by the SBA and
 
the U.S. Department of the Treasury.
Under the PPP,
 
eligible small businesses and other entities and individuals can apply for loans from existing
 
SBA lenders
and other approved PPP lenders, subject to numerous limitations and eligibility
 
criteria. The Bank is participating as a
lender in the PPP and made a total of $56.7 million of PPP loans in 2020 and 2021.
 
The PPP loans charge 1% interest
annually.
 
Forgiveness of these loans has been slow,
 
and PPP loans earn less than market rates.
 
Since the opening of the
PPP,
 
various banks have been subject to litigation regarding the process and procedures used in processing applications
 
for
the PPP,
 
and greater governmental attention is directed at preventing fraud.
 
We may be exposed
 
to similar litigation risks,
from both customers and non-customers that approached the Bank regarding PPP
 
loans we extended. If any such litigation
is filed against the Bank and is not resolved favorably to the Bank, it may result in financial
 
liability or adversely affect our
reputation. Litigation can be costly, regardless
 
of outcome. Any financial liability,
 
litigation costs or reputational damage
caused by PPP related litigation could have a material adverse effect on our
 
business, financial condition and results of
operations.
 
The Bank also has credit risk on PPP loans, if the SBA determines deficiencies
 
in the manner in which PPP loans were
originated, funded or serviced by the Bank, such as an issue with the eligibility of a borrower to
 
receive a PPP loan, or
obtain forgiveness of a PPP properly,
 
including those related to the ambiguities in the laws, rules and guidance
 
regarding
the PPP’s operation. In the event of a loss resulting
 
from a default on a PPP loan and a determination by the SBA that there
were one or more deficiencies in the manner in which the PPP loan was originated,
 
funded, or serviced by the Company,
the SBA may deny its liability under the PPP loan guaranty,
 
reduce the amount of the guaranty, or,
 
if it has already paid
under the guaranty, seek recovery of any
 
loss related to the deficiency from the Company.
 
Similar issues may also result in
the denial of forgiveness of PPP loans, which could expose us to potential borrower
 
bankruptcies and potential losses and
additional costs.
At December 31, 2021 we had $8.1 million PPP loans outstanding and had not realized
 
any losses on such loans.
 
ITEM 1B. UNRESOLVED
 
STAFF COMMENTS
None.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank conducts its business from its main office and seven full-service
 
branches.
 
The Bank also operates loan
production offices in Auburn and Phenix City,
 
Alabama.
The Bank owns its main campus in downtown Auburn, Alabama, which comprises
 
over 5 acres and includes the Bank's
temporary main office, operations center,
 
drive-through facility,
 
and parking deck.
 
The operations center, built as a theater
in 1968, and remodeled by the Bank after purchasing it in 1985, has approximately 23,000
 
square feet of space. All of the
Bank’s loan servicing, data processing activities,
 
and other operations, are located in the operations building.
 
Currently,
 
the
Bank’s temporary main office
 
is located in the operations center as the Bank completes Phase I of its main campus
redevelopment plan.
 
The temporary main office branch offers the full line of the Bank’s
 
services and has one ATM.
 
The
Bank’s drive-through facility located
 
on the main office campus was constructed in October 2012.
 
This drive-through
facility has five drive-through lanes, including an ATM,
 
and a walk-up teller window.
41
Phase I of the redevelopment plan includes the construction of a new headquarters building,
 
the AuburnBank Center, and a
parking deck.
 
Construction activities for Phase I commenced during the second half of 2020
 
and the parking deck was
completed in April of 2021.
 
The parking deck has approximately 500 parking spaces, is open to the public and charges
hourly, monthly,
 
and special event rates, and is expected to provide for future parking needs on the Bank’s
 
main campus,
including the new headquarters building.
 
The new headquarters building will have approximately 90,000
 
square feet of
space and is expected to be complete in the second quarter of 2022.
 
Upon completion of Phase I, the Bank’s main office,
Auburn loan production office, and all of its back-office operations
 
will be relocated to the new headquarters building.
 
The
Bank expects to lease approximately 46,000 square feet of office space
 
and approximately 5,000 square feet of retail space
in the new headquarters building to third party tenants.
In January 2019, the Bank purchased a parcel that adjoins the operations center in order
 
to improve ingress and egress to
the Bank’s main campus.
 
The building improvements currently on this adjoining parcel, as
 
well as the operations building,
will be demolished under Phase II of the Bank's campus redevelopment plan.
 
In February 2022, the Company entered into
an agreement, subject to a 180 day inspection period and customary closing conditions,
 
to sell this combined parcel of
approximately 0.85 acres to a hotel developer.
 
As part of the agreement, the Bank will negotiate a long-term lease with the
hotel developer for 100 to 150 parking spaces in the Bank’s
 
parking deck.
 
Upon closing, the Company currently expects
this sale to be accretive to 2022 earnings by approximately $0.70 per share.
The Opelika branch is located in Opelika, Alabama. This branch, built in 1991,
 
is owned by the Bank and has
approximately 4,000 square feet of space. This branch offers the full line of the
 
Bank’s services and has drive-through
windows and an ATM.
 
This branch offers parking for approximately 36 vehicles.
The Bank’s Notasulga branch was opened
 
in August 2001. This branch is located in Notasulga, Alabama, about 15
 
miles
west of Auburn, Alabama. This branch is owned by the Bank and has approximately 1,344
 
square feet of space. The Bank
leased the land for this branch from a third party.
 
In May 2021,
 
the Bank’s land lease renewed for another one
 
year term.
This branch offers the full line of the Bank’s
 
services including safe deposit boxes and a drive-through window.
 
This
branch offers parking for approximately 11
 
vehicles, including a handicapped ramp.
In November 2002, the Bank opened a loan production office
 
in Phenix City, Alabama, about 35
 
miles south of Auburn,
Alabama. In November 2020,
 
the Bank renewed its lease for another year.
In February 2009, the Bank opened a branch located on Bent Creek Road in Auburn,
 
Alabama. This branch is owned by the
Bank and has approximately 4,000 square feet of space. This branch offers
 
the full line of the Bank’s services and
 
has
drive-through windows and a drive-up ATM.
 
This branch offers parking for approximately 29 vehicles.
In December 2011, the Bank opened a branch located
 
on Fob James Drive in Valley,
 
Alabama, about 30 miles northeast of
Auburn, Alabama.
 
This branch is owned by the Bank and has approximately 5,000 square feet of space.
 
This branch offers
the full line of the Bank’s services and has drive-through
 
windows and a drive-up ATM.
 
This branch offers parking for
approximately 35 vehicles.
 
Prior to December 2011, the Bank leased office
 
space for a loan production office in Valley,
Alabama.
 
The loan production office was originally opened in September 2004.
In February 2015, the Bank relocated its Auburn Kroger branch to a new location within the
 
Corner Village Shopping
Center, in Auburn, Alabama. In February 2015,
 
the Bank entered into a new lease agreement for five years with options for
two 5-year extensions. In February 2020, the Bank exercised its option to renew the lease
 
for another five years. The Bank
leases approximately 1,500 square feet of space for the Corner Village
 
branch. Prior to relocation, the Bank’s
 
Auburn
Kroger branch was located in the Kroger supermarket in the same shopping center.
 
The Auburn Kroger branch was
originally opened in August 1988. The Corner Village
 
branch offers the full line of the Bank’s
 
deposit and other services
including an ATM,
 
except safe deposit boxes.
In September 2015, the Bank relocated its Auburn Wal
 
-Mart Supercenter branch to a new location the Bank purchased in
December 2014 at the intersection of S. Donahue Avenue
 
and E. University Drive in Auburn, Alabama.
 
The South
Donahue branch, built in 2015, has approximately 3,600 square feet of space.
 
Prior to relocation, the Bank’s Auburn
 
Wal-
Mart Supercenter branch was located inside the Wal
 
-Mart shopping center on the south side of Auburn, Alabama.
 
The
Auburn Wal-Mart Supercenter
 
branch was originally opened in September 2000. The South Donahue branch offers
 
the full
line of the Bank’s services and has drive-through
 
windows and an ATM.
 
This branch offers parking for approximately 28
vehicles.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
42
In May 2017, the Bank relocated its Opelika Kroger branch to a new location the Bank purchased
 
in August 2016 near the
Tiger Town
 
Retail Shopping Center and the intersection of U.S. Highway 280 and Frederick
 
Road in Opelika, Alabama.
 
The Tiger Town
 
branch, built in 2017, has approximately 5,500 square feet of space.
 
Prior to relocation, the Bank’s
Opelika Kroger branch was located inside the Kroger supermarket in the Tiger
 
Town retail center in Opelika,
 
Alabama. The
Opelika Kroger branch was
 
originally opened in July 2007. The Tiger Town
 
branch offers the full line of the Bank’s
services and has drive-through windows and an ATM.
 
This branch offers parking for approximately 36 vehicles.
In September 2018, the Bank opened a loan production office on East Samford
 
Avenue in Auburn,
 
Alabama.
 
The location
has approximately 2,500 square feet of space and is leased through 2028.
 
The loan production office was previously
located in the Center on the Bank’s
 
main campus. This location offers parking for approximately
 
16 vehicles.
ITEM 3.
 
LEGAL PROCEEDINGS
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 7, 2022,
there were approximately 3,516,971 shares of the Company’s
 
Common Stock issued and outstanding, which were held by
approximately 369 shareholders of record. The following table sets forth, for the indicated
 
periods, the high and low closing
sale prices for the Company’s Common Stock
 
as reported on the Nasdaq Global Market, and the cash dividends declared to
shareholders during the indicated periods.
 
Closing
 
Cash
 
Price
 
Dividends
Per Share (1)
Declared
 
High
Low
2021
First Quarter
$
 
48.00
 
$
 
37.55
 
$
 
0.26
 
Second Quarter
 
38.90
 
 
34.50
 
 
0.26
 
Third Quarter
 
35.36
 
 
33.25
 
 
0.26
 
Fourth Quarter
 
34.79
 
 
31.32
 
 
0.26
 
2020
First Quarter
$
 
59.99
 
$
 
24.11
 
$
 
0.255
 
Second Quarter
 
63.40
 
 
36.81
 
 
0.255
 
Third Quarter
 
56.80
 
 
26.26
 
 
0.255
 
Fourth Quarter
 
43.00
 
 
36.75
 
 
0.255
 
(1)
 
The price information represents actual transactions.
The Company has paid cash dividends on its capital stock since 1985. Prior to this time, the
 
Bank paid cash dividends since
its organization in 1907, except during the Depression years of 1932
 
and 1933. Holders of Common Stock are entitled to
receive such dividends as may be declared by the Company’s
 
Board of Directors. The amount and frequency of cash
dividends will be determined in the judgment of the Board based upon a number of
 
factors, including the Company’s
earnings, financial condition, capital requirements and other relevant factors.
 
The Board currently intends to continue its
present dividend policies.
43
Federal Reserve policy could restrict future dividends on our Common Stock, depending
 
on our earnings and capital
position and likely needs. See “Supervision and Regulation – Payment of Dividends”
 
and “Management’s Discussion
 
and
Analysis of Financial Condition and Results of Operations – Capital Adequacy”.
The amount of dividends payable by the Bank is limited by law and regulation.
 
The need to maintain adequate capital in
the Bank also limits dividends that may be paid to the Company.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
aubn-20201231p44i0.jpg
44
Performance Graph
The following performance graph compares the cumulative, total return on the
 
Company’s Common Stock
 
from
December 31, 2016 to December 31, 2021, with that of the Nasdaq Composite Index and
 
SNL Southeast Bank Index
(assuming a $100 investment on December 31, 2016). Cumulative total return represents
 
the change in stock price and the
amount of dividends received over the indicated period, assuming the reinvestment of
 
dividends.
 
Period Ending
Index
12/31/2016
12/31/2017
12/31/2018
12/31/2019
12/31/2020
12/31/2021
Auburn National Bancorporation, Inc.
100.00
127.56
106.32
182.85
146.96
117.06
NASDAQ Composite Index
100.00
129.64
125.96
172.18
249.51
304.85
S&P U.S. BMI Banks - Southeast Region Index
100.00
123.70
102.20
144.05
129.15
184.47
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
45
Issuer Purchases of Equity Securities
Period
Total Number of
Shares Purchased
Average Price Paid
per Share
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
The Approximate
Dollar Value
 
of Shares
that May Yet
 
Be Under
the Plans or
Programs(1)
October 1 – October 31, 2021
 
1,684
 
 
33.85
 
 
1,684
 
3,623,268
November 1 – November 30, 2021
 
7,169
 
 
33.85
 
 
7,169
 
3,380,597
December 1 – December 31, 2021
––
––
––
3,380,597
Total
 
8,853
 
 
33.85
 
 
8,853
 
3,380,597
(1) On March 9, 2021 the Company adopted a $5 million stock repurchase program that became effective April 1, 2021.
Securities Authorized for Issuance Under Equity Compensation Plans
See the information included under Part III, Item 12, which is incorporated
 
in response to this item by reference.
Unregistered Sale of Equity Securities
Not applicable.
ITEM 6.
 
SELECTED FINANCIAL DATA
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,
 
2021 and 2020 and our results of operations for
the years ended December 31, 2021 and 2020. The purpose of this discussion is to provide
 
information about our financial
condition and results of operations which is not otherwise apparent from the
 
consolidated financial statements. The
following discussion and analysis should be read along with our consolidated
 
financial statements and the related notes
included elsewhere herein. In addition, this discussion and analysis contains forward-looking
 
statements, so you should
refer to Item 1A, “Risk Factors” and “Special Cautionary Notice Regarding Forward-Looking Statements”.
 
OVERVIEW
The Company was incorporated in 1990 under the laws of the State of Delaware and became a bank
 
holding company after
it acquired its Alabama predecessor,
 
which was a bank holding company established in 1984. The Bank, the Company's
principal subsidiary, is an Alabama
 
state-chartered bank that is a member of the Federal Reserve System and has operated
continuously since 1907. Both the Company and the Bank are headquartered
 
in Auburn, Alabama. The Bank conducts its
business primarily in East Alabama, including Lee County and surrounding areas.
 
The Bank operates full-service branches
in Auburn, Opelika, Notasulga and Valley,
 
Alabama.
 
The Bank also operates loan production offices in Auburn and
Phenix City, Alabama.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
46
Summary of Results of Operations
Year ended December 31
(Dollars in thousands, except per share data)
2021
2020
Net interest income (a)
$
24,460
$
24,830
Less: tax-equivalent adjustment
470
492
Net interest income (GAAP)
23,990
24,338
Noninterest income
4,288
5,375
Total revenue
28,278
29,713
Provision for loan losses
(600)
1,100
Noninterest expense
19,433
19,554
Income tax expense
 
1,406
1,605
Net earnings
$
8,039
$
7,454
Basic and diluted net earnings per share
$
2.27
$
2.09
(a) Tax-equivalent.
 
See "Table 1 - Explanation of Non-GAAP Financial Measures".
Financial Summary
The Company’s net earnings were $8.0
 
million for the full year 2021, compared to $7.5 million for the full year 2020.
 
Basic and diluted net earnings per share were $2.27 per share for the full year 2021,
 
compared to $2.09 per share for the full
year 2020.
 
Net interest income (tax-equivalent) was $24.5
 
million in 2021, a 1% decrease compared to $24.8 million in 2020. This
decrease was primarily due to net interest margin compression
 
,
 
partially offset by balance sheet growth.
 
Net interest
margin (tax-equivalent) decreased to 2.55% in 2021,
 
compared to 2.92% in 2020, primarily due to the lower interest rate
environment and changes in our asset mix resulting from the significant increase
 
in deposits from government stimulus and
relief programs and customers’ increased savings.
 
At December 31, 2021, the Company’s allowance
 
for loan losses was $4.9 million, or 1.08% of total loans, compared to
$5.6 million, or 1.22%
 
of total loans, at December 31, 2020.
 
Excluding
 
Paycheck Protection Program (“PPP”) loans, which
are guaranteed by the SBA,
 
the Company’s allowance for loan losses
 
was 1.10% and 1.27% of total loans at December 31,
2021 and 2020, respectively
.
 
The Company recorded a negative provision for loan losses of $0.6
 
million in 2021 compared
to a charge of $1.1 million during 2020.
 
The negative provision for loan losses was primarily related to improvements in
economic conditions in our primary market area, and related improvements in our
 
asset quality.
 
The provision for loan
losses is based upon various estimates and judgements, including the absolute level
 
of loans, loan growth, credit quality and
the amount of net charge-offs.
 
Net charge-offs as a percent of average loans were 0.02% in 2021
 
,
 
compared to net
recoveries as a percent of average loans of 0.03% in 2020.
 
Noninterest income was $4.3 million in 2021 compared to $5.4
 
million in 2020.
 
The decrease was primarily due to a $0.8
million decrease in mortgage lending income in 2021 as refinance activity declined
 
in our primary market area and a $0.3
million non-taxable death benefit from bank-owned life insurance received
 
in 2020.
 
Noninterest expense was $19.4
 
million in 2021 compared to $19.6
 
million in 2020. The decrease was primarily due to a
reduction of $0.8
 
million in various expenses related to the redevelopment of the Company’s
 
headquarters in downtown
Auburn.
 
This decrease was mostly offset by increases in salaries and benefits expe
 
nse of $0.4 million and a $0.2 million
increase in FDIC and other regulatory assessments during 2021.
Income tax expense was $1.4
 
million in 2021 and $1.6 million in 2020 reflecting an effective tax rate of 14.89
 
%
 
and
17.72%, respectively.
 
This decrease was primarily due to an income tax benefit related to a New Markets Tax
 
Credit
investment funded in the fourth quarter of 2021.
 
The Company’s effective income
 
tax rate is principally impacted by tax-
exempt earnings from the Company’s investments
 
in municipal securities, bank-owned life insurance, and New Markets
Tax Credits.
 
47
The Company paid cash dividends of $1.04
 
per share in 2021, an increase of 2% from 2020. At December 31, 2021, the
Bank’s regulatory capital ratios
 
were well above the minimum amounts required to be “well capitalized” under current
regulatory standards with a total risk-based capital ratio of 17.06%,
 
a tier 1 leverage ratio of 9.35% and common equity tier
1 (“CET1”) of 16.23% at December 31, 2021.
 
COVID-19 Impact Assessment
The COVID-19 pandemic has occurred in waves of different
 
variants since the first quarter of 2020.
 
Vaccines
 
to protect
against and/or reduce the severity of COVID-19 were widely introduced at the beginning
 
of 2021.
 
At times, the pandemic
has severely restricted the level of economic activity in our markets. In response to the COVID
 
-19 pandemic, the State of
Alabama, and most other states, have taken preventative or protective actions to prevent the
 
spread of the virus, including
imposing restrictions on travel and business operations and a statewide mask mandate,
 
advising or requiring individuals to
limit or forego their time outside of their homes, limitations on gathering of people and social distancing,
 
and causing
temporary closures of businesses that have been deemed to be non-essential. Though certain
 
of these measures have been
relaxed or eliminated, especially as vaccination levels increased, such
 
measures could be reestablished in cases of new
waves, especially a wave of a COVID-19 variant that is more resistant
 
to existing vaccines.
 
COVID-19 has significantly affected local state, national and global
 
health and economic activity and its future effects are
uncertain and will depend on various factors, including, among others, the duration
 
and scope of the pandemic, especially
new variants of the virus, effective vaccines and drug treatments, together
 
with governmental, regulatory and private sector
responses. COVID-19 has had continuing significant effects
 
on the economy, financial
 
markets and our employees,
customers and vendors. Our business, financial condition and results of operations
 
generally rely upon the ability of our
borrowers to make deposits and repay their loans, the value of collateral underlying our
 
secured loans, market value,
stability and liquidity and demand for loans and other products and services we offer,
 
all of which are affected by the
pandemic.
 
We have implemented
 
a number of procedures in response to the pandemic to support the safety and well-being of our
employees, customers and shareholders.
 
We believe our business continuity
 
plan has worked to provide essential banking services to our communities and
customers, while protecting our employees’ health.
 
As part of our efforts to exercise social distancing in
accordance with the guidelines of the Centers for Disease Control and the Governor
 
of the State of Alabama,
starting March 23, 2020, we limited branch lobby service to appointment only while continuing
 
to operate our
branch drive-thru facilities and ATMs.
 
As permitted by state public health guidelines, on June 1, 2020, we re-
opened some of our branch lobbies.
 
In 2021, we opened our remaining branch lobbies.
 
We continue to provide
services through our online and other electronic channels.
 
In addition, we maintain remote work access to help
employees stay at home while providing continuity of service.
 
We are focused on servicing
 
the financial needs of our commercial and consumer clients with extensions
 
and
deferrals to loan customers effected by COVID-19, provided
 
such customers were not more than 30 days past due
at the time of the request; and
 
We
 
were an active PPP lender. PPP loans were forgivable,
 
in whole or in part, if the proceeds are used for payroll
and other permitted purposes in accordance with the requirements of the PPP.
 
These loans carry a fixed rate of
1.00% and a term of two years (loans made before June 5, 2020) or five years (loans
 
made on or after June 5,
2020), if not forgiven, in whole or in part.
 
Payments are deferred until either the date on which the Small Business
Administration (“SBA”) remits the amount of forgiveness proceeds
 
to the lender or the date that is 10 months after
the last day of the covered period if the borrower does not apply for forgiveness
 
within that 10-month period.
 
We
believe these loans and our participation in the program helped our customers and the communities
 
we serve.
COVID-19 has also had various economic effects, generally.
 
These include supply chain disruptions and manufacturing
delays, shortages of certain goods and services, reduced consumer expenditure on
 
hospitality and travel, and migration from
larger urban centers to less populated areas and remote work.
 
The demand for single family housing has exceeded existing
supplies.
 
When coupled with construction delays attributable to supply chain disruptions
 
and worker shortages, these
factors have caused housing prices and apartment rents to increase, generally.
 
Stimulative monetary and fiscal policy,
along with shortages of certain goods and services, and rising petroleum and food prices
 
have led to the highest inflation in
decades.
 
Although fiscal stimulus remains under consideration by the President and Congress,
 
the Federal Reserve is
considering increasing its target interest rates and reducing its holding of
 
securities to stem inflation.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
48
A summary of PPP loans extended during 2020 follows:
 
(Dollars in thousands)
# of SBA
Approved
Mix
$ of SBA
Approved
Mix
SBA Tier:
$2 million to $10 million
%
$
%
$350,000 to less than $2 million
23
5
14,691
40
Up to $350,000
400
95
21,784
60
Total
423
100
%
$
36,475
100
%
We collected
 
approximately $1.5 million in fees related to our PPP loans during 2020.
 
Through December 31, 2021, we
have recognized all of these fees, net of related costs.
 
As of December 31, 2021, we had received payments and
forgiveness on all PPP loans extended during 2020.
 
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits,
 
and Venues
 
Act (the “Economic Aid
Act”) was signed into law. The
 
Economic Aid Act provides a second $900 billion stimulus package, including
 
$325 billion
in additional PPP loans.
 
The Economic Aid Act also permits the collection of a higher amount of PPP
 
loan fees by
participating banks.
 
A summary of PPP loans extended during 2021 under the Economic Aid
 
Act follows:
(Dollars in thousands)
# of SBA
Approved
Mix
$ of SBA
Approved
Mix
SBA Tier:
$2 million to $10 million
%
$
%
$350,000 to less than $2 million
12
5
6,494
32
Up to $350,000
242
95
13,757
68
Total
254
100
%
$
20,251
100
%
We collected
 
approximately $1.0 million in fees related to PPP loans under the Economic Aid Act.
 
Through December 31,
2021, we have recognized $0.7 million of these fees, net of related costs.
 
As of December 31, 2021, we have received
payments and forgiveness on 116
 
PPP loans under the Economic Aid Act, totaling $12.1 million.
 
The outstanding balance
for the remaining 138 PPP loans under the Economic Aid Act
 
was approximately $8.1 million at December 31, 2021.
 
We continue to closely
 
monitor this pandemic, and are working to continue our services during the pandemic
 
and to address
developments as those occur.
 
Our results of operations for year ended December 31, 2021, and our financial condition
 
at
that date reflect only the ongoing effects of the pandemic, and
 
may not be indicative of future results or financial
conditions, including possible changes in monetary or fiscal stimulus, and
 
the possible effects of the expiration or extension
of temporary accounting and bank regulatory relief measures in response to the
 
COVID-19 pandemic.
 
As of December 31, 2021,
 
all of our capital ratios were in excess of all regulatory requirements to be well capitalized.
 
The
effects of the COVID-19 pandemic on our borrowers could result in adverse changes
 
to credit quality and our regulatory
capital ratios.
 
We continue to
 
closely monitor this pandemic, and are working to continue our services during the pandemic
and to address developments as those occur.
CRITICAL ACCOUNTING POLICIES
The accounting and financial reporting policies of the Company conform
 
with U.S. generally accepted accounting
principles and with general practices within the banking industry.
 
In connection with the application of those principles, we
have made judgments and estimates which, in the case of the determination of our allowance
 
for loan losses, our
assessment of other-than-temporary impairment, recurring and
 
non-recurring fair value measurements, the valuation of
other real estate owned, and the valuation of deferred tax assets, were critical to the determination
 
of our financial position
and results of operations. Other policies also require subjective judgment and assumptions
 
and may accordingly impact our
financial position and results of operations.
 
49
Allowance for Loan Losses
The Company assesses the adequacy of its allowance for loan losses prior
 
to the end of each calendar quarter. The level of
the allowance is based upon management’s
 
evaluation of the loan portfolio, past loan loss experience, current asset quality
trends, known and inherent risks in the portfolio, adverse situations that may affect
 
a borrower’s ability to repay (including
the timing of future payment), the estimated value of any underlying collateral,
 
composition of the loan portfolio, economic
conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory
 
recommendations. This
evaluation is inherently subjective as it requires material estimates including the
 
amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible to significant change. Loans are
 
charged off, in whole or
in part, when management believes that the full collectability of the loan is unlikely.
 
A loan may be partially charged-off
after a “confirming event” has occurred which serves to validate that full repayment pursuant
 
to the terms of the loan is
unlikely.
The Company deems loans impaired when, based on current information and events, it is
 
probable that the Company will
be unable to collect all amounts due according to the contractual terms of the loan agreement.
 
Collection of all amounts due
according to the contractual terms means that both the interest and principal payments of a
 
loan will be collected as
scheduled in the loan agreement.
An impairment allowance is recognized if the fair value of the loan is less than the recorded
 
investment in the loan. The
impairment is recognized through the allowance. Loans that are impaired are
 
recorded at the present value of expected
future cash flows discounted at the loan’s effective
 
interest rate, or if the loan is collateral dependent, impairment
measurement is based on the fair value of the collateral, less estimated disposal costs.
The level of allowance maintained is believed by management to be adequate
 
to absorb probable losses inherent in the
portfolio at the balance sheet date. The allowance is increased by provisions charged
 
to expense and decreased by charge-
offs, net of recoveries of amounts previously charged-off.
In assessing the adequacy of the allowance, the Company also considers the results of its
 
ongoing internal, independent
loan review process. The Company’s loan
 
review process assists in determining whether there are loans in the portfolio
whose credit quality has weakened over time and evaluating the risk characteristics of the
 
entire loan portfolio. The
Company’s loan review process includes the judgment
 
of management, the input from our independent loan reviewers, and
reviews that may have been conducted by bank regulatory agencies as part of their examination
 
process. The Company
incorporates loan review results in the determination of whether or not it is probable
 
that it will be able to collect all
amounts due according to the contractual terms of a loan.
As part of the Company’s quarterly assessment
 
of the allowance, management divides the loan portfolio into five segments:
commercial and industrial, construction and land development, commercial real estate, residential
 
real estate, and consumer
installment loans. The Company
 
analyzes each segment and estimates an allowance allocation for each loan
 
segment.
The allocation of the allowance for loan losses begins with a process of estimating the
 
probable losses inherent for these
types of loans. The estimates for these loans are established by category and based
 
on the Company’s internal system of
credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s
 
internal system of
credit risk grades is based on its experience with similarly graded loans. For
 
loan segments where the Company believes it
does not have sufficient historical loss data, the Company may
 
make adjustments based, in part, on loss rates of peer bank
groups. At December 31, 2021 and 2020, and for the years then ended, the Company adjusted
 
its historical loss rates for the
commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.
The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s
 
estimate of
probable losses for several “qualitative and environmental” factors.
 
The allocation for qualitative and environmental
factors is particularly subjective and does not lend itself to exact mathematical calculation.
 
This amount represents
estimated probable inherent credit losses which exist, but have not yet been identified, as of
 
the balance sheet date, and are
based upon quarterly trend assessments in delinquent and nonaccrual loans, credit
 
concentration changes, prevailing
economic conditions, changes in lending personnel experience, changes in lending
 
policies or procedures and other
influencing factors.
 
These qualitative and environmental factors are considered for each of the five loan segments
 
and the
allowance allocation, as determined by the processes noted above, is increased or
 
decreased based on the incremental
assessment of these factors.
50
The Company regularly re-evaluates its practices in determining the allowance
 
for loan losses. Since the fourth quarter of
2016, the Company has increased its look-back period each quarter to incorporate
 
the effects of at least one economic
downturn in its loss history. The Company believes
 
the extension of its look-back period is appropriate due to the risks
inherent in the loan portfolio. Absent this extension, the early cycle periods in
 
which the Company experienced significant
losses would be excluded from the determination of the allowance for loan losses and its balance
 
would decrease. For the
year ended December 31, 2021, the Company increased its look-back period to
 
51 quarters to continue to include losses
incurred by the Company beginning with the first quarter of 2009. The Company
 
will likely continue to increase its look-
back period to incorporate the effects of at least one economic downturn in
 
its loss history. During 2020,
 
the Company
adjusted certain qualitative and economic factors related to changes in economic conditions
 
driven by the impact of the
COVID-19 pandemic and resulting adverse economic conditions, including
 
higher unemployment in our primary market
area.
 
During 2021, the Company adjusted certain qualitative and economic factors to reflect
 
improvements in economic
conditions in our primary market area.
 
Further adjustments may be made in the future as a result of the ongoing COVID-19
pandemic.
 
Assessment for Other-Than-Temporary
 
Impairment of Securities
On a quarterly basis, management makes an assessment to determine
 
whether there have been events or economic
circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily
 
impaired.
 
For debt securities with an unrealized loss, an other-than-temporary
 
impairment write-down is triggered when (1) the
Company has the intent to sell a debt security,
 
(2) it is more likely than not that the Company will be required to sell the
debt security before recovery of its amortized cost basis, or (3) the Company does not expect
 
to recover the entire amortized
cost basis of the debt security.
 
If the Company has the intent to sell a debt security or if it is more likely than not that it
 
will
be required to sell the debt security before recovery,
 
the other-than-temporary write-down is equal to the entire difference
between the debt security’s amortized cost
 
and its fair value.
 
If the Company does not intend to sell the security or it is not
more likely than not that it will be required to sell the security before recovery,
 
the other-than-temporary impairment write-
down is separated into the amount that is credit related (credit loss component) and the amount due
 
to all other factors.
 
The
credit loss component is recognized in earnings and is the difference between
 
the security’s amortized cost basis and
 
the
present value of its expected future cash flows.
 
The remaining difference between the security’s
 
fair value and the present
value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive
income, net of applicable taxes.
The Company is required to own certain stock as a condition of membership, such as
 
Federal Home Loan Bank (“FHLB”)
and Federal Reserve Bank (“FRB”).
 
These non-marketable equity securities are accounted for at cost
 
which equals par or
redemption value.
 
These securities do not have a readily determinable fair value as their ownership is restricted and
 
there is
no market for these securities.
 
The Company records these non-marketable equity securities as a component
 
of other
assets, which are periodically evaluated for impairment. Management considers
 
these non-marketable equity securities to
be long-term investments. Accordingly,
 
when evaluating these securities for impairment, management considers
 
the
ultimate recoverability of the par value rather than by recognizing temporary declines in
 
value.
Fair Value
 
Determination
U.S. GAAP requires management to value and disclose certain of the Company’s
 
assets and liabilities at fair value,
including investments classified as available-for-sale and derivatives.
 
ASC 820,
Fair Value
 
Measurements and Disclosures
,
which defines fair value, establishes a framework for measuring fair value in accordance
 
with U.S. GAAP and expands
disclosures about fair value measurements.
 
For more information regarding fair value measurements and disclosures,
please refer to Note 14, Fair Value,
 
of the consolidated financial statements that accompany this report.
Fair values are based on active market prices of identical assets or liabilities when available.
 
Comparable assets or
liabilities or a composite of comparable assets in active markets are used when identical assets
 
or liabilities do not have
readily available active market pricing.
 
However, some of the Company’s
 
assets or liabilities lack an available or
comparable trading market characterized by frequent transactions between
 
willing buyers and sellers. In these cases, fair
value is estimated using pricing models that use discounted cash flows and
 
other pricing techniques. Pricing models and
their underlying assumptions are based upon management’s
 
best estimates for appropriate discount rates, default rates,
prepayments, market volatility and other factors, taking into account current observable
 
market data and experience.
These assumptions may have a significant effect on the reported
 
fair values of assets and liabilities and the related income
and expense. As such, the use of different models and assumptions, as
 
well as changes in market conditions, could result in
materially different net earnings and retained earnings results.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
51
Other Real Estate Owned
Other real estate owned (“OREO”), consists of properties obtained through foreclosure or
 
in satisfaction of loans and is
reported at the lower of cost or fair value, less estimated costs to sell at the date acquired with any loss
 
recognized as a
charge-off through the allowance for loan losses. Additional
 
OREO losses for subsequent valuation adjustments are
determined on a specific property basis and are included as a component of other noninterest
 
expense along with holding
costs. Any gains or losses on disposal of OREO are also reflected in noninterest expense.
 
Significant judgments and
complex estimates are required in estimating the fair value of OREO, and the period of time
 
within which such estimates
can be considered current is significantly shortened during periods of
 
market volatility. As a result, the net proceeds
realized from sales transactions could differ significantly from
 
appraisals, comparable sales, and other estimates used to
determine the fair value of OREO.
Deferred Tax
 
Asset Valuation
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available
 
evidence, it is more-likely-
than-not that some portion or the entire deferred tax asset will not be realized. The
 
ultimate realization of deferred tax assets
is dependent upon the generation of future taxable income during the periods
 
in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred
 
tax liabilities, projected future taxable income and tax
planning strategies in making this assessment. Based upon the level of taxable income over
 
the last three years and
projections for future taxable income over the periods in which the deferred tax assets are
 
deductible, management believes
it is more likely than not that we will realize the benefits of these deductible differences
 
at December 31, 2021. The amount
of the deferred tax assets considered realizable, however,
 
could be reduced if estimates of future taxable income are
reduced.
 
Average Balance
 
Sheet and Interest Rates
Year ended December 31
 
2021
2020
Average
Yield/
Average
Yield/
(Dollars in thousands)
Balance
Rate
Balance
Rate
Loans and loans held for sale
 
$
459,712
4.45%
$
465,378
4.74%
Securities - taxable
320,766
1.28%
234,420
1.68%
Securities - tax-exempt (a)
62,736
3.57%
63,029
3.72%
Total securities
383,502
1.66%
297,449
2.11%
Federal funds sold
38,659
0.15%
30,977
0.41%
Interest bearing bank deposits
77,220
0.13%
56,104
0.41%
Total interest-earning assets
959,093
2.81%
849,908
3.38%
Deposits:
 
 
NOW
178,197
0.12%
154,431
0.34%
Savings and money market
296,708
0.22%
242,485
0.44%
Certificates of deposits
159,111
1.03%
165,120
1.36%
Total interest-bearing deposits
634,016
0.39%
562,036
0.68%
Short-term borrowings
3,349
0.51%
1,864
0.48%
Total interest-bearing liabilities
637,365
0.39%
563,900
0.68%
Net interest income and margin (a)
$
24,460
2.55%
$
24,830
2.92%
(a) Tax-equivalent.
 
See "Table 1 - Explanation of Non-GAAP
 
Financial Measures".
RESULTS
 
OF OPERATIONS
Net Interest Income and Margin
Net interest income (tax-equivalent) was $24.5 million in 2021, compared
 
to $24.8 million in 2020.
 
This decrease was due
to a decline in the Company’s net interest
 
margin (tax-equivalent),
 
partially offset by balance sheet growth.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
52
The tax-equivalent yield on total interest-earning assets decreased by 57 basis points
 
in 2021 from 2020 to 2.81%.
 
This
decrease was primarily due to the lower rate environment and changes in our asset
 
mix from the significant increase in
deposits from government stimulus and relief programs and customers’ increased savings.
The cost of total interest-bearing liabilities decreased 29 basis points to 0.39%
 
in 2021 compared to 0.68 in 2020.
 
The net
decrease in our funding costs was primarily due to lower prevailing market interest rates.
 
Our funding costs declined less
than the rates earned on our interest earning assets.
 
The Company continues to deploy various asset liability management strategies
 
to manage its risk to interest rate
fluctuations. The Company’s
 
net interest margin could experience pressure due to reduced earning asset
 
yields and
increased competition for quality loan opportunities.
 
Provision for Loan Losses
The provision for loan losses represents a charge to earnings necessary to provide
 
an allowance for loan losses that
management believes, based on its processes and estimates, should be adequate
 
to provide for the probable losses on
outstanding loans. The Company recorded a negative provision for loan losses of $0.6
 
million during 2021, compared to
$1.1 million in provision for loan losses during 2020.
 
The negative provision for loan losses was primarily related to
improvements in economic conditions in our primary market area.
 
The provision for loan losses is based upon various
factors, including the absolute level of loans, loan growth, the credit quality,
 
and the amount of net charge-offs or
recoveries.
 
Based upon its assessment of the loan portfolio, management adjusts the allowance
 
for loan losses to an amount it believes
should be appropriate to adequately cover its estimate of probable losses in the loan portfolio.
 
The Company’s allowance
for loan losses as a percentage of total loans was 1.08% at December 31, 2021, compared
 
to 1.22% at December 31, 2020.
Excluding PPP loans, which are guaranteed by the SBA, the Company’s
 
allowance for loan losses was 1.10% and 1.27% of
total loans at December 31, 2021 and 2020, respectively.
 
While the policies and procedures used to estimate the allowance
for loan losses, as well as the resulting provision for loan losses charged to operations,
 
are considered adequate by
management and are reviewed from time to time by our regulators, they are based on estimates
 
and judgments and are
therefore approximate and imprecise. Factors beyond our control (such as conditions
 
in the local and national economy,
local real estate markets, or industries) may have a material adverse effect
 
on our asset quality and the adequacy of our
allowance for loan losses resulting in significant increases in the provision
 
for loan losses.
Noninterest Income
 
Year ended December 31
(Dollars in thousands)
2021
2020
Service charges on deposit accounts
$
566
$
585
Mortgage lending
1,547
2,319
Bank-owned life insurance
403
724
Securities gains, net
15
103
Other
1,757
1,644
Total noninterest income
$
4,288
$
5,375
The decrease in service charges on deposit accounts was primarily driven by a decline
 
in consumer spending activity as a
result of the COVID-19 pandemic.
The Company’s income from mortgage lending
 
is primarily attributable to the (1) origination and sale of new mortgage
loans and (2) servicing of mortgage loans. Origination income, net, is comprised of gains
 
or losses from the sale of the
mortgage loans originated, origination fees, underwriting fees and other fees associated
 
with the origination of loans, which
are netted against the commission expense associated with these originations. The
 
Company’s normal practice is to
originate mortgage loans for sale in the secondary market and to either sell or
 
retain the MSRs when the loan is sold.
 
MSRs are recognized based on the fair value of the servicing right on the date the corresponding
 
mortgage loan is sold.
 
Subsequent to the date of transfer, the Company
 
has elected to measure its MSRs under the amortization method.
 
Servicing
fee income is reported net of any related amortization expense.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
53
The Company evaluates MSRs for impairment on a quarterly basis.
 
Impairment is determined by grouping MSRs by
common predominant characteristics, such as interest rate and loan type.
 
If the aggregate carrying amount of a particular
group of MSRs exceeds the group’s aggregate fair
 
value, a valuation allowance for that group is established.
 
The valuation
allowance is adjusted as the fair value changes.
 
An increase in mortgage interest rates typically results in an increase in the
fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease
 
in the fair value of MSRs.
 
The following table presents a breakdown of the Company’s
 
mortgage lending income for 2021 and 2020.
Year ended December 31
(Dollars in thousands)
2021
2020
Origination income
$
1,417
$
2,300
Servicing fees, net
130
19
Total mortgage lending income
$
1,547
$
2,319
The Company’s income from mortgage lending
 
typically fluctuates as mortgage interest rates change and is primarily
attributable to the origination and sale of new mortgage loans. Origination income
 
decreased in 2021 compared to 2020 due
to a decrease in refinance activity in our primary market.
 
The decrease in origination income was partially offset by an
increase in servicing fees, net of related amortization expense as prepayment
 
speeds slowed during 2021, resulting in
decreased amortization expense.
 
Income from bank-owned life insurance decreased primarily due to $0.3
 
million in non-taxable death benefits received in
2020. The assets that support these policies are administered by the life insurance carriers
 
and the income we receive (i.e.,
increases or decreases in the cash surrender value of the policies and death benefits received)
 
on these policies is dependent
upon the returns the insurance carriers are able to earn on the underlying investments that
 
support these policies. Earnings
on these policies are generally not taxable.
Noninterest Expense
Year ended December 31
(Dollars in thousands)
2021
2020
Salaries and benefits
$
11,710
$
11,316
Net occupancy and equipment
1,743
2,511
Professional fees
995
1,052
FDIC and other regulatory assessments
426
256
Other
4,559
4,419
Total noninterest expense
$
19,433
$
19,554
The increase in salaries and benefits expense was primarily due to a decrease in deferred
 
costs related to the PPP loan
program, routine annual wage and benefit increases, and management increasing the
 
minimum hourly wage for banking
positions to $15.
The decrease in net occupancy and equipment was primarily due to a reduction
 
of various expenses related to the
redevelopment of the Company’s headquarters
 
in downtown Auburn.
 
This amount includes revised depreciation estimates
and other temporary relocation costs. For more information regarding changes
 
in accounting estimates, please refer to Note
1, Summary of Significant Accounting Policies, of the consolidated financial statements
 
that accompany this report.
The increase in FDIC and other regulatory assessments was primarily due to the expiration
 
of FDIC assessment credits
during 2020 and an increased assessment base during 2021.
Income Tax
 
Expense
Income tax expense was $1.4 million in 2021 and $1.6 million in 2020.
 
The Company’s effective income
 
tax rate was
14.89% in 2021, compared to 17.72% in 2020.
 
This change was primarily due to an income tax benefit related to a New
Markets Tax Credit investment
 
funded in the fourth quarter of 2021.
 
The Company’s effective income
 
tax rate is
principally impacted by tax-exempt earnings from the Company’s
 
investments in municipal securities, bank-owned life
insurance, and New Markets Tax
 
Credits.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
54
BALANCE SHEET ANALYSIS
Securities
 
Securities available-for-sale were $421.9
 
million at December 31, 2021, compared to $335.2 million at December 31, 2020.
 
This increase reflects an increase in the amortized cost basis of securities available-for-sale
 
of $95.7 million, and a decrease
of $9.0 million in the fair value of securities available-for-sale.
 
The increase in the amortized cost basis of securities
available-for-sale was primarily attributable to management
 
allocating more funding to the investment portfolio following
the significant increases in customer deposits. The decrease in the fair value of securities
 
was primarily due to an increase
in long-term interest rates. The average annualized tax-equivalent
 
yields earned on total securities were 1.66%
 
in 2021 and
2.11%
 
in 2020.
The following table shows the carrying value and weighted average yield of securities available
 
-for-sale as of December
31, 2021 according to contractual maturity.
 
Actual maturities may differ from contractual maturities of mortgage-backed
securities (“MBS”) because the mortgages underlying the securities may be called
 
or prepaid with or without penalty.
 
 
December 31, 2021
1 year
 
1 to 5
5 to 10
 
After 10
Total
 
(Dollars in thousands)
or less
years
years
years
Fair Value
Agency obligations
$
5,007
49,604
69,802
124,413
Agency MBS
680
35,855
186,836
223,371
State and political subdivisions
170
647
15,743
57,547
74,107
Total available-for-sale
$
5,177
50,931
121,400
244,383
421,891
Weighted average yield (1):
Agency obligations
2.00%
1.36%
1.31%
1.36%
Agency MBS
3.42%
1.48%
1.34%
1.37%
State and political subdivisions
4.25%
2.85%
2.18%
2.77%
2.64%
Total available-for-sale
2.07%
1.40%
1.47%
1.68%
1.59%
(1) Yields are calculated based on amortized cost.
Loans
December 31
(In thousands)
2021
2020
Commercial and industrial
$
83,977
82,585
Construction and land development
32,432
33,514
Commercial real estate
 
258,371
255,136
Residential real estate
77,661
84,154
Consumer installment
6,682
7,099
Total loans
459,123
462,488
Less:
 
unearned income
(759)
(788)
Loans, net of unearned income
$
458,364
461,700
Total loans, net of unearned income,
 
were $458.4 million at December 31, 2021, and $461.7 million at December
 
31, 2020.
 
Excluding PPP loans, total loans, net of unearned income, were $450.5
 
million, an increase of $7.5 million, or 2% from
December 31, 2020.
 
This increase was primarily due to an increase in commercial and industrial loans
 
,
 
net of PPP,
 
of
$12.2 million, partially offset by a decrease in residential real estate loans of
 
$6.5 million, as lower rates increased refinance
activity and payoffs for consumer mortgage loans.
 
Four loan categories represented the majority of the loan portfolio at
December 31, 2021: commercial real estate (56%), residential real estate (17%),
 
commercial and industrial (18%) and
construction and land development (7%).
 
Approximately 25% of the Company’s commercial
 
real estate loans were
classified as owner-occupied at December 31, 2021.
 
 
 
 
 
 
 
 
 
55
Within the residential real estate portfolio
 
segment, the Company had junior lien mortgages of approximately $7.2 million,
or 2%, and $8.7 million, or 2%, of total loans, net of unearned income at December 31,
 
2021 and 2020, respectively.
 
For
residential real estate mortgage loans with a consumer purpose, the Company
 
had no loans that required interest only
payments at December 31, 2021 and 2020. The Company’s
 
residential real estate mortgage portfolio does not include any
option ARM loans, subprime loans, or any material amount of other high-risk consumer
 
mortgage products.
 
The average yield earned on loans and loans held for sale was 4.45% in 2021
 
and 4.74% in 2020.
 
The specific economic and credit risks associated with our loan portfolio include,
 
but are not limited to, the effects of
current economic conditions, including the COVID-19 pandemic’s
 
effects, on our borrowers’ cash flows, real estate market
sales volumes, valuations, availability and cost of financing properties,
 
real estate industry concentrations, competitive
pressures from a wide range of other lenders, deterioration in certain credits, interest rate
 
fluctuations, reduced collateral
values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration
 
of borrowers, fraud, and any
violation of applicable laws and regulations.
 
The Company attempts to reduce these economic and credit risks through its loan-to-value
 
guidelines for collateralized
loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial
 
position. Also, we have
established and periodically review,
 
lending policies and procedures. Banking regulations limit a bank’s
 
credit exposure by
prohibiting unsecured loan relationships that exceed 10% of its capital; or 20%
 
of capital, if loans in excess of 10% of
capital are fully secured. Under these regulations, we are prohibited from having secured
 
loan relationships in excess of
approximately $21.0 million. Furthermore, we have an internal limit
 
for aggregate credit exposure (loans outstanding plus
unfunded commitments) to a single borrower of $18.9
 
million. Our loan policy requires that the Loan Committee of the
Board of Directors approve any loan relationships that exceed this internal limit.
 
At December 31, 2021, the Bank had no
relationships exceeding these limits.
We periodically analyze
 
our commercial loan portfolio to determine if a concentration of credit
 
risk exists in any one or
more industries. We
 
use classification systems broadly accepted by the financial services industry in
 
order to categorize our
commercial borrowers. Loan concentrations to borrowers in the following classes
 
exceeded 25% of the Bank’s total risk-
based capital at December 31, 2021 (and related balances at December 31,
 
2020).
 
December 31
(In thousands)
2021
2020
Lessors of 1-4 family residential properties
$
47,880
$
49,127
Hotel/motel
43,856
42,900
Multi-family residential properties
42,587
40,203
Shopping centers
29,574
30,000
In light of disruptions in economic conditions caused by COVID-19, the financial regulators
 
have issued guidance
encouraging banks to work constructively with borrowers affected
 
by the virus in our community.
 
This guidance, including
the Interagency Statement on COVID-19 Loan Modifications and the Interagency Examiner
 
Guidance for Assessing Safety
and Soundness Considering the Effect of the COVID-19
 
Pandemic on Institutions, provides that the agencies will not
criticize financial institutions that mitigate credit risk through prudent actions
 
consistent with safe and sound practices.
 
Specifically, examiners
 
will not criticize institutions for working with borrowers as part of a risk
 
mitigation strategy
intended to improve existing loans, even if the restructured loans have or develop
 
weaknesses that ultimately result in
adverse credit classification.
 
Upon demonstrating the need for payment relief, the bank will work with qualified borrowers
that were otherwise current before the pandemic to determine the most appropriate
 
deferral option.
 
For residential
mortgage and consumer loans the borrower may elect to defer payments for up to three
 
months.
 
Interest continues to
accrue and the amount due at maturity increases.
 
Commercial real estate, commercial, and small business borrowers may
elect to defer payments for up to three months or pay scheduled interest payments for a
 
six-month period.
 
The bank
recognizes that a combination of the payment relief options may be prudent dependent
 
on a borrower’s business type.
 
As
of December 31, 2021, we had one COVID-19 loan deferral totaling $0.1
 
million, compared to $32.3 million, or 7% of total
loans at December 31, 2020.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
56
The tables below provide information concerning the composition of these COVID-19
 
modifications as of December 31,
2021 and 2020.
 
COVID-19 Modifications
Modification Types
(Dollars in thousands)
# of Loans
Modified
Balance
% of Portfolio
Modified
Interest Only
Payment
P&I
 
Payments
Deferred
December 31, 2021:
Residential real estate
1
$
59
100
%
Total
1
$
59
%
%
100
%
December 31, 2020:
Commercial and industrial
2
$
741
%
100
%
%
Commercial real estate
12
31,399
7
100
Residential real estate
2
133
100
Total
16
$
32,273
7
%
99
%
1
%
COVID-19 Modifications within Commercial Real Estate
 
Segment
(Dollars in thousands)
# of Loans
Modified
Balance of
Loans Modified
% of Total
 
Loan Class
December 31, 2020:
Hotel/motel
10
$
26,427
49
%
Multifamily
1
3,530
9
Restaurants
1
1,442
10
There were no COVID-19 modifications within the commercial real estate segment at December
 
31, 2021.
Section 4013 of the CARES Act provides that a qualified loan modification is exempt by law
 
from classification as a TDR
pursuant to GAAP.
 
In addition, the Interagency Statement on COVID-19 Loan Modifications provides
 
circumstances in
which a loan modification is not subject to classification as a TDR if such loan is not eligible
 
for modification under
Section 4013.
 
Allowance for Loan Losses
 
The Company maintains the allowance for loan losses at a level that management believes
 
appropriate to adequately cover
the Company’s estimate of probable
 
losses inherent in the loan portfolio. The
 
allowance for loan losses was $4.9 million at
December 31, 2021 compared to $5.6 million at December 31, 2020,
 
which management believed to be adequate at each of
the respective dates. The judgments and estimates associated
 
with the determination of the allowance for loan losses are
described under “Critical Accounting Policies.”
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
57
A summary of the changes in the allowance for loan losses and certain asset quality ratios
 
for the years ended December 31,
2021 and 2020 are presented below.
 
Year ended December 31
(Dollars in thousands)
2021
2020
Allowance for loan losses:
Balance at beginning of period
$
5,618
4,386
Charge-offs:
Commercial and industrial
(7)
Commercial real estate
 
(254)
Residential real estate
 
(3)
Consumer installment
(37)
(38)
Total charge
 
-offs
(294)
(45)
Recoveries:
Commercial and industrial
140
94
Residential real estate
 
55
63
Consumer installment
20
20
Total recoveries
215
177
Net (charge-offs) recoveries
(79)
132
Provision for loan losses
(600)
1,100
Ending balance
$
4,939
5,618
as a % of loans
1.08
%
1.22
as a % of nonperforming loans
1,112
%
1,052
Net charge-offs (recoveries) as a % of average loans
0.02
%
(0.03)
As described under “Critical Accounting Policies”, management assesses the adequacy
 
of the allowance prior to the end of
each calendar quarter. The level of the allowance
 
is based upon management’s evaluation
 
of the loan portfolios, past loan
loss experience, known and inherent risks in the portfolio, adverse situations that
 
may affect the borrower’s ability to repay
(including the timing of future payment), the estimated value of any underlying
 
collateral, composition of the loan
portfolio, economic conditions, industry and peer bank loan loss rates, and other
 
pertinent factors. This evaluation is
inherently subjective as it requires various material estimates and judgments including
 
the amounts and timing of future
cash flows expected to be received on impaired loans that may be susceptible to
 
significant change. The ratio of our
allowance for loan losses to total loans outstanding was 1.08% at December 31,
 
2021, compared to 1.22% at December 31,
2020.
 
Excluding PPP loans, which are guaranteed by the SBA, the Company’s
 
allowance for loan losses was 1.10% and
1.27% of total loans at December 31, 2021 and 2020, respectively.
 
In the future, the allowance to total loans outstanding
ratio will increase or decrease to the extent the factors that influence our quarterly allowance
 
assessment, including the
duration and magnitude of COVID-19 effects, in their entirety either improve
 
or weaken.
 
In addition our regulators, as an
integral part of their examination process, will periodically review the Company’s
 
allowance for loan losses, and may
require the Company to make additional provisions to the allowance for loan losses based
 
on their judgment about
information available to them at the time of their examinations.
Nonperforming Assets
 
At December 31, 2021 the Company had $0.8
 
million in nonperforming assets compared to $0.5
 
million at December 31,
2020.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
58
The table below provides information concerning total nonperforming assets
 
and certain asset quality ratios.
 
December 31
(Dollars in thousands)
2021
2020
Nonperforming assets:
Nonperforming (nonaccrual) loans
$
444
534
Other real estate owned
374
Total nonperforming assets
$
818
534
as a % of loans and other real estate owned
0.18
%
0.12
as a % of total assets
0.07
%
0.06
Nonperforming loans as a % of total loans
0.10
%
0.12
Accruing loans 90 days or more past due
$
141
The table below provides information concerning the composition of nonaccrual
 
loans at December 31, 2021 and 2020,
respectively.
 
December 31
(In thousands)
2021
2020
Nonaccrual loans:
Commercial real estate
$
187
212
Residential real estate
257
322
Total nonaccrual loans /
 
nonperforming loans
$