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AUBURN NATIONAL BANCORPORATION, INC - Annual Report: 2020 (Form 10-K)

10-K
 
 
 
 
 
 
 
 
 
 
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, 2020
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:
$
132,361,395
 
as of June 30, 2020.
 
 
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:
3,566,326
 
shares of common stock as
of March 8, 2021.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Proxy Statement for the Annual Meeting
 
of Shareholders, scheduled to be held
 
May 11, 2021, 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” 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, including
 
as a result of 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 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 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;
 
 
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 and the timing and
 
amount of rental income upon completion of the
project;
 
 
 
4
 
 
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.
 
 
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.
 
 
 
 
 
5
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 ATMs.
 
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 advertisin
 
g
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
 
Lee County’s population was estimated
 
to be 164,542 in 2019, and has increased approximately 17.3
 
%
 
from 2010 to 2019.
 
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 2019, the Auburn-Opelika MSA grew 1
 
7.3%, the second fastest growing MSA in Alabama.
 
The U.S.
Census Bureau estimates that the Auburn-Opelika MSA population will
 
grow 5.41% from 2020 to 2025.
 
During the same
time, the U.S. Census Bureau estimates that household income
 
will increase 13.70%, to $66,363, which is approximately
the same as the Birmingham-Hoover MSA.
 
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 residentia
 
l
 
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.
 
 
 
 
6
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.
 
Employees
 
At December 31, 2020,
 
the Company and its subsidiaries had 152 full-time equivalent employees,
 
including 36 officers. In
response to the COVID-19 pandemic, 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.
 
On June 1, 2020, we re-opened some of our branch lobbies as permitted
 
by state public health guidelines.
 
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.
 
Statistical Information
 
Certain statistical information is included in response to Item
 
7 of this Annual Report on Form 10-K.
 
Certain statistical
information is also included in response to Item 6, Item 7A and Item
 
8 of this Annual Report on Form 10-K.
 
 
SUPERVISION AND REGULATION
 
The Company and the Bank are extensively regulated under federal
 
and state laws applicable to banks and bank holding
companies.
 
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.
 
 
 
7
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”).
 
The Company has not elected to become a financial holding
company, but it may elect to
 
do so in the future.
 
Financial holding companies continue to be subject to
 
Federal Reserve supervision, regulation and examination, but the
Gramm-Leach-Bliley Act of 1999 the “GLB Act”) applies the concept
 
of functional regulation to subsidiary activities.
 
For
example, insurance activities would be subject to supervision
 
and regulation by state insurance authorities.
 
 
The BHC Act permits acquisitions of banks by bank holding
 
companies, subject to various restrictions, including that the
acquirer is “well capitalized” and “well managed”.
 
Under the Alabama Banking Code, with the prior approval of the
Alabama Superintendent, an Alabama bank may acquire and
 
operate one or more banks in other states pursuant to a
transaction in which the Alabama bank is the surviving bank.
 
In addition, one or more Alabama banks may enter into a
merger transaction with one or more out-of-state banks,
 
and an out-of-state bank resulting from such transaction
 
may
continue to operate the acquired branches in Alabama.
 
The Dodd-Frank Act permits banks, including Alabama banks,
 
to
branch anywhere in the United States.
 
The Company is a legal entity separate and distinct from the Bank.
 
Various
 
legal limitations restrict the Bank from lending
or otherwise supplying funds to the Company.
 
The Company and the Bank are subject to Sections 23A and
 
23B of the
Federal Reserve Act and Federal Reserve Regulation W thereunder.
 
Section 23A defines “covered transactions,” which
include extensions of credit, and limits a bank’s
 
covered transactions with any affiliate to 10%
 
of such bank’s capital and
surplus.
 
All covered and exempt transactions between a bank and its affiliates
 
must be on terms and conditions consistent
with safe and sound banking practices, and banks and their subsidiaries
 
are prohibited from purchasing low-quality assets
from the bank’s affiliates.
 
Finally, Sectio
 
n
 
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 bank 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.”
 
 
 
8
Bank Regulation
 
The Bank is a state bank that is a member of the Federal Reserve.
 
It is subject to supervision, regulation and examination
by the Federal Reserve and the Alabama Superintendent, which monitor
 
all areas of the Bank’s operations,
 
including loans,
reserves, mortgages, issuances and redemption of capital securities, payment
 
of dividends, establishment of
 
branches,
capital adequacy and compliance with laws.
 
The Bank is a member of the FDIC and, as such, its deposits are
 
insured by
the FDIC to the maximum extent provided by law,
 
and is subject to various FDIC regulations.
 
See “FDIC Insurance
Assessments.”
 
Alabama law permits statewide branching by banks.
 
The powers granted to Alabama-chartered banks by state law
 
include
certain provisions designed to provide such banks competitive
 
equality with national banks.
 
 
The Federal Reserve has adopted the Federal Financial Institutions Examination
 
Council’s (“FFIEC”) rating system,
 
which
assigns each financial institution a confidential composite “CAMELS”
 
rating based on an evaluation and rating of six
essential components of an institution’s
 
financial condition and operations:
 
Capital Adequacy, Asset
 
Quality, Management,
Earnings, Liquidity and Sensitivity to market risk, as well as the
 
quality of risk management practices.
 
For most
institutions, the FFIEC has indicated that market risk primarily reflects
 
exposures to changes in interest rates.
 
When
regulators evaluate this component, consideration is expected
 
to be given to: management’s
 
ability to identify, measure,
monitor and control market risk; the institution’s
 
size; the nature and complexity of its activities and its risk profile; and
 
the
adequacy of its capital and earnings in relation to its level of market
 
risk exposure.
 
Market risk is rated based upon, but not
limited to, an assessment of the sensitivity of the financial institution’s
 
earnings or the economic value of its capital to
adverse changes in interest rates, foreign exchange rates, commodity
 
prices or equity prices; management’s
 
ability to
identify, measure, monitor
 
and control exposure to market risk; and the nature and complexity
 
of interest rate risk exposure
arising from non-trading positions. Composite ratings are based on
 
evaluations of an institution’s managerial,
 
operational,
financial and compliance performance. The composite CAMELS rating
 
is not an arithmetical formula or rigid weighting of
numerical component ratings. Elements of subjectivity and
 
examiner judgment, especially as these relate to qualitative
assessments, are important elements in assigning ratings.
 
The federal bank regulatory agencies are reviewing the CAMELS
rating system and their consistency.
 
The GLB Act and related regulations require banks and their
 
affiliated companies to adopt and disclose privacy policies,
including policies regarding the sharing of personal information
 
with third parties.
 
The GLB Act also permits bank
subsidiaries to engage in “financial activities” similar to those
 
permitted to financial holding companies. In December 2015,
Congress amended the GLB Act as part of the Fixing America’s
 
Surface Transportation Act. This
 
amendment provided
financial institutions that meet certain conditions an exemption to
 
the requirement to deliver an annual privacy notice. On
August 10, 2018, the federal Consumer Financial Protection Bureau
 
(“CFPB”) announced that it had finalized conforming
amendments to its implementing regulation, Regulation P.
 
 
A variety of federal and state privacy laws govern the collection, safeguarding,
 
sharing and use of customer information,
and require that financial institutions have policies regarding information
 
privacy and security.
 
Some state laws also protect
the privacy of information of state residents and require adequate
 
security of such data, and certain state laws may,
 
in some
circumstances, require us to notify affected individuals
 
of security breaches of computer databases that contain their
personal information. These laws may also require us to notify law enforcement,
 
regulators or consumer reporting agencies
in the event of a data breach, as well as businesses and governmental agencies
 
that own data.
 
 
 
9
Community Reinvestment Act and Consumer Laws
 
The Bank is subject to the provisions of the CRA and the Fede
 
ral 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, with compliance dates
of October 1, 2020, and January 1, 2023 or 2024. The FDIC
 
has not issued final revised CRA regulations. On November
24, 2020, the OCC sought additional comment on the general
 
performance standards of its CRA regulations. On September
21, 2020, the Federal Reserve issued an advanced notice of proposed
 
rulemaking seeking comment on ways to strengthen,
clarify and tailor its CRA regulations, which, if adopted,
 
would govern the Bank’s CRA compliance.
 
Under the Federal
Reserve proposal, “small banks” would be limited to banks with assets
 
of $750 million or $1 billion, and could elect
between the existing CRA rules or any newly adopted CRA rules.
 
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.
 
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.
 
 
10
 
Residential Mortgages
 
CFPB regulations require that lenders determine whether a consumer
 
has the ability to repay a mortgage loan.
 
These
regulations establish certain minimum requirements for creditors
 
when making ability to repay determinations, and provide
certain safe harbors from liability for mortgages that are "qualified
 
mortgages" and are not “higher-priced.”
 
Generally,
these CFPB regulations apply to all consumer,
 
closed-end loans secured by a dwelling including home
 
-purchase loans,
refinancing and home equity loans—whether first or subordinate
 
lien. Qualified mortgages must generally satisfy detailed
requirements related to product features, underwriting standards,
 
and requirements where the total points and fees on a
mortgage loan cannot exceed specified amounts or percentages of the
 
total loan amount. Qualified mortgages must have:
(1) a term not exceeding 30 years; (2) regular periodic
 
payments that do not result in negative amortization, deferral of
principal repayment, or a balloon payment; (3) and be supported
 
with documentation of the borrower and its credit. On
December 10, 2020, the CFPB issued final rules related to
 
“qualified mortgage” loans. Lenders are required under the law
to determine that consumers have the ability to repay mortgage
 
loans before lenders make those loans. Loans that meet
standards for QM loans are presumed to be loans for which consumers
 
have the ability to repay.
 
We focus our residential
 
mortgage origination on qualified mortgages and those that meet
 
our investors’ requirements, but
we may make loans that do not meet the safe harbor requirements
 
for “qualified mortgages.”
 
The Economic Growth, Regulatory Relief, and Consumer Protection
 
Act of 2018 (the “2018 Growth Act”) provides that
certain residential mortgages held in portfolio by banks with less than
 
$10 billion in consolidated assets automatically are
deemed “qualified mortgages.” This relieves smaller institutions from
 
many of the requirements to satisfy the criteria listed
above for “qualified mortgages.” Mortgages meeting the “qualified
 
mortgage” safe harbor may not have negative
amortization, must follow prepayment penalty limitations included
 
in the Truth in Lending Act, and may not have
 
fees
greater than 3% of the total value of the loan.
 
The Bank generally services the loans it originates, including those it
 
sells.
 
The CFPB’s mortgage servicing standards
include requirements regarding force-placed insurance, certain
 
notices prior to rate adjustments on adjustable rate
mortgages, and periodic disclosures to borrowers. Servicers are
 
prohibited from processing foreclosures when a loan
modification is pending, and must wait until a loan is more than 120
 
days delinquent before initiating a foreclosure action.
Servicers must provide borrowers with direct and ongoing access
 
to its personnel, and provide prompt review of any loss
mitigation application. Servicers must maintain accurate and accessible
 
mortgage records for the life of a loan and until one
year after the loan is paid off or transferred. These
 
standards increase the cost and compliance risks of servicing mortgage
loans, and the mandatory delays in foreclosures could result in loss of
 
value on collateral or the proceeds we may realize
from a sale of foreclosed property.
 
 
The Federal Housing Finance Authority (“FHFA”)
 
updated, effective January 1, 2016, The Federal
 
National Mortgage
Association’s (“Fannie Mae’s”)
 
and the Federal Home Loan Mortgage Corporation (“Freddie
 
Mac’s”) (individually and
collectively, “GSE”) repurchase
 
rules, including the kinds of loan defects that could lead to a
 
repurchase request to, or
alternative remedies with, the mortgage loan originator or
 
seller.
 
These rules became effective January 1, 2016.
 
FHFA also
has updated these GSEs’ representations and warranties framework
 
and provided an independent dispute resolution
(“IDR”) process to allow a neutral third party to resolve demands
 
after the GSEs’ quality control and appeal processes have
been exhausted.
 
The Bank is subject to the CFPB’s
 
integrated disclosure rules under the Truth in Lending
 
Act and the Real Estate
Settlement Procedures Act, referred to as “TRID”, for
 
credit transactions secured by real property.
 
Our residential mortgage
strategy, product offerings,
 
and profitability may change as these regulations are interpreted
 
and applied in practice, and
may also change due to any restructuring of Fannie Mae and
 
Freddie Mac as part of the resolution of their conservatorships.
The 2018 Growth Act reduced the scope of TRID rules by eliminating
 
the wait time for a mortgage, if an additional creditor
offers a consumer a second offer with a lower
 
annual percentage rate. Congress encouraged federal
 
regulators to provide
better guidance on TRID in an effort to provide
 
a clearer understanding for consumers and bankers alike. The law also
provides partial exemptions from the collection, recording and reporting
 
requirements under Sections 304(b)(5) and (6) of
the Home Mortgage Disclosure Act (“HMDA”), for those banks with
 
fewer than 500 closed-end mortgages or less than
500 open-end lines of credit in both of the preceding two years,
 
provided the bank’s rating under
 
the CRA for the previous
two years has been at least “satisfactory.”
 
On August 31, 2018, the CFPB issued an interpretive and procedural
 
rule to
implement and clarify these requirements under the 2018
 
Growth Act.
 
 
 
 
11
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.
 
Anti-Money Laundering and Sanctions
 
The International Money Laundering Abatement and Anti-Terrorism
 
Funding Act of 2001 specifies “know your customer”
requirements that obligate financial institutions to take actions
 
to verify the identity of the account holders in connection
with opening an account at any U.S. financial institution.
 
Bank regulators are required to consider compliance with anti-
money laundering laws in acting upon merger and acquisition
 
and other expansion proposals under the BHC Act and the
Bank Merger Act, and sanctions for violations of this Act can
 
be imposed in an amount equal to twice the sum involved in
the violating transaction, up to $1 million.
 
 
Under the Uniting and Strengthening America by Providing Appropriate
 
Tools Required
 
to Intercept and Obstruct
Terrorism Act of 2001
 
(the “USA PATRIOT
 
Act”), financial institutions are subject to prohibitions against specified
financial transactions and account relationships as well as to
 
enhanced due diligence and “know your customer” standards
in their dealings with foreign financial institutions and foreign customers.
 
 
The USA PATRIOT
 
Act requires financial institutions to establish anti-money laundering
 
programs, and sets forth
minimum standards, or “pillars” for these programs, including:
 
 
 
the development of internal policies, procedures, and controls;
 
 
the designation of a compliance officer;
 
 
 
an ongoing employee training program;
 
 
 
an independent audit function to test the programs; and
 
 
ongoing customer due diligence and monitoring.
 
Federal Financial Crimes Enforcement Network (“FinCEN”)
 
rules effective May 2018 require banks to know the beneficial
owners of customers that are not natural persons, update customer information
 
in order to develop a customer risk profile,
and generally monitor such matters.
 
 
 
 
12
On August 13, 2020, the federal bank regulators issued a joint statement
 
clarifying that isolated or technical violations or
deficiencies are generally not considered the kinds of problems that
 
would result in an enforcement action. The statement
addresses how the agencies evaluate violations of individual
 
pillars of the Bank Secrecy Act and anti-money laundering
(“AML/BSA”) compliance program. It describes how the agencies incorporate
 
the customer due diligence regulations and
recordkeeping requirements issued by the U.S. Department of
 
the Treasury (“Treasury”)
 
as part of the internal controls
pillar of a financial institution's AML/BSA compliance program.
 
On September 16, 2020, FinCEN issued an advanced notice of
 
proposed rulemaking seeking public comment on a wide
range of potential regulatory amendments under the Bank Secrecy Act.
 
The proposal seeks comment on incorporating an
“effective and reasonably designed” AML/BSA program
 
component to empower financial institutions to allocate
 
resources
more effectively.
 
This component also would seek to implement a common
 
understanding between supervisory agencies
and financial institutions regarding the necessary
 
AML/BSA program elements, and would seek to impose minimal
additional obligations on AML programs that already comply under
 
the existing supervisory framework.
 
 
On October 23, 2020, FinCEN and the Federal Reserve invited
 
comment on a proposed rule that would amend the
recordkeeping and travel rules under the Bank Secrecy Act, which would
 
lower the applicable threshold from $3,000 to
$250 for international transactions and apply these to transactions
 
using convertible virtual currencies and digital assets
with legal tender status.
 
On January 1, 2021, Congress enacted the Anti-Money Laundering
 
Act of 2020 and the Corporate Transparency Act
(collectively, the “AML Act”),
 
to strengthen anti-money laundering and countering terrorism financing
 
programs. Among
other things, the AML Act:
 
• specifies
 
uniform disclosure of beneficial ownership information for all
 
U.S. and foreign entities conducting business
in the U.S.;
 
• increases
 
potential fines and penalties for BSA violations and
 
improves whistleblower incentives;
 
• codifies
 
the risk-based approach to AML compliance;
 
• modernizes
 
AML systems;
 
• expands
 
the duties and powers FinCEN; and
 
• emphasizes
 
coordination and information-sharing among financial institutions,
 
U.S. financial regulators and foreign
financial regulators.
 
The United States has imposed various sanctions upon various foreign
 
countries, such as China, Iran, North Korea, Russia
and Venezuela,
 
and their certain government officials and persons.
 
Banks are required to comply with these sanctions,
which require additional customer screening and transaction monitoring.
 
Other Laws and Regulations
 
The Company is also required to comply with various corporate
 
governance and financial reporting requirements under the
Sarbanes-Oxley Act of 2002, as well as related rules and regulations
 
adopted by the SEC, the Public Company Accounting
Oversight Board and Nasdaq. In particular,
 
the Company is required to report annually on internal contro
 
ls 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 ob
 
tain 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, 2020 are
included in this report with no material weaknesses reported.
 
 
 
13
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
 
2020, the Bank paid cash dividends of
approximately $3.6 million to the Company.
 
At December 31, 2020, the Bank could have declared and paid
 
additional
dividends of approximately $6.8 million without prior
 
regulatory approval.
 
In addition, the Company and the Bank are subject to various general
 
regulatory policies and requirements relating to the
payment of dividends, including requirements to maintain capital
 
above regulatory minimums. The appropriate federal and
state regulatory authorities are authorized to determine when
 
the payment of dividends would be an unsafe or unsound
practice, and may prohibit such
 
dividends. The Federal Reserve has indicated that paying dividends
 
that deplete a state
member bank’s capital base to
 
an inadequate level would be an unsafe and unsound banking practice.
 
The Federal Reserve
has indicated that depository institutions and their holding companies
 
should generally pay dividends only out of current
year’s operating earnings.
 
 
Federal Reserve Supervisory Letter SR-09-4 (February 24,
 
2009), as revised December 21, 2015, applies to dividend
payments, stock redemptions and stock repurchases.
 
Prior consultation with the Federal Reserve supervisory staff
 
is
required before:
 
 
redemptions or repurchases of capital instruments when the bank
 
holding company is experiencing financial
weakness; and
 
 
redemptions and purchases of common or perpetual preferred
 
stock which would reduce such Tier 1 capital
 
at
end of the period compared to the beginning of the period.
 
Bank holding company directors must consider different
 
factors to ensure that its dividend level is prudent relative to
maintaining a strong financial position, and is not based on overly optimistic
 
earnings scenarios, such as potential events
that could affect its ability to pay,
 
while still maintaining a strong financial position. As a general matter,
 
the Federal
Reserve has indicated that the board of directors of a bank holding
 
company should consult with the Federal Reserve and
eliminate, defer or significantly reduce the bank holding company’s
 
dividends if:
 
 
its net income available to shareholders for the past four quarters,
 
net of dividends previously paid during that
period, is not sufficient to fully fund the dividends;
 
 
 
its prospective rate of earnings retention is not consistent with its capital
 
needs and overall current and
prospective financial condition; or
 
 
 
It will not meet, or is in danger of not meeting, its minimum regulatory
 
capital adequacy ratios.
 
 
The Basel III Capital Rules further limit permissible dividends,
 
stock repurchases and discretionary bonuses by the
Company and the Bank, respectively,
 
unless the Company and the Bank meet capital conservation buffer
 
requirement
effective January 1, 2019.
 
See "Basel III Capital Rules."
 
Under a new provision of the capital rules, effective January
 
1, 2021, if a bank’s capital ratios
 
are within its buffer
requirements, the maximum amount of capital distributions it
 
can make is based on its eligible retained income. Eligible
retained income equals the greater of:
 
 
net income for the four preceding calendar quarters, net of any distributions
 
and associated tax effects not
already reflected in net income; or
 
 
the average net income over the preceding four quarters.
 
 
 
 
 
 
14
Regulatory Capital Changes
 
 
Simplification
 
The federal bank regulators issued final rules on July 22, 2019
 
simplifying their capital rules.
 
The last of these changes
become effective on April 1, 2020.
 
The principal changes for standardized approaches institutions, such
 
the Company and
the Bank are:
 
 
Deductions from capital for certain items, such as temporary difference
 
DTAs, MSAs and
 
investments in
unconsolidated were decreased to those amounts that individually exceed
 
25% of CET1;
 
 
Institutions can elect to deduct investments in unconsolidated
 
subsidiaries or subject them to capital requirements;
and
 
 
Minority interests would be includable up to 10% of (i) CET1
 
capital, (ii) Tier 1 capital and (iii) total
 
capital.
 
 
HVCRE
 
In December 2019, the federal banking regulators published
 
a final rule, effective April 1, 2020, to implement the “high
volatility commercial real estate,” or “HVCRE” changes in Section 214
 
of the 2018 Growth Act.
 
The new rules define
HVCRE loans as loans
 
secured by land or improved real property that:
 
 
finance or refinance the acquisition, development, or construction
 
of real property;
 
 
the purpose of such loans must be to acquire, develop,
 
or improve such real property into income producing
property; and
 
 
the repayment of the loan must depend on the future income or
 
sales proceeds from, or refinancing of, such real
property.
 
Various
 
exclusions from HVCRE are specified.
 
Banking institutions and their holding companies are required
 
to assign
150% risk weight to HVCRE loans.
 
 
Community Capital Rule
 
On October 29, 2019, the federal banking regulators adopted,
 
effective January 1, 2020, an optional community banking
leverage ratio framework applicable to depository institutions
 
and their holding companies intended to reduce regulatory
burdens for qualifying community banking organizations
 
that do not use advanced approaches capital measures, and that
have:
 
 
less than $10 billion of assets;
 
 
a leverage ratio greater than 9%;
 
 
off-balance sheet exposures of 25% or less of total
 
consolidated assets; and
 
 
trading assets plus trading liabilities of less than 5% of total consolidated
 
assets.
 
The leverage ratio would be Tier 1
 
capital divided by average total consolidated assets, taking into account
 
the capital
simplification discussed above and the CECL related capital
 
transitions.
 
The community bank leverage ratio will be the sole capital measure,
 
and electing institutions will not have to calculate or
use any other capital measure.
 
It is estimated that 85% of depository institutions will be eligible to
 
use this rule.
 
The
Company expect they would be eligible to make such election, if they 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.
 
 
 
15
Capital
 
The Federal Reserve has risk-based capital guidelines for bank holding
 
companies and state member banks, respectively.
 
These guidelines required at year end 2019 a minimum ratio
 
of capital to risk-weighted assets (including certain off
 
-balance
sheet activities, such as standby letters of credit) and capital conservation
 
buffer of 10.5%.
 
Tier 1 capital includes common
equity and related retained earnings and a limited amount of qualifying
 
preferred stock, less goodwill and certain core
deposit intangibles.
 
Voting
 
common equity must be the predominant form of capital.
 
Tier 2 capital consists of non–
qualifying preferred stock, qualifying subordinated, perpetual, and/or
 
mandatory convertible debt, term subordinated debt
and intermediate term preferred stock, up to 45% of pretax
 
unrealized holding gains on available for sale equity securities
with readily determinable market values that are prudently valued,
 
and a limited amount of general loan loss allowance.
Tier 1 and Tier
 
2 capital equals total capital.
 
 
In addition, the Federal Reserve has established minimum leverage
 
ratio guidelines for bank holding companies not subject
to the Small BHC Policy,
 
and state member banks, which provide for a minimum leverage
 
ratio of Tier 1 capital to adjusted
average quarterly assets (“leverage ratio”) equal to 4%.
 
However, bank regulators expect banks and bank holding
companies to operate with a higher leverage ratio.
 
The guidelines also provide that institutions experiencing internal
growth or making acquisitions will be expected to maintain strong capital
 
positions substantially above the minimum
supervisory levels without significant reliance on intangible
 
assets.
 
Higher capital may be required in individual cases and
depending upon a bank holding company’s
 
risk profile.
 
All bank holding companies and banks are expected to hold capital
commensurate with the level and nature of their risks including the
 
volume and severity of their problem loans.
 
Lastly, the
Federal Reserve’s guidelines indicate
 
that the Federal Reserve will continue to consider a “tangible Tier
 
1 leverage ratio”
(deducting all intangibles) in evaluating proposals for expansion
 
or new activity.
 
The level of Tier 1 capital to
 
risk-adjusted
assets is becoming more widely used by the bank regulators to
 
measure capital adequacy. The
 
Federal Reserve has not
advised the Company or the Bank of any specific minimum leverage
 
ratio or tangible Tier 1 leverage ratio
 
applicable to
them. Under Federal Reserve policies, bank holding companies are
 
generally expected to operate with capital positions well
above the minimum ratios. The Federal Reserve believes the
 
risk-based ratios do not fully take into account the quality of
capital and interest rate, liquidity,
 
market and operational risks. Accordingly,
 
supervisory assessments of capital adequacy
may differ significantly from conclusions based
 
solely
 
on the level of an organization’s
 
risk-based capital ratio.
 
The Federal Deposit Insurance Corporation Improvement Act of 1991
 
(“FDICIA”), among other things, requires the federal
banking agencies to take “prompt corrective action” regarding depository
 
institutions that do not meet minimum capital
requirements.
 
FDICIA establishes five capital tiers: “well capitalized,”
 
“adequately capitalized,” “undercapitalized,”
“significantly undercapitalized” and “critically undercapitalized.”
 
A depository institution’s capital tier will
 
depend upon
how its capital levels compare to various relevant capital measures
 
and certain other factors, as established by regulation.
 
See
 
“Prompt Corrective Action Rules.”
 
Basel III Capital Rules
 
The Federal Reserve and the other bank regulators adopted
 
in June 2013 final capital rules for bank holding companies and
banks implementing the Basel Committee on Banking Supervision’s
 
“Basel III: A Global Regulatory Framework for more
Resilient Banks and Banking Systems.”
 
These new U.S. capital rules are called the “Basel III
 
Capital Rules,” and generally
were fully phased-in on January 1, 2019.
 
 
 
 
16
The Basel III Capital Rules limit Tier
 
1 capital to common stock and noncumulative perpetual preferred
 
stock, as well as
certain qualifying trust preferred securities and cumulative perpetual
 
preferred stock issued before May 19, 2010, each of
which were grandfathered in Tier
 
1 capital for bank holding companies with less than $15 billion
 
in assets.
 
The Company
had no qualifying trust preferred securities or cumulative preferred
 
stock outstanding at December 31, 2020.
 
The Basel III
Capital Rules also introduced a new capital measure, “Common
 
Equity Tier I Capital” or “CET1.”
 
CET1 includes common
stock and related surplus, retained earnings and, subject to
 
certain adjustments, minority common equity interests in
subsidiaries.
 
CET1 is reduced by deductions for:
 
 
Goodwill and other intangibles, other than mortgage servicing assets
 
(“MSRs”), which are treated separately,
 
net
of associated deferred tax liabilities (“DTLs”);
 
 
 
Deferred tax assets (“DTAs”)
 
arising from operating losses and tax credit carryforwards net
 
of allowances and
DTLs;
 
 
 
Gains on sale from any securitization exposure; and
 
 
 
Defined benefit pension fund net assets (i.e., excess plan assets),
 
net of associated DTLs.
 
The Company made a one-time election in 2015 and, as a
 
result, CET1 will not be adjusted for certain accumulated other
comprehensive income (“AOCI”).
 
Additional “threshold deductions” of the following that are individually
 
greater than 10% of CET1 or collectively greater
than 15% of CET1 (after the above deductions are also made):
 
 
MSAs, net of associated DTLs;
 
 
DTAs arising from temporary
 
differences that could not be realized through net operating loss
 
carrybacks, net of
any valuation allowances and DTLs; and
 
 
Significant common stock investments in unconsolidated financial institutions,
 
net of associated DTLs.
 
As discussed below, recent
 
regulations change these items to simplify and improve their
 
capital treatment.
 
Noncumulative perpetual preferred stock and Tier
 
1 minority interest not included in CET1, subject to limits, will qualify as
additional Tier I capital.
 
All other qualifying preferred stock, subordinated debt and qualifying minority
 
interests will be
included in Tier 2 capital.
 
In addition to the minimum risk-based capital requirements, a
 
new “capital conservation buffer” of CET1
 
capital of at least
2.5% of total risk weighted assets, will be required.
 
The capital conservation buffer will be calculated
 
as the
lowest
 
of:
 
 
the banking organization’s
 
CET1 capital ratio minus 4.5%;
 
 
 
the banking organization’s
 
tier 1 risk-based capital ratio minus 6.0%; and
 
 
 
the banking organization’s
 
total risk-based capital ratio minus 8.0%.
 
 
 
17
Full compliance with the capital conservation buffer was
 
required by January 1, 2019. At such time, permissible dividends,
stock repurchases and discretionary bonuses will be limited to
 
the following percentages based on the capital conservation
buffer as calculated above, subject
 
to any further regulatory limitations, including those based on risk assessments
 
and
enforcement actions:
 
Buffer %
Buffer % Limit
More than 2.50%
None
> 1.875% - 2.50%
60.0%
> 1.250% - 1.875%
40.0%
> 0.625% - 1.250%
20.0%
≤ 0.625
- 0 -
 
Effective March 20, 2020, the Federal Reserve and
 
the other federal banking regulators adopted an interim final rule that
amended the capital conservation buffer in light of the
 
disruptive effects of the COVID-19 pandemic.
 
The interim final rule
was adopted
 
as a final rule on August 26, 2020. The new rule revises the definition of
 
“eligible retained income” for
purposes of the maximum payout ratio to allow banking organizations
 
to more freely use their capital buffers to promote
lending and other financial intermediation activities, by making the limitations
 
on capital distributions more gradual. The
eligible retained income is now the greater of (i) net income
 
for the four preceding quarters, net of distributions and
associated tax effects not reflected in net income; and
 
(ii) the average of all net income over the preceding four quarters.
The interim final rule only affects the capital buffers,
 
and banking organizations were encouraged
 
to make prudent capital
distribution decisions.
 
 
The various capital elements and total capital under the Basel
 
III Capital Rules, as fully phased in on January 1, 2019
 
are:
 
Fully Phased In
January 1, 2019
Minimum CET1
 
4.50%
CET1 Conservation Buffer
 
2.50%
Total CET1
 
7.0%
Deductions
 
from CET1
100%
Minimum Tier 1 Capital
 
6.0%
Minimum Tier 1 Capital
plus
conservation buffer
8.5%
Minimum Total Capital
 
8.0%
Minimum Total Capital
plus
conservation buffer
10.5%
 
Changes in Risk-Weightings
 
The Basel III Capital Rules significantly change the risk weightings
 
used to determine risk weighted capital adequacy.
 
Among various other changes, the Basel III Capital Rules apply a 250%
 
risk-weighting to MSRs, DTAs
 
that cannot be
realized through net operating loss carry-backs and significant (greater
 
than 10%) investments in other financial
institutions.
 
A 150% risk-weighted category applies to “high volatility commercial
 
real estate loans,” or “HVCRE,” which
are credit facilities for the acquisition, construction or development of
 
real property, excluding one
 
-to-four family
residential properties or commercial real estate projects
 
where: (i) the loan-to-value ratio is not in excess of interagency real
estate lending standards; and (ii) the borrower has contributed
 
capital equal to not less than 15% of the real estate’s
 
“as
completed” value before the loan was made.
 
The Basel III Capital Rules also changed some of the risk weightings
 
used to determine risk-weighted capital adequacy.
Among other things, the Basel III Capital Rules:
 
 
Assigned a 250% risk weight to MSRs;
 
 
18
 
 
Assigned up to a 1,250% risk weight to structured securities,
 
including private label mortgage securities, trust
preferred CDOs and asset backed securities;
 
 
Retained existing risk weights for residential mortgages, but assign
 
a 100% risk weight to most commercial real
estate loans and a 150% risk-weight for HVCRE;
 
 
Assigned a 150% risk weight to past due exposures (other than
 
sovereign exposures and residential mortgages);
 
 
 
Assigned a 250% risk weight to DTAs,
 
to the extent not deducted from capital (subject to certain maximums);
 
 
Retained the existing 100% risk weight for corporate
 
and retail loans; and
 
 
Increased the risk weight for exposures to qualifying securities firms from
 
20% to 100%.
 
HVCRE loans currently have a risk weight of 150%. Section 214
 
of the 2018 Growth Act, restricts the federal bank
regulators from applying this risk weight except to certain ADC loans.
 
The federal bank regulators issued a notice of a
proposed rule on September 18, 2018 to implement Section 214
 
of the 2018 Growth Act, by revising the definition
HVCRE. If this proposal is adopted, it is expected that this proposal
 
could reduce the Company’s risk weighted
 
assets and
thereby may increase the Company’s
 
risk-weighted capital.
 
 
The Financial Accounting Standards Board’s
 
(the “FASB”) Accounting
 
Standards Update (“ASU”) No. 2016-13 “Financial
Instruments – Credit Losses (Topic
 
326): Measurement of Credit Losses on Financial Instruments” on
 
June 16, 2016, which
changed the loss model to take into account current expected
 
credit losses (“CECL”) in place of the incurred loss method.
The Federal Reserve and the other federal banking agencies adopted
 
rules effective on April 1, 2019 that allows banking
organizations to phase in the regulatory capital effect
 
of a reduction in retained earnings upon adoption
 
of CECL over a
three year period.
 
On May 8, 2020, the agencies issued a statement describing the measurement
 
of expected credit
 
losses
using the CECL methodology,
 
and updated concepts and practices in existing supervisory guidance
 
that remain applicable.
CECL is effective for the Company beginning January 1,
 
2023 and has not been adopted early.
 
CECL’s
 
effects upon the
Company have
 
not yet been determined.
 
 
 
Prompt Corrective Action Rules
 
All of the federal bank regulatory agencies’ regulations establish
 
risk-adjusted measures and relevant capital levels that
implement the “prompt corrective action” standards.
 
The relevant capital measures are the total risk-based capital
 
ratio,
Tier 1 risk-based capital ratio, Common equity
 
tier 1 capital ratio, as well as, the leverage capital
 
ratio.
 
Under the
regulations, a state member bank will be:
 
 
well capitalized if it has a total risk-based capital ratio of 10% or
 
greater, a Tier
 
1 risk-based capital ratio of 8% or
greater, a Common equity tier 1 capital
 
ratio of 6.5% or greater, a leverage capital
 
ratio of 5% or greater and is not
subject to any written agreement, order,
 
capital directive or prompt corrective action directive by a federal bank
regulatory agency to maintain a specific capital level for any capital
 
measure;
 
 
“adequately capitalized” if it has a total risk-based capital ratio
 
of 8% or greater, a Tier
 
1 risk-based capital ratio of
6% or greater, a Common Equity Tier
 
1 capital ratio of 4.5% or greater, and generally has
 
a leverage capital ratio
of 4% or greater;
 
 
“undercapitalized” if it has a total risk-based capital ratio of less than 8%,
 
a Tier 1 risk-based capital ratio
 
of less
than 6%, a Common Equity Tier 1
 
capital ratio of less than 4.5% or generally has a leverage capital
 
ratio of less
than 4%;
 
 
“significantly undercapitalized” if it has a total risk-based capital ratio
 
of less than 6%, a Tier 1 risk-based capital
ratio of less than 4%, a Common Equity Tier
 
1 capital ratio of less than
 
3%, or a leverage capital ratio of less than
3%; or
 
 
“critically undercapitalized” if its tangible equity is equal to or
 
less than 2% to total assets.
 
 
 
19
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 Bankruptc
 
y
 
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 pro
 
file may be assessed by its off-balance sheet exposure,
 
trading of assets and liabilities,
notional derivatives’ exposure, and other methods.
 
 
The federal bank regulators implemented
 
a CARES Act provision by replacing interim final rules
 
adopted in March 2020,
temporarily reducing the community bank leverage ratio threshold.
 
The threshold is 8% through the end of 2020, 8.5%
 
for
2021, and 9% beginning January 1, 2022. Two
 
quarter grace
 
periods are allowed to permit banks that temporarily fall
below these thresholds to remain well-capitalized for regulatory purposes.
 
FDICIA
 
FDICIA directs that each federal bank regulatory agency prescribe
 
standards for depository institutions and depository
institution holding companies relating to internal controls, information
 
systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth composition,
 
a maximum ratio of classified assets to capital,
minimum earnings sufficient to absorb
 
losses, a minimum ratio of market value to book value for publicly traded
 
shares,
safety and soundness, and such other standards as the federal
 
bank regulatory agencies deem appropriate.
 
 
Enforcement Policies and Actions
 
The Federal Reserve and the Alabama Superintendent monitor
 
compliance with laws and regulations.
 
The CFPB monitors
compliance with laws and regulations applicable to consumer
 
financial products and services.
 
Violations of laws and
regulations, or other unsafe and unsound practices, may result
 
in these agencies imposing fines, penalties and/or restitution,
cease and desist orders, or taking other formal or informal enforcement
 
actions.
 
Under certain circumstances, these
agencies may enforce these remedies directly against officers,
 
directors, employees and others participating in the affairs
 
of
a bank or bank holding company,
 
in the form of fines, penalties, or the recovery,
 
or claw-back, of compensation.
 
The
federal prudential banking regulators have been bringing more
 
enforcement actions recently.
 
 
 
20
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 de
 
posits 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.
 
The
Federal Reserve also engaged in several rounds of quantitative
 
easing (“QE”) to reduce interest rates by buying bonds, and
“Operation Twist” to reduce
 
long term interest rates by buying long term bonds, while selling intermediate
 
term securities.
 
Beginning December 2013, the Federal Reserve began to taper
 
the level of bonds purchased, but continues to reinvest the
principal of its securities as these mature.
 
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.
 
The Federal Reserve’s current
 
policy is to seek maximum employment and inflation of 2%
 
over the longer run, with
inflation moderately running over 2% for some time. It continues
 
a target federal funds range of 0-0.25%, and
 
monthly
purposes of at least $80 billion of Treasury
 
securities and $40 billion of agency mortgage-backed securities until
 
substantial
further progress has been made towards its goals.
 
In light of disruptions in economic conditions caused by the outbreak
 
of COVID-19 and the stress in U.S. financial markets,
the Federal Reserve, Congress and the Department of the Treasury
 
took a host of fiscal and monetary measures to minimize
the economic effect of COVID-19.
 
 
The CARES Act provided a $2 trillion stimulus package and
 
various measures to provide relief from the COVID-19
pandemic, including:
 
 
The Paycheck Protection Program (“PPP”), which expands eligibility for
 
special new SBA guaranteed loans,
forgivable loans and other relief to small businesses affected
 
by COVID-19.
 
 
A new $500 billion federal stimulus program for air carriers
 
and other companies in severely distressed sectors of
the American economy. The
 
lending programs impose stock buyback, dividend, executive compensation,
 
and
other restrictions on direct loan recipients.
 
 
Optional temporary suspension of certain requirements under
 
ASC 340-10 TDR classifications for a limited period
of time to account for the effects of COVID-19.
 
The creation of rapid tax rebates and expansion of unemployment
 
benefits to provide relief to individuals.
 
 
Substantial federal spending and significant changes for health care
 
companies, providers, and patients.
 
 
Over $525 billion of PPP loans were made in 2020.
 
 
 
 
 
 
 
 
 
 
 
 
 
21
 
On December 27, 2020, the Economic Aid to Hard-Hit Smal
 
l
 
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,
as well as assessments by the FDIC to pay interest on Financing Corporation
 
(“FICO”) bonds.
 
 
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.
 
 
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.
 
 
 
 
22
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 $0.1
 
million in 2020
and 2019, 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 prope
 
rty, 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-affilia
 
ted, 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 2019 or 2020.
 
At December 31, 2020, the Bank
had outstanding $33.5 million in construction and land development
 
loans and $201.1 million in total CRE loans (excluding
owner occupied), which represent approximately 34.9% and
 
266.0%, respectively, of the
 
Bank’s total risk-based capital
 
at
December 31, 2020.
 
The Company has always had significant exposures to loans secured
 
by commercial real estate due to
the nature of its markets and the loan needs of both its retail
 
and commercial customers.
 
The Company believes its long
term experience in CRE lending, underwriting policies, internal controls,
 
and other policies currently in place, as well as its
loan and credit monitoring and administration procedures, are
 
generally appropriate to manage its concentrations as
required under the Guidance.
 
 
In 2013, the Federal Reserve and other banking regulators issued their
 
“Interagency Guidance on Leveraged Lending”
highlighting standards for originating leveraged transactions and
 
managing leveraged portfolios, as well as requiring banks
to identify their highly leveraged transactions, or HLTs.
 
The Government Accountability Office issued a
 
statement on
October 23, 2017 that this guidance constituted a “rule” for purposes
 
of the Congressional Review Act, which provides
Congress with the right to review the guidance and issue a joint resolution
 
for signature by the President disapproving it.
 
No such action was taken, and instead, the federal bank regulators
 
issued a September 11, 2018 “Statement Reaffirming
 
the
Role of Supervisory Guidance.”
 
This Statement indicated that guidance does not have the
 
force or effect of law or provide
the basis for enforcement actions, but this guidance can outline
 
supervisory agencies’ views of supervisory expectations
 
and
priorities, and appropriate practices.
 
The federal bank regulators continue to identify elevated risks in
 
leveraged loans and
shared national credits.
 
The Bank did not have any loans at year-end 2020
 
or 2019 that were leveraged loans subject to the Interagency Guidance
on Leveraged Lending or that were shared national credits. [Note
 
to Auburn: Confirm]
 
 
 
23
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 organi
 
zations similar
to the Company.
 
This Guidance applies to incentive compensation to executives
 
as well as employees, who, “individually
or a part of a group, have the ability to expose the relevant banking organization
 
to material amounts of risk.”
 
Incentive
compensation should:
 
Provide employees incentives that appropriately balance risk
 
and reward;
 
Be compatible with effective controls and risk-management;
 
and
 
 
 
24
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, depositor
 
y
 
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 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
 
 
 
25
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,
2019 or 2020, and historically have not relied on brokered
 
deposits.
 
On November 20, 2020, the Federal Reserve and the other federal
 
bank regulators issued temporary relief for community
banks with less than $10 billion in total assets as of December
 
31, 2019 related to certain regulations and reporting
requirements that largely result from growth due to the various
 
relief and stimulus actions in response to the COVID-19
pandemic. In particular, the interim final rule
 
permits these institutions to use asset data as of December 31,
 
2019, to
determine the applicability of various regulatory asset thresholds
 
during calendar years 2020 and 2021. For the same
reasons, the Federal Reserve temporarily revised the instructions to
 
a number of its regulatory reports to provide that
community banking organizations may use asset data
 
as of December 31, 2019, in order to determine reporting
requirements for reports due in calendar years 2020 or 2021.
 
 
On November 30, 2020, the bank regulators issued a statement
 
urging banks to cease entering into new contracts using
 
U.S.
dollar LIBOR rates as soon as practicable and in any event by December
 
31, 2021, to effect orderly,
 
and safe and sound
LIBOR transition. Banks were reminded that operating with insufficient
 
fallback interest rates could undermine financial
stability and banks’ safety and soundness.
 
Any alternative reference rate may be used that a bank determines
 
is appropriate
for its funding and customer needs.
 
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.
 
 
 
26
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 2021:
 
 
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, and are continuing.
 
The Federal Reserve is maintaining a targeted
 
federal funds rate of
0-0.25%, and has provided stimulus by buying bonds and providing
 
market liquidity.
 
Legislation is pending to
provide an additional $1.9 trillion of fiscal stimulus, and foreclosure
 
moratoria have been extended.
 
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, continue to affect consumer confidence levels and
 
economic activity.
 
Changes in payment behaviors and
payment rates may increase in delinquencies and default rates,
 
which could affect our earnings and credit quality.
 
 
Our ability to assess the creditworthiness of our customers and
 
those we do business with, and the values of our
assets and loan collateral may be adversely affected and less
 
predictable as a result of the pandemic and
government responses.
 
The accounting for loan modifications and deferrals may provide
 
only temporary relief.
 
The process we use to estimate losses inherent in our credit exposure
 
or estimate the value of certain assets
requires difficult, subjective, and complex judgments, including
 
forecasts of economic conditions and how those
economic predictions might affect the ability of our borrowers
 
to repay their loans or the value of assets.
 
 
The end of the LIBOR reference rate is currently scheduled for
 
most tenors by June 30, 2023, although U.S. bank
regulators informed banks November 30, 2020 that they should
 
stop using LIBOR for new loans and contracts and
derivatives, including hedging, and involves risks of potential marked
 
disruption and costs of compliance and
conversion.
 
New hedges may not be as effective as hedges based
 
on LIBOR.
 
Nonperforming and similar assets take significant time to resolve
 
and may adversely affect our results of
 
operations and
financial condition.
 
 
Our nonperforming loans were 0.12% of total loans as of December
 
31, 2020, and had no other real estate owned
(“OREO”).
 
Twenty-five percent, or
 
$117.0 million, of our total loans were in hotels/motels,
 
retail and shopping centers
and restaurants, and $31.4 million of these had COVID-19 modifications
 
to require interest only payments.
 
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.
 
 
 
 
27
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,
 
and changes in borrower behaviors.
 
Certain borrowers may not recover
fully or may fail as a result of COVID-19 effects.
 
If the credit quality of our customer base materially decreases,
 
if the risk
profile of the market, industry or group of customers changes
 
materially or weaknesses in the real estate markets worsen,
borrower payment behaviors change, or if our allowance for loan
 
losses is not adequate, our business, financial condition,
including our liquidity and capital, and results of operations
 
could be materially adversely affected.
 
CECL, a new
accounting standard for estimating loan losses, is effective for
 
the Company beginning January 1, 2023, and its effects upon
the Company have not yet been determined.
 
Changes in the real estate markets, including
 
the secondary market for residential mortgage
 
loans, may continue to
adversely affect us.
 
 
The CFPB’s mortgage and servicing
 
rules, including TRID rules for closed end credit transactions,
 
enforcement actions,
reviews and settlements, affect the mortgage markets and
 
our mortgage operations.
 
The CFPB requires that lenders
determine whether a consumer has the ability to repay a mortgage loan
 
have limited the secondary market for and liquidity
of many mortgage loans that are not “qualified mortgages.”
 
Recently adopted changes to the CFPB’s
 
qualified mortgage
rules are reportedly being reconsidered.
 
The Tax Cuts and Jobs
 
Act’s (the “2017 Tax
 
Act”) limitations on the deductibility of residential mortgage interest
 
and state
and local property and other taxes and federal moratoria
 
on single-family foreclosures and rental evictions could adversely
affect consumer behaviors and the volumes of housing sales,
 
mortgage and home equity loan originations, as well as the
value and liquidity of residential property held as collateral by lenders
 
such as the Bank, and the secondary markets for
single and multi-family loans.
 
Acquisition, construction and development loans for residential development
 
may be
similarly adversely affected.
 
Fannie Mae and Freddie Mac (“GSEs”), have been in conservatorship
 
since September 2008.
 
Since Fannie Mae and
Freddie Mac dominate the residential mortgage markets, any
 
changes in their operations and requirements, as well as their
respective restructurings and capital, could adversely affect
 
the primary and secondary mortgage markets, and our
residential mortgage businesses, our results of operations and
 
the returns on capital deployed in these businesses.
 
The
timing and effects of resolution of these government sponsored
 
enterprises cannot be predicted.
 
Weaknesses in real
 
estate markets the FHFA’s
 
moratoria on foreclosures and real estate owned evictions may adversely
affect the length of time and costs required to
 
manage and dispose of, and the values realized from the sale
 
of our OREO.
 
We may be
 
contractually obligated to repurchase
 
mortgage loans we sold to third parties on terms unfavorable
 
to us.
 
As part of its routine business, the Company originates mortgage loans
 
that it subsequently sells in the secondary market,
including to governmental agencies and GSEs.
 
In connection with the sale of these loans, the Company makes customary
representations and warranties, the breach of which may result in
 
the Company being required to repurchase the loan or
loans.
 
Furthermore, the amount paid may be greater than the fair value of the
 
loan or loans at the time of the repurchase.
 
Although mortgage loan repurchase requests made to us have been
 
limited, if these increased, we may have to establish
reserves for possible repurchases and adversely affect our results of operation
 
and financial condition.
 
Mortgage servicing rights requirements
 
may change and require
 
us to incur additional costs and risks.
 
The CFPB’s residential mortgage
 
servicing standards may adversely affect our costs to
 
service residential mortgage loans,
and together with the Basel III Rules and the effects of
 
lower interest rates from COVID-19 stimulus, may decrease the
returns on, and values of, our MSRs.
 
This could reduce our income from servicing these types
 
of loans and make it more
difficult and costly to timely realize the value of collateral
 
securing such loans upon a borrower default.
 
 
 
28
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
43.6%
 
of our portfolio in CRE loans at year-end 2020 compared
 
to 48.0% at year-end 2019.
 
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 2020, 25% of our total loans were CRE
 
loans to hotels/motels, retail and shopping centers and restaurants,
businesses that have been severely affected by the effects
 
of COVID-19.
 
Our future success is dependent on
 
our ability to compete effectively in highly competitive markets.
 
 
The East Alabama banking markets which we operate
 
are highly competitive and our future growth and success will
depend on our ability to compete effectively in these markets.
 
We compete for loans,
 
deposits and other financial services
with other local, regional and national commercial banks, thrifts, credit
 
unions, mortgage lenders, and securities and
insurance brokerage firms.
 
Lenders operating nationwide over the internet are growing rapidly.
 
Many of our competitors
offer products and services different from
 
us, and have substantially greater resources, name recognition and
 
market
presence than we do, which benefits them in attracting business.
 
In addition, larger competitors may be able to
 
price loans
and deposits more aggressively than we are able to and have broader
 
and more diverse customer and geographic bases to
draw upon.
 
Out of state banks may branch into our markets.
 
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.
 
 
 
29
Attractive acquisition opportunities may not be available
 
to us in the future.
 
 
While we seek continued organic growth, we also may
 
consider the acquisition of other businesses.
 
We expect that other
banking and financial companies, many of which have significantly
 
greater resources, will compete with us to acquire
financial services businesses.
 
This competition could increase prices for potential acquisitions that
 
we believe are
attractive.
 
Also, acquisitions are subject to various regulatory approvals.
 
If we fail to receive the appropriate regulatory
approvals, we will not be able to consummate an acquisition that
 
we believe is in our best interests, and regulatory
approvals could contain conditions that reduce the anticipated
 
benefits of any transaction.
 
Among other things, our
regulators consider our capital, liquidity,
 
profitability, regulatory compliance
 
and levels of goodwill and intangibles when
considering acquisition and expansion proposals.
 
Any acquisition could be dilutive to our earnings and shareholders’
equity per share of our common stock.
 
 
Future acquisitions and expansion activities
 
may disrupt our business, dilute shareholder
 
value and adversely affect our
operating results.
 
 
We regularly evaluate
 
potential acquisitions and expansion opportunities, including new
 
branches and other offices.
 
To the
extent that we grow through acquisitions, we cannot assure you that
 
we will be able to adequately or profitably manage this
growth.
 
Acquiring other banks, branches, or businesses, as well as other geographic
 
and product expansion activities,
involve various risks including:
 
 
 
risks of unknown or contingent liabilities, and potential asset quality issues;
 
 
unanticipated costs and delays;
 
 
risks that acquired new businesses will not perform consistent with
 
our growth and profitability expectations;
 
 
risks of entering new markets or product areas where we have
 
limited experience;
 
 
risks that growth will strain our infrastructure, staff, internal
 
controls and management, which may require
additional personnel, time and expenditures;
 
 
difficulties, expenses and delays of integrating the operations
 
and personnel of acquired institutions;
 
 
 
potential disruptions to our business;
 
 
possible loss of key employees and customers of acquired institutions;
 
 
potential short-term decreases in profitability; and
 
 
diversion of our management’s
 
time and attention from our existing operations and business.
 
 
 
30
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, and data breaches. 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 competito
 
rs 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.
 
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 has 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,
 
it is not
possible to be certain that such actions have been or will be
 
effective in controlling these various operational risks
 
that
evolve continuously.
 
Potential gaps in our risk management policies and internal
 
audit procedures
 
may leave us exposed unidentified or
unanticipated risk, which could negatively affect our business.
 
Our enterprise risk management and internal audit program is
 
designed to mitigate material risks and loss to us. We
 
have
developed and continue to develop risk management and internal
 
audit policies and procedures to reflect the ongoing
review of our risks and expect to continue to do so in the future.
 
Nonetheless, our policies and procedures may not be
comprehensive and may not identify timely every risk to which we
 
are exposed, and our internal audit process may fail to
detect such weaknesses or deficiencies in our risk management
 
framework. Many of our risk management models and
estimates use observed historical market behavior to model
 
or project potential future exposure.
 
Models used by our
business are based on assumptions and projections. These
 
models may not operate properly or our inputs and assumptions
may be inaccurate, or changes in economic conditions, customer
 
behaviors or regulations.
 
As a result, these methods may
not fully predict future exposures, which can be significantly
 
greater than historically.
 
Other risk management methods
depend upon the evaluation of information regarding markets,
 
clients, or other matters that are publicly available or
otherwise accessible to us. This information may not always
 
be accurate, complete, up-to-date or properly evaluated.
Furthermore, there can be no assurance that we can effectively
 
review and monitor all risks or that all of our employees will
closely follow our risk management policies and procedures,
 
nor can there be any assurance that our risk management
policies and procedures will enable us to accurately identify all
 
risks and limit our exposures based on our assessments. In
addition, we may have to implement more extensive and perhaps
 
different risk management policies and procedu
 
res as our
regulation changes.
 
All of these could adversely affect our financial condition
 
and results of operations.
 
 
 
31
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.
 
Other
financial service institutions and their service providers have reported
 
material security breaches in their websites or other
systems, some of which have involved sophisticated and targeted
 
attacks, including use of stolen access credentials,
malware, ransomware, phishing and distributed denial-of
 
-service attacks, among other means.
 
Such cyber-attacks may also
seek to disrupt the operations of public companies or their business
 
partners, effect unauthorized fund transfers, obtain
unauthorized access to confidential information, destroy data,
 
disable or degrade service, or sabotage systems.
 
Denial of
service attacks have
 
been launched against a number of financial services institutions,
 
and we may be subject to these types
of attacks in the future. Hacking and identity theft risks, in particular,
 
could cause serious reputational harm.
 
Despite our cybersecurity policies and procedures and our
 
Board of Director’s and Management’s
 
efforts to monitor and
ensure the integrity of the system we use, we may not be able
 
to anticipate the rapidly evolving security threats, nor may we
be able to implement preventive measures effective against
 
all such threats. The techniques used by cyber criminals change
frequently, may not be recognized
 
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.
 
 
 
 
32
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,
 
natural disasters, 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 coronavirus or 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.
 
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.
 
Any such adverse changes may adversely affect our
 
profitability, growth asset
 
quality and financial
condition.
 
Financial Risks
 
Our ability to realize our deferred
 
tax assets may be reduced in the
 
future if our estimates of future
 
taxable income from
our operations and tax planning strategies do not support
 
this amount, and the amount of net operating loss carry-forwards
realizable for income tax purposes may
 
be reduced under Section 382 of
 
the Internal Revenue Code by sales of our capital
securities.
 
 
We are
 
allowed to carry-back losses for two years for Federal income tax purposes.
 
As of December 31, 2020, we had a
net deferred tax liability of $1.5 million with gross deferred tax assets
 
of $1.9 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.
 
 
 
33
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%
 
is continuing significant monthly purchases of U.S. Treasury
 
and agency
mortgage-backed securities to help combat the economic effect
 
of the COVID-19 pandemic.
 
Since November 2020,
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.
 
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 these rates and 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 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 2019 and 2020 rate reductions by
the Federal Reserve and the effects of the COVID
 
-19 pandemic have reduced market rates, which adversely affected
 
our
net interest income and our results of operations.
 
The production of mortgages and other loans and the value of
 
collateral securing our loans are dependent on demand within
the markets we serve, as well as interest rates.
 
Lower interest rates typically increase mortgage originations, decrease
 
MSR
values, and facilitate pandemic-related trends to single family houses.
 
Increases in market interest rates would tend to
decrease mortgage originations, increase MSR values and potentially
 
increase net interest spread depending upon the yield
curve and the magnitude and duration of interest rate increase.
 
Liquidity risks could affect operations and jeopardize
 
our financial condition.
 
 
Liquidity is essential to our business.
 
An inability to raise funds through deposits, borrowings,
 
proceeds from loan
repayments or sales proceeds from maturing loans and securities,
 
and other sources could have a negative effect on our
liquidity.
 
Our funding sources include federal funds purchased, securities sold
 
under repurchase agreements, core and non-
core deposits, and short-
 
and long-term debt.
 
We maintain a
 
portfolio of securities that can be used as a source of liquidity.
 
We are
 
also members of the FHLB and the Federal Reserve Bank of Atlanta, where
 
we can obtain advances collateralized
with eligible assets.
 
There are other sources of liquidity available to
 
the Company or the Bank should they be needed,
including our ability to acquire additional non-core deposits.
 
We may be able, depending
 
upon market conditions, to
otherwise borrow money or issue and sell debt and preferred or
 
common securities in public or private transactions.
 
Our
access to funding sources in amounts adequate to finance or
 
capitalize our activities on terms which are acceptable to
 
us
could be impaired by factors that affect us specifically,
 
or the financial services industry or the economy in general.
 
General conditions that are not specific to us, such as disruptions in
 
the financial markets or negative views and
expectations about the prospects for the financial services industry
 
could adversely affect us.
 
 
 
34
The COVID-19 pandemic generally has increased our deposits and at
 
banks, generally, while
 
reducing the interest rate
earnings
 
available on loans and securities.
 
Such excess liquidity and the resulting balance sheet growth requires
 
capital
support and may reduce returns on assets and equity.
 
Changes in accounting and tax rules applicable to
 
banks could adversely affect our financial conditions and
 
results of
operations.
 
 
From time to time, the FASB
 
and the SEC change the financial accounting and reporting standards
 
that govern the
preparation of our financial statements.
 
These changes can be difficult to predict and can materially
 
impact how we record
and report our financial condition and results of operations.
 
In some cases, we could be required to apply a new or revised
standard retroactively, resulting
 
in us restating prior period financial statements
.
The
 
FASB’s
 
guidance under ASU No.
2016-13 includes significant changes to the manner in which
 
banks’ allowance for loan losses will be effective for
 
us
beginning January 1, 2023.
 
Instead of using historical losses, the CECL model is forward-looking
 
with respect to expected
losses over the life of loans and other instruments, and could materially
 
affect our results of operations and financial
condition, including the variability of our results of operations
 
and our regulatory capital, notwithstanding a three-year
phase-in of CECL for regulatory capital purposes.
 
We may need
 
to raise additional capital in the future,
 
but that capital may not be available when it is needed or
 
on
favorable terms.
 
 
We anticipate that our
 
current capital resources will satisfy our capital requirements
 
for the foreseeable future under
currently effective rules.
 
We may,
 
however, need to raise additional capital
 
to support our growth or currently
unanticipated losses, or to meet the needs of our communities,
 
resulting from failures or cutbacks by our competitors.
 
Our
ability to raise additional capital, if needed, will depend, among
 
other things, on conditions in the capital markets at that
time, which are limited by events outside our control, and on
 
our financial performance.
 
If we cannot raise additional
capital on acceptable terms when needed, our ability to further
 
expand our operations through internal growth and
acquisitions could be limited.
 
 
Our associates may take excessive risks which could negatively
 
affect our financial condition and business.
 
Banks are in the business of accepting certain risks.
 
Our executive officers and other members of management,
 
sales
intermediaries, investment professionals, product managers, and
 
other associates, make decisions and choices that involve
exposing us to risk. We
 
endeavor, in the design and implementation
 
of our compensation programs and practices, to avoid
giving our associates incentives to take excessive risks; however,
 
associates may nonetheless take such risks.
 
Similarly,
although we employ controls and procedures designed to prevent
 
misconduct, to monitor associates’ business decisions and
prevent them from taking excessive risks, these controls and
 
procedures may not be effective. If our associates take
excessive risks, risks to our reputation, financial condition and
 
business operations could be materially and adversely
affected.
 
Our ability to continue to pay dividends to shareholders
 
in the future is subject to our profitability,
 
capital, liquidity and
regulatory requirements
 
and these limitations may prevent or limit future
 
dividends.
 
 
Cash available to pay dividends to our shareholders is derived
 
primarily from dividends paid to the Company by the Bank.
 
The ability of the Bank to pay dividends, as well as our ability
 
to pay dividends to our shareholders, will continue to be
subject to and limited by laws limiting dividend payments by
 
the Bank, the results of operations of our subsidiaries and our
need to maintain appropriate liquidity and capital at all levels
 
of our business consistent with regulatory requirements and
the needs of our businesses.
 
See “Supervision and Regulation”.
 
A limited trading market exists for our common shares,
 
which could result in price volatility.
 
Your
 
ability to sell or purchase common shares depends
 
upon the existence of an active trading market for our common
stock.
 
Although our common stock is quoted on the Nasdaq Global Market
 
under the trading symbol “AUBN,” our historic
trading volume has been limited historically.
 
As a result, you may be unable to sell or purchase shares of our
 
common
stock at the volume, price and time that you desire.
 
Additionally, whether the purchase
 
or sales prices of our common stock
reflects a reasonable valuation of our common stock also is affected
 
by an active 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.
 
 
 
35
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 may 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 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 by our new President is
 
not yet known, their views and actions could have
a material adverse effect on financial services regulation,
 
generally.
 
Litigation and regulatory actions could
 
harm our reputation and adversely affect our
 
results of operations and financial
condition.
 
A substantial legal liability or a significant regulatory action against us,
 
as well as regulatory inquiries or investigations,
could harm our reputation, result in material fines or penalties,
 
result in significant legal 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 and 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:
 
 
 
36
 
 
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 dividends on our capital stock.
 
 
 
ability to make discretionary bonuses to attract and retain quality personnel;
 
 
 
ability to make acquisitions or engage in new activities;
 
 
 
flexibility if we become subject to prompt corrective action restrictions;
 
 
 
ability to make payments of principal and interest on our capital
 
instruments; and
 
The Federal Reserve may require
 
us to commit capital resources
 
to support the Bank.
 
As a matter of policy, the Federal
 
Reserve expects a bank holding company to act as a source of financial
 
and managerial
strength to a subsidiary bank and to commit resources to support
 
such subsidiary bank. The Federal Reserve may require a
bank holding company to make capital injections into a troubled
 
subsidiary bank. In addition, the Dodd-Frank Act amended
the FDI Act to require that all companies that control a FDIC-insured
 
depository institution serve as a source of financial
strength to their depository institution subsidiaries. Under these
 
requirements, we could be required to provide financial
assistance to the Bank should it experience financial distress,
 
even if further investment was not otherwise warranted. See
“Supervision and Regulation.”
 
 
 
37
Our operations are subject to risk of loss from
 
unfavorable fiscal, monetary and political developments
 
in the U.S.
 
Our businesses and earnings are affected by the fiscal, monetary
 
and other policies and actions
 
of various U.S.
governmental and regulatory authorities. Changes in these are
 
beyond our control and are difficult to predict and,
consequently, changes in these
 
policies could have negative effects on our activities and results
 
of operations.
 
Failures of
the executive and legislative branches to agree on spending plans and
 
budgets previously have led to Federal government
shutdowns, which may adversely affect the U.S. economy.
 
Additionally, any prolonged
 
government shutdown may inhibit
our ability to evaluate the economy,
 
generally, and affect
 
government workers who are not paid during such events, and
where the absence of government services and data could adversely affect
 
consumer and business sentiment, our local
economy and our customers and therefore our business.
 
Litigation and regulatory investigations
 
are increasingly
 
common in our businesses and
 
may result in significant financial
losses and/or harm to our reputation.
 
We face risks of litigation
 
and regulatory investigations and actions in the ordinary course
 
of operating our businesses,
including the risk of class action lawsuits. Plaintiffs
 
in class action and other lawsuits against us may seek very large
 
and/or
indeterminate amounts, including punitive and treble damages. Due to
 
the vagaries of litigation, the ultimate outcome of
litigation and the amount or range of potential loss at particular
 
points in time may be difficult to ascertain. We
 
do not have
any material pending litigation or regulatory matters affecting
 
us.
 
Failures to comply with the fair lending
 
laws, CFPB regulations or the Community
 
Reinvestment Act, or CRA, could
adversely affect us.
 
The Bank is subject to, among other things, the provisions of
 
the Equal Credit Opportunity Act, or ECOA, and the Fair
Housing Act, both of which prohibit discrimination based on
 
race or color, religion, national origin, sex
 
and familial status
in any aspect of a consumer, commercial credit
 
or residential real estate transaction. The DOJ and the federal
 
bank
regulatory agencies have issued an Interagency Policy Statement
 
on Discrimination in Lending have provided guidance
 
to
financial institutions to evaluate whether discrimination exists
 
and how the agencies will respond to lending discrimination,
and what steps lenders might take to prevent discriminatory lending
 
practices. Failures to comply with ECOA, the Fair
Housing Act and other fair lending laws and regulations, including
 
CFPB regulations, could subject us to enforcement
actions or litigation, and could have a material adverse effect
 
on our business financial condition and results of operations.
Our Bank is also subject to the CRA and periodic CRA examinations.
 
The CRA requires us to serve our entire
communities, including low- and moderate-income neighborhoods.
 
Our CRA ratings could be adversely affected by actual
or alleged violations of the fair lending or consumer financial
 
protection laws. Even though we have maintained an
“satisfactory” CRA rating since 2000, we cannot predict
 
our future CRA ratings. Violations of fair
 
lending laws or if our
CRA rating falls to less than “satisfactory” could adversely affect
 
our business, including expansion through branching or
acquisitions.
 
COVID-19 Risks
 
The COVID-19 pandemic is expected to 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 certain of these measures have
been relaxed or eliminated, the pandemic has moved in disruptive
 
and unpredictable waves.
 
 
 
38
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. Auburn University’s
 
guidelines for the spring
semester of 2020 and the 2021 involve both remote and in person
 
instructions as well as social distancing measures and
modified class schedules. The economic effects of these
 
measures is not presently known. Hyundai’s
 
Montgomery and
Kia’s West
 
Point, Georgia plants were closed for a portion of the first
 
quarter of 2020, but began a phased reopen in the
second quarter of 2020 in response to COVID-19.
 
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,” volati
 
lity 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;
 
 
Increased savings and debt reduction by consumers could reduce
 
demand for credit and our earning assets;
 
 
Significant volatility in United States financial markets and our
 
investment securities portfolio, including credit
concerns in municipal securities;
 
 
Declines in the credit quality of our loan portfolio, owing to
 
the effects of the COVID-19 pandemic in the
markets we serve, leading to increased provisions for loan losses and
 
increases in our allowance for possible
credit losses;
 
 
Declines in the value of collateral for loans, including real estate
 
collateral, especially in industries such as
travel, hospitality, restaura
 
nts 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;
 
 
 
39
 
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 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. 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.
 
 
 
40
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 $36.5 million of PPP loans in 2020.
 
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.
 
 
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 office building site,
 
which is located in
downtown Auburn, Alabama.
 
During 2020 the main office was demolished and a
 
temporary main office branch was
constructed in the AuburnBank Center (the “Center”).
 
The Bank also owns the Center, which was
 
located next to the
Bank’s recently demolished main
 
office.
 
The Center has approximately 23,000 square feet of space.
 
All of the Bank’s
mortgage servicing, data processing activities, and other operations,
 
are located in the Center.
 
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.
 
In January 2019, the Bank purchased a parcel that adjoins the
 
Center in order to improve ingress and egress to the Bank's
main campus, which comprises over 5 acres in downtown Auburn and
 
includes the Bank's main office site, drive-through
facility, and the Center.
 
The building improvements on this adjoining parcel,
 
as well as the main office, will be demolished
as part of Phase I of the Bank's plan to redevelop its main campus.
 
Phase I of this redevelopment plan will include the
construction of a new headquarters building and a parking deck.
 
Construction activities commenced during the second half
of 2020 and upon completion of Phase I, the Bank's main office
 
branch and all of its back-office operations will
 
be located
in the new headquarters building.
 
Any unused office/retail space in this new building will be
 
available for lease to third
parties.
 
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.
 
 
 
41
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 2019,
 
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 Ban
 
k
leases approximately 1,500 square feet of space for the Corner Village
 
branch. Prior to relocation, the Bank’s
 
Auburn
Kroger branch was located in the Kroger supermarket in the same
 
shopping center. The Auburn Kroger
 
branch was
originally opened in August 1988. The Corner Village
 
branch offers the full line of the Bank’s
 
deposit and other services
including an ATM,
 
except safe deposit boxes.
 
In September 2015, the Bank relocated its Auburn Wal
 
-Mart Supercenter branch to a new location the Bank purchased
 
in
December 2014 at the intersection of S. Donahue Avenue
 
and E. University Drive in Auburn, Alabama.
 
The South
Donahue branch, built in 2015, has approximately 3,600
 
square feet of space.
 
Prior to relocation, the Bank’s Auburn
 
Wal-
Mart Supercenter branch was located inside the Wal
 
-Mart shopping center on the south side of Auburn, Alabama.
 
The
Auburn Wal-Mart Supercenter
 
branch was originally opened in September 2000. The South Donahue branch
 
offers the full
line of the Bank’s services and
 
has drive-through windows and an ATM.
 
This branch offers parking for approximately 28
vehicles.
 
In May 2017, the Bank relocated its Opelika Kroger branch to
 
a new location the Bank purchased in August 2016 near the
Tiger Town
 
Retail Shopping Center and the intersection of U.S. Highway 280
 
and Frederick Road in Opelika, Alabama.
 
The Tiger Town
 
branch, built in 2017, has approximately 5,500
 
square feet of space.
 
Prior to relocation, the Bank’s
Opelika Kroger branch was located inside the Kroger supermarket in
 
the Tiger Town
 
retail center in Opelika, Alabama. The
Opelika Kroger branch was originally opened in July 2007.
 
The Tiger Town
 
branch offers the full line of the Bank’s
services and has drive-through windows and an ATM.
 
This branch offers parking for approximately 36 vehicles.
 
In September 2018, the Bank opened a loan production office
 
on East Samford Avenue in
 
Auburn, Alabama.
 
The location
has approximately 2,500 square feet of space and is leased through 2028
 
.
 
The loan production office was previously
located in the Center on the Bank’s
 
main campus. This location offers parking for approximately
 
16 vehicles.
 
ITEM 3.
 
LEGAL PROCEEDINGS
 
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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
42
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 8, 2021,
there were approximately 3,566,326 shares of the Company’s
 
Common Stock issued and outstanding, which were held by
approximately 373 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
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
 
2019
First Quarter
$
 
39.43
 
$
 
30.61
 
$
 
0.25
 
Second Quarter
 
39.55
 
 
31.06
 
 
0.25
 
Third Quarter
 
47.38
 
 
32.33
 
 
0.25
 
Fourth Quarter
 
53.90
 
 
40.00
 
 
0.25
 
(1)
 
The price information represents actual transactions.
 
The Company has paid cash dividends on its capital stock since 1985.
 
Prior to this time, the Bank paid cash dividends since
its organization in 1907, except during the Depression
 
years of 1932 and 1933. Holders of Common Stock are entitled to
receive such dividends as may be declared by the Company’s
 
Board of Directors. The amount and frequency of cash
dividends will be determined in the judgment of the Board
 
based upon a number of factors, including the Company’s
earnings, financial condition, capital requirements and other
 
relevant factors. The Board currently intends to continue its
present dividend policies.
 
Federal Reserve policy could restrict future dividends on our
 
Common Stock, depending on our earnings and capital
position and likely needs. See “Supervision and Regulation –
 
Payment of Dividends” and “Management’s
 
Discussion and
Analysis of Financial Condition and Results of Operations –
 
Capital Adequacy”.
 
The amount of dividends payable by the Bank is limited by law and
 
regulation.
 
The need to maintain adequate capital in
the Bank also limits dividends that may be paid to the Company.
aubn-20201231p43i0.gif
 
 
 
 
 
 
 
 
43
Performance Graph
 
The following performance graph compares the cumulative, total
 
return on the Company’s Co
 
mmon Stock from
December 31, 2015 to December 31, 2020,
 
with that of the Nasdaq Composite Index and SNL Southeast Bank Index
(assuming a $100 investment on December 31, 2015).
 
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
12/31/2015
12/31/2016
12/31/2017
12/31/2018
12/31/2019
12/31/2020
Auburn National Bancorporation, Inc.
100
109.08
139.15
115.94
199.43
160.34
NASDAQ Composite Index
100
108.87
141.13
137.12
187.44
271.64
SNL Southeast Bank Index
100
132.75
164.21
135.67
191.06
172.07
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
44
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, 2020
––
––
––
5,000,000
November 1 – November 30, 2020
––
––
––
5,000,000
December 1 – December 31, 2020
––
––
––
5,000,000
Total
––
––
––
5,000,000
(1) On March 10, 2020 the Company adopted a $5 million stock repurchase program that became effective April 1, 2020.
 
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, 2020 and 2019 and our results of operations for
the years ended December 31, 2020 and 2019. 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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
45
Summary of Results of Operations
Year ended December 31
(Dollars in thousands, except per share data)
2020
2019
Net interest income (a)
$
24,830
$
26,621
Less: tax-equivalent adjustment
492
557
Net interest income (GAAP)
24,338
26,064
Noninterest income
5,375
5,494
Total revenue
29,713
31,558
Provision for loan losses
1,100
(250)
Noninterest expense
19,554
19,697
Income tax expense
 
1,605
2,370
Net earnings
$
7,454
$
9,741
Basic and diluted net earnings per share
$
2.09
$
2.72
(a) Tax-equivalent.
 
See "Table 1 - Explanation of Non-GAAP Financial Measures".
 
Financial Summary
 
The Company’s net earnings were $7.5
 
million for the full year 2020, compared to $9.7 million for the full year
 
2019.
 
Basic and diluted net earnings per share were $2.09 per share
 
for the full year 2020, compared to $2.72 per share for the full
year 2019.
 
The decrease in full year 2020 net earnings was primarily driven
 
by the negative impact of the COVID-19
pandemic, which resulted in elevated provision for loan losses,
 
compared to 2019, in addition to a lower interest rate
environment.
 
Net interest income (tax-equivalent) was $24.8 million in 2020,
 
a 7% decrease compared to $26.6 million in 2019.
This
decrease was primarily due to net interest margin compression
 
resulting from the Federal Reserve’s
 
interest rate reductions
in response to COVID-19.
 
Net interest margin (tax-equivalent) decreased
 
to 2.92% in 2020, compared to 3.43% in 2019,
primarily due to the lower interest rate environment and changes
 
in our asset mix resulting from the significant increase in
customer deposits.
 
 
At December 31, 2020, the Company’s
 
allowance for loan losses was $5.6 million, or 1.22%
 
of total loans, compared to
$4.4 million, or 0.95% of total loans, at December 31, 2019.
 
Excluding Paycheck Protection Program (“PPP”) loans, the
Company’s allowance for loan
 
losses was 1.27% of total loans at December 31, 2020.
 
The Company recorded a provision
for loan losses of $1.1 million in 2020 compared to a
 
negative provision for loan losses of $0.3 million during 2019.
The
increase in the provision for loan losses was related to changes
 
in economic conditions and portfolio trends driven by the
impact of COVID-19 and resulting adverse economic conditions,
 
including higher unemployment in our primary market
area.
 
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 recoveries as a percent of average loans were 0.03% in
2020 compared to net charge-offs as a percent
 
of average loans of 0.03% in 2019.
 
 
Noninterest income was $5.4 million in 2020 compared to
 
$5.5 million in 2019.
 
Although total noninterest income was
largely unchanged in 2020, 2019 included a $1.7
 
million gain that resulted from the termination of a loan guarantee
program operated by the State of Alabama.
 
This decrease was partially offset by an increase
 
in mortgage lending income of
$1.5 million during 2020 compared to 2019, as lower interest
 
rates for mortgage loans increased refinancing activity and
pricing margins improved.
 
 
Noninterest expense was $19.6 million in 2020 compared to
 
$19.7 million in 2019.
The decrease was primarily due to a
reduction of $0.6 million in salaries and benefits expense which was offset
 
by an increase of $0.6 million in various
expenses related to the planned redevelopment of the Company’s
 
headquarters in downtown Auburn.
 
 
Income tax expense was $1.6 million in 2020 and $2.4
 
million in 2019 reflecting an effective tax rate of 17.72%
 
and
19.57%, respectively.
 
This change was primarily due to a decrease in the level of
 
earnings before taxes relative to tax-
exempt sources of income.
 
The Company’s effective
 
income tax rate is principally impacted by tax-exempt earnings
 
from
the Company’s investments in
 
municipal securities
 
and bank-owned life insurance.
 
 
 
 
46
The Company paid cash dividends of $1.02 per share in 2020,
 
an increase of 2% from 2019. At December 31, 2020, 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
 
18.31%, a tier 1 leverage ratio of 10.32% and common equity
tier 1 (“CET1”) of 17.27% at December 31, 2020.
 
 
COVID-19 Impact Assessment
 
In December 2019, COVID-19 was first reported in China and
 
has since spread to a number of other countries, including
the United States. In March 2020, the World
 
Health Organization declared COVID-19 a global
 
pandemic and the United
States declared a National Public Health Emergency.
 
The COVID-19 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,
increases in reported cases could cause these measures to be
 
reestablished.
 
Auburn University, a major
 
source of economic
activity in Lee County, went to
 
remote instruction on March 16, 2020.
 
Auburn University announced its guidelines for the
remainder of the 2020/2021 school year,
 
which involves both remote and in person instruction as well as other social
distancing measures.
 
The economic effects of these measures are
 
not presently known.
 
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, the
development and distribution of COVID-19 testing and contact
 
tracing, effective drug treatments and vaccines, 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.
 
See “Balance Sheet Analysis – Loans” for supplemental COVID
 
-19
disclosures.
 
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.
 
On June 1, 2020, we re-opened some of our branch lobbies as permitted
 
by
state public health guidelines.
 
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 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 are
 
a participating lender in the PPP.
 
PPP loans are forgivable, in whole or in part, if the
 
proceeds are used for
payroll and other permitted purposes in accordance with the requirements
 
of the PPP.
 
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 is good for our customers
 
and the
communities we serve.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
47
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
%
 
The Company extended $36.5 million in loans to 423 small businesses
 
under the PPP during 2020.
 
We collected
approximately $1.5 million in fees related to our PPP loans,
 
which are being recognized net of related costs, as a yield
adjustment over the life of the underlying PPP loans.
 
During 2020, we received payments and forgiveness on 158
 
loans
totaling
 
$17.5 million.
 
The outstanding balance for the remaining 265 loans as December
 
31, 2020 was approximately
$19.0 million.
 
 
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.
 
As of February 28, 2021, the Company has extended $17.4
 
million in loans to 169 small
businesses under the PPP provided by the Economic Aid Act.
 
 
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 the year ended December 31, 2020
 
,
 
and our financial condition
at that date reflect only the initial effects of the pandemic,
 
and may not be indicative of future results or financial
conditions, including possible additional 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, 2020,
 
all of our capital ratios were in excess of all regulatory requirements to be
 
well capitalized.
 
The
effects of the COVID-19 pandemic on our borrowers
 
could result in adverse changes to credit quality and our regulatory
capital ratios.
 
We continue to closely
 
monitor this pandemic, and are working to continue our services during
 
the pandemic
and to address developments as those occur.
 
CRITICAL ACCOUNTING POLICIES
 
The accounting and financial reporting policies of the Company conform
 
with U.S. generally accepted accounting
principles and with general practices within the banking industry.
 
In connection with the application of those principles, we
have made judgments and estimates which, in the case of the determination
 
of our allowance for loan losses, our
assessment of other-than-temporary impairment, recurring and non-recurring
 
fair value measurements, the valuation of
other real estate owned, and the valuation of deferred tax assets,
 
were critical to the determination of our financial position
and results of operations. Other policies also require subjective
 
judgment and assumptions and may accordingly impact our
financial position and results of operations.
 
 
Allowance for Loan Losses
 
The Company assesses the adequacy of its allowance for loan
 
losses prior to the end of each calendar quarter.
 
The level of
the allowance is based upon management’s
 
evaluation of the loan portfolio, past loan loss experience,
 
current asset quality
trends, known and inherent risks in the portfolio, adverse situations
 
that may affect a borrower’s ability to
 
repay (including
the timing of future payment), the estimated value of any underlying
 
collateral, composition of the loan portfolio, economic
conditions, industry and peer bank loan loss rates and other pertinent
 
factors, including regulatory recommendations. This
evaluation is inherently subjective as it requires material estimates including
 
the amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible
 
to significant change. Loans are charged off, in whole
 
or
in part, when management believes that the full collectability of the
 
loan is unlikely. A loan
 
may be partially charged-off
after a “confirming event” has occurred which serves to validate
 
that full repayment pursuant to the terms of the loan is
unlikely.
 
 
 
48
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, 2020 and 2019, and for the years then ended,
 
the Company adjusted its historical loss rates for the
commercial real estate portfolio segment based, in part, on loss rates of peer
 
bank groups.
 
The estimated loan loss allocation for all five loan portfolio segments
 
is then adjusted for management’s
 
estimate of
probable losses for several “qualitative and environmental” factors.
 
The allocation for qualitative and environmental
factors is particularly subjective and does not lend itself to exact mathematical
 
calculation.
 
This amount represents
estimated probable inherent credit losses which exist, but have not yet
 
been identified, as of the balance sheet date, and are
based upon quarterly trend assessments in delinquent and nonaccrual
 
loans, credit concentration changes, prevailing
economic conditions, changes in lending personnel experience,
 
changes in lending policies or procedures and other
influencing factors.
 
These qualitative and environmental factors are considered
 
for each of the five loan segments and the
allowance allocation, as determined by the processes noted
 
above, is increased or decreased based on the incremental
assessment of these factors.
 
The Company regularly re-evaluates its practices in determining the
 
allowance for loan losses. Since the fourth quarter of
2016, the Company has increased its look-back period each quarter
 
to incorporate the effects of at least one economic
downturn in its loss history. The
 
Company believes the extension
 
of its look-back period is appropriate due to the risks
inherent in the loan portfolio. Absent this extension, the early
 
cycle periods in which the Company experienced significant
losses would be excluded from the determination of the allowance for
 
loan losses and its balance would decrease. For the
year ended December 31, 2020, the Company increased its look
 
-back period to 47 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.
 
Further adjustments may be made in the future as a result of the ongoing COVID
 
-19 pandemic.
 
 
 
 
49
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. Ma
 
nagement 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 15, Fair Value,
 
of the consolidated financial statements that accompany this report.
 
Fair values are based on active market prices of identical assets or
 
liabilities when available.
 
Comparable assets or
liabilities or a composite of comparable assets in active markets are
 
used when identical assets or liabilities do not have
readily available active market pricing.
 
However, some of the Company’s
 
assets or liabilities lack an available or
comparable trading market characterized by frequent transactions between
 
willing buyers and sellers. In these cases, fair
value is estimated using pricing models that use discounted cash
 
flows and other pricing techniques. Pricing models and
their underlying assumptions are based upon management’s
 
best estimates for appropriate discount rates, default rates,
prepayments, market volatility and other factors, taking into
 
account current observable market data and experience.
 
These assumptions may have a significant effect on the reported
 
fair values of assets and liabilities and the related income
and expense. As such, the use of different models and
 
assumptions, as well as changes in market conditions, could
 
result in
materially different net earnings and retained earnings
 
results.
 
 
Other Real Estate Owned
 
Other real estate owned (“OREO”), consists of properties obtained
 
through foreclosure or in satisfaction of loans and is
reported at the lower of cost or fair value, less estimated costs to
 
sell at the date acquired with any loss recognized as a
charge-off through the allowance for loan
 
losses. Additional OREO losses for subsequent valuation adjustments
 
are
determined on a specific property basis and are included as a
 
component of other noninterest expense along with holding
costs. Any gains or losses on disposal of OREO are also reflected
 
in noninterest expense. Significant judgments and
complex estimates are required in estimating the fair value of OREO, and
 
the period of time within which such estimates
can be considered current is significantly shortened during periods
 
of market volatility. As a
 
result, the net proceeds
realized from sales transactions could differ significantly
 
from appraisals, comparable sales, and other estimates used
 
to
determine the fair value of other OREO.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
50
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,
 
2020. 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
 
2020
2019
Average
Yield/
Average
Yield/
(Dollars in thousands)
Balance
Rate
Balance
Rate
Loans and loans held for sale
 
$
465,378
4.74%
$
474,259
4.83%
Securities - taxable
234,420
1.68%
178,410
2.24%
Securities - tax-exempt (a)
63,029
3.72%
66,628
3.99%
Total securities
297,449
2.11%
245,038
2.72%
Federal funds sold
30,977
0.41%
20,223
2.09%
Interest bearing bank deposits
56,104
0.41%
36,869
2.16%
Total interest-earning assets
849,908
3.38%
776,389
3.97%
Deposits:
 
 
NOW
154,431
0.34%
134,430
0.53%
Savings and money market
242,485
0.44%
218,630
0.44%
Certificates of deposits
165,120
1.36%
170,835
1.46%
Total interest-bearing deposits
562,036
0.68%
523,895
0.80%
Short-term borrowings
1,864
0.48%
1,443
0.49%
Total interest-bearing liabilities
563,900
0.68%
525,338
0.80%
Net interest income and margin (a)
$
24,830
2.92%
$
26,621
3.43%
(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 $24.8 million in 2020,
 
compared to $26.6 million in 2019.
 
This decrease was due
to a decline in the Company’s net interest
 
margin (tax-equivalent).
 
 
The tax-equivalent yield on total interest-earning assets decreased
 
by 59 basis points in 2020 from 2019 to 3.38%.
 
This
decrease was primarily due to the lower rate environment, including
 
a 150 basis point reduction in the federal funds rate
that occurred in March 2020 and changes in our asset mix from the
 
significant short-term liquidity increase in customer
deposits.
 
 
The cost of total interest-bearing liabilities decreased 12 basis points
 
in 2020 from 2019 to 0.68%.
Such costs declined less
than the declines in 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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
51
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 provision for loan losses was $1.1 million
 
in 2020, compared to a negative provision for loan losses
of $0.3 million in 2019. The increase in the provision for loan losses
 
was related to adverse changes in economic conditions
and portfolio trends driven by the impact of COVID-19 pandemic, including
 
higher unemployment 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 1.22% at December
 
31, 2020, compared to 0.95% at December 31, 2019.
At December 31, 2020, the Company’s
 
allowance for loan losses was 1.27% of total loans, excluding
 
PPP loans. 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)
2020
2019
Service charges on deposit accounts
$
585
$
717
Mortgage lending
2,319
866
Bank-owned life insurance
724
437
Gain from loan guarantee program
1,717
Securities gains (losses), net
103
(123)
Other
1,644
1,880
Total noninterest income
$
5,375
$
5,494
 
The decrease in service charges on deposit accounts
 
was driven by a decline in consumer spending activity as a result of
 
the
COVID-19 pandemic.
 
The Company’s income from mortgage
 
lending is primarily attributable to the (1) origination and sale
 
of new mortgage
loans and (2) servicing of mortgage loans. Origination income, net, is
 
comprised of gains or losses from the sale of the
mortgage loans originated, origination fees, underwriting fees and
 
other fees associated with the origination of loans, which
are netted against the commission expense associated with these
 
originations. The Company’s normal
 
practice is to
originate mortgage loans for sale in the secondary market and
 
to either sell or retain the MSRs when the loan is sold.
 
 
MSRs are recognized based on the fair value of the servicing
 
right on the date the corresponding mortgage loan is sold.
 
Subsequent to the date of transfer, the Company
 
has elected to measure its MSRs under the amortization method.
 
Servicing
fee income is reported net of any related amortization expense.
 
 
The Company evaluates MSRs for impairment on a quarterly basis.
 
Impairment is determined by grouping MSRs by
common predominant characteristics, such as interest rate and loan
 
type.
 
If the aggregate carrying amount of a particular
group of MSRs exceeds the group’s aggregate
 
fair value, a valuation allowance for that group is established.
 
The valuation
allowance is adjusted as the fair value changes.
 
An increase in mortgage interest rates typically results in an increase in
 
the
fair value of the MSRs while a decrease in mortgage interest rates
 
typically results in a decrease in the fair value of MSRs.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
52
The following table presents a breakdown of the Company’s
 
mortgage lending income for 2020 and 2019.
Year ended December 31
(Dollars in thousands)
2020
2019
Origination income
$
2,300
$
545
Servicing fees, net
19
321
Total mortgage lending income
$
2,319
$
866
 
The increase in mortgage lending income was primarily due to
 
an increase in mortgage refinance activity.
 
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. The increase in mortgage
 
lending income was partially offset by a decrease in
servicing fees, net of related amortization expense as prepayment
 
speeds increased during 2020, resulting in increased
amortization expense.
 
 
Income from bank-owned life insurance increased 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.
 
 
In 2019, the Company recognized a gain of $1.7 million resulting
 
from the termination of a Loan Guarantee Program (the
"Program") operated by the State of Alabama.
 
For more information regarding the Program, please refer
 
to Note 5, Loans
and Allowance for Loan Losses, of the consolidated financial
 
statements that accompany this report.
 
The decrease in other noninterest income was primarily due to
 
a $0.3 million pre-tax gain from an insurance recovery
received in the first quarter of 2019.
 
 
Noninterest Expense
Year ended December 31
(Dollars in thousands)
2020
2019
Salaries and benefits
$
11,316
$
11,931
Net occupancy and equipment
2,511
1,907
Professional fees
1,052
1,014
FDIC and other regulatory assessments
256
181
Other
4,419
4,664
Total noninterest expense
$
19,554
$
19,697
 
The decrease in salaries and benefits expense was primarily due
 
to lower full-time equivalent employees, incentive accruals
and an increase in deferred costs related to the PPP
 
loan program.
 
 
The increase in net occupancy and equipment expense was primarily
 
due to 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.
 
Income Tax
 
Expense
 
Income tax expense was $1.6 million in 2020 compared to
 
$2.4 million in 2019.
 
The Company’s effective
 
income tax rate
was 17.72%
 
in 2020, compared to 19.57% in 2019.
 
This change was primarily due to a decrease in the level of earnings
before taxes relative to tax-exempt sources of income. The Company’s
 
effective income tax rate is principally impacted
 
by
tax-exempt earnings from the Company’s
 
investments in municipal securities and bank-owned life insurance.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
53
BALANCE SHEET ANALYSIS
 
Securities
 
 
Securities available-for-sale were $335.2
 
million at December 31, 2020, compared to $235.9 million at December
 
31, 2019.
 
This increase reflects an increase in the amortized cost basis
 
of securities available-for-sale of $91.9 million, and
 
an
increase of $7.4 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
 
increase in the fair value of securities was primarily due to a
decrease in long-term interest rates. The average annualized
 
tax-equivalent yields earned on total securities were 2.11%
 
in
2020 and 2.72% in 2019.
 
The following table shows the carrying value and weighted average
 
yield of securities available-for-sale as of December
31, 2020 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, 2020
1 year
 
1 to 5
5 to 10
 
After 10
Total
 
(Dollars in thousands)
or less
years
years
years
Fair Value
Agency obligations
$
5,048
24,834
55,367
12,199
97,448
Agency MBS
1,154
20,502
141,814
163,470
State and political subdivisions
477
632
8,405
64,745
74,259
Total available-for-sale
$
5,525
26,620
84,274
218,758
335,177
Weighted average yield:
Agency obligations
1.59%
1.84%
1.51%
1.22%
1.56%
Agency MBS
3.31%
1.67%
1.42%
1.46%
State and political subdivisions
4.01%
4.13%
2.32%
2.81%
2.77%
Total available-for-sale
1.80%
1.95%
1.63%
1.82%
1.78%
 
Loans
December 31
(In thousands)
2020
2019
2018
2017
2016
Commercial and industrial
$
82,585
56,782
63,467
59,086
49,850
Construction and land development
33,514
32,841
40,222
39,607
41,650
Commercial real estate
 
255,136
270,318
261,896
239,033
220,439
Residential real estate
84,154
92,575
102,597
106,863
110,855
Consumer installment
7,099
8,866
9,295
9,588
8,712
Total loans
462,488
461,382
477,477
454,177
431,506
Less:
 
unearned income
(788)
(481)
(569)
(526)
(560)
Loans, net of unearned income
$
461,700
460,901
476,908
453,651
430,946
 
Total loans, net of unearned
 
income, were $461.7 million at December 31, 2020
 
,
 
and $460.9 million at December 31, 2019.
 
Excluding PPP loans, total loans, net of unearned income, were
 
$442.7 million, a decrease of $18.2 million, or 4% from
December 31, 2019.
 
This decrease was primarily due to a decrease in commercial
 
real estate loans and residential real
estate loans of $15.2 million and $8.4 million, respectively,
 
as lower rates increased refinance activity and payoffs for
multi-family residential and consumer mortgage loans.
 
Four loan categories represented the majority of the
 
loan portfolio
at December 31, 2020: commercial real estate (55%), residential real
 
estate (18%), commercial and industrial (18%) and
construction and land development (7%).
 
Approximately 21% of the Company’s
 
commercial real estate loans were
classified as owner-occupied at December 31, 2020.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
54
Within the residential real estate portfolio
 
segment, the Company had junior lien mortgages of approximately $8.7
 
million,
or 2%, and $10.8 million, or 2%, of total loans, net of unearned
 
income at December 31, 2020 and 2019, respectively.
 
For
residential real estate mortgage loans with a consumer purpose,
 
the Company had no loans that required interest only
payments at December 31, 2020,
 
compared to approximately $0.8 million at December 31, 2019.
 
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 4.74%
 
in 2020 and 4.83% in 2019.
 
 
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 flo
 
ws, 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 $20.4 million. Furthermore, we have an internal
 
limit for aggregate credit exposure (loans outstanding plus
unfunded commitments) to a single borrower of $18.3
 
million. Our loan policy requires that the Loan Committee of the
Board of Directors approve any loan relationships that exceed
 
this internal limit. At December 31, 2020,
 
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, 2020 (and related balances
 
at December 31, 2019).
 
 
December 31
(In thousands)
2020
2019
Lessors of 1-4 family residential properties
$
49,127
$
43,652
Hotel/motel
42,900
43,719
Multi-family residential properties
40,203
44,839
Shopping centers
30,000
30,407
 
Supplemental COVID-19 Industry Exposure
 
We have identified
 
certain commercial sectors with enhanced risk resulting from
 
the impact of COVID-19.
 
Loans within
these sectors represent 86% of the Company’s
 
total COVID-19 related modifications at December 31,
 
2020.
 
The table
below summarizes the loans outstanding for these sectors at December
 
31, 2020.
 
Portfolio Segment
(Dollars in
 
thousands)
Commercial and
industrial
Construction and
land development
Commercial real
estate
Total
% of Total Loans
December 31, 2020:
Hotel/motel
$
866
10,549
42,900
$
54,315
12
%
Shopping centers
8
30,000
30,008
6
Retail, excluding shopping centers
327
18,053
18,380
4
Restaurants
1,407
12,865
14,272
3
Total
$
2,608
10,549
103,818
$
116,975
25
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
55
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 nine-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, 2020 we have granted loan payment deferrals
 
or payments of interest-only primarily on commercial and
industrial and commercial real estate loans totaling $32.3
 
million, or 7% of total loans.
 
This was a decline from $87.1
million, or 18% of total loans at September 30, 2020
 
and $112.7 million, or 24% of total loans at June 30,
 
2020.
 
The tables
below provide information concerning the composition of these
 
COVID-19 modifications as of December 31, 2020, all of
which represent second deferral requests.
 
COVID-19 Modifications
Modification Types
(Dollars in thousands)
# of Loans
Modified
Balance
% of Portfolio
Modified
Interest Only
Payment
P&I
 
Payments
Deferred
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 Segments
(Dollars in thousands)
# of Loans
Modified
Balance of
Loans Modified
% of Total
Segment Loans
Hotel/motel
10
$
26,427
49
%
Restaurants
1
1,442
10
 
Section 4013 of the CARES Act provides that a qualified loan modification
 
is exempt by law from classification as a TDR
pursuant to GAAP.
 
In addition, the Interagency Statement on COVID-19 Loan Modifications
 
provides circumstances in
which a loan modification is not subject to classification as a TDR
 
if such loan is not eligible for modification under
Section 4013.
 
 
Allowance for Loan Losses
 
 
The Company maintains the allowance for loan losses at a level
 
that management believes appropriate to adequately cover
the Company’s estimate of probable
 
losses inherent in the loan portfolio. The allowance for loan losses was $5.
 
6
 
million at
December 31, 2020 compared to $4.4 million at December 31,
 
2019, 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.”
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
56
A summary of the changes in the allowance for loan losses and certain
 
asset quality ratios for each of the five years in the
five year period ended December 31, 2020 is presented below.
 
Year ended December 31
(Dollars in thousands)
2020
2019
2018
2017
2016
Allowance for loan losses:
Balance at beginning of period
$
4,386
4,790
4,757
4,643
4,289
Charge-offs:
Commercial and industrial
(7)
(364)
(52)
(449)
(97)
Commercial real estate
 
(38)
(194)
Residential real estate
 
(6)
(26)
(107)
(182)
Consumer installment
(38)
(38)
(52)
(40)
(67)
Total charge
 
-offs
(45)
(408)
(168)
(596)
(540)
Recoveries:
Commercial and industrial
94
117
70
461
29
Construction and land development
347
1,212
Commercial real estate
 
1
19
Residential real estate
 
63
109
79
115
127
Consumer installment
20
27
33
87
11
Total recoveries
177
254
201
1,010
1,379
Net recoveries (charge-offs)
132
(154)
33
414
839
Provision for loan losses
1,100
(250)
(300)
(485)
Ending balance
$
5,618
4,386
4,790
4,757
4,643
as a % of loans
1.22
%
0.95
1.00
1.05
1.08
as a % of nonperforming loans
1,052
%
2,345
2,691
160
196
Net (recoveries) charge-offs as a % of
 
average loans
(0.03)
%
0.03
(0.01)
(0.09)
(0.19)
 
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 1.22
 
%
 
at December 31,
 
2020, compared to 0.95% at December 31,
2019.
 
At December 31, 2020, the Company’s
 
allowance for loan losses was 1.27% of total loans, excluding PPP
 
loans.
 
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, 2020 the Company had $0.5 million in nonperforming
 
assets compared
 
to $0.2 million at December 31,
2019.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
57
The table below provides information concerning total nonperforming
 
assets and certain asset quality ratios.
 
December 31
(Dollars in thousands)
2020
2019
2018
2017
2016
Nonperforming assets:
Nonperforming (nonaccrual) loans
$
534
187
178
2,972
2,370
Other real estate owned
172
152
Total
 
nonperforming assets
$
534
187
350
2,972
2,522
as a % of loans and other real estate owned
0.12
%
0.04
0.07
0.66
0.59
as a % of total assets
0.06
%
0.02
0.04
0.35
0.30
Nonperforming loans as a % of total loans
0.12
%
0.04
0.04
0.66
0.55
Accruing loans 90 days or more past due
$
141
 
The table below provides information concerning the composition
 
of nonaccrual loans at December 31, 2020
 
and 2019,
respectively.
 
December 31
(In thousands)
2020
2019
Nonaccrual loans:
Commercial real estate
$
212
Residential real estate
322
187
Total nonaccrual loans / nonperforming
 
loans
$
534
187
 
The Company discontinues the accrual of interest income when (1)
 
there is a significant deterioration in the financial
condition of the borrower and full repayment of principal and
 
interest is not expected or (2) the principal or interest is more
than 90 days past due, unless the loan is both well-secured
 
and in the process of collection. At December 31, 2020
 
and
2019, respectively, the Company
 
had $0.5 million and $0.2 million in loans on nonaccrual.
 
At December 31, 2020 there were $0.1 million in loans 90 days
 
past due and still accruing interest, compared to none at
December 31, 2019.
 
 
Other Real Estate Owned
 
At December 31, 2020 and 2019, respectively,
 
the Company held no OREO properties acquired from borrowers.
 
 
Potential Problem Loans
 
 
Potential problem loans represent those loans with a well-defined
 
weakness and where information about possible credit
problems of borrowers has caused management to have serious doubts
 
about the borrower’s ability to comply with present
repayment terms.
 
This definition is believed to be substantially consistent with the
 
standards established by the Federal
Reserve, the Company’s primary regulator,
 
for loans classified as substandard, excluding nonaccrual loans.
 
Potential
problem loans, which are not included in nonperforming assets,
 
amounted to $2.9 million, or 1.0% of total loans at
December 31, 2020, compared to $4.4 million, or 1.0% of
 
total loans at December 31, 2019.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
58
The table below provides information concerning the composition
 
of potential problem loans at December 31, 2020
 
and
2019, respectively.
 
December 31
(In thousands)
2020
2019
Potential problem loans:
Commercial and industrial
$
218
266
Construction and land development
254
1,043
Commercial real estate
188
99
Residential real estate
2,229
2,899
Consumer installment
23
64
Total potential problem loans
$
2,912
4,371
 
At December 31, 2020, approximately $0.9 million or 30.3%
 
of total potential problem loans were past due at least 30 but
less than 90 days.
 
 
The following table is a summary of the Company’s
 
performing loans that were past due at least 30 days but
 
less than
90 days as of December 31, 2020 and 2019, respectively.
 
December 31
(In thousands)
2020
2019
Performing loans past due 30 to 89 days:
Commercial and industrial
$
230
24
Construction and land development
61
456
Commercial real estate
29
 
Residential real estate
1,509
1,608
Consumer installment
29
64
Total performing loans past due
 
30 to 89 days
$
1,858
2,152
 
Deposits
December 31
(In thousands)
2020
2019
Noninterest bearing demand
$
245,398
196,218
NOW
155,870
138,315
Money market
199,937
160,934
Savings
78,187
61,486
Certificates of deposit under $100,000
54,920
59,516
Certificates of deposit and other time deposits of $100,000
 
or more
105,481
107,683
Total deposits
$
839,793
724,152
 
Total deposits increased
 
$115.6 million, or 16%, to $839.8
 
million at December 31, 2020,
 
compared to $724.2 million at
December 31, 2019. Noninterest-bearing deposits were $245.4
 
million, or 29% of total deposits, at December 31, 2020,
compared to $196.2 million, or 27% of total deposits at December
 
31, 2019. These increases reflect deposits from
customers who received PPP loans, the impact of government stimulus
 
checks, delayed tax payments and reduced customer
spending during the COVID-19 pandemic.
 
The average rates paid on total interest-bearing deposits were
 
0.68% in 2020 and 0.80% in 2019.
 
 
 
 
59
Other Borrowings
 
 
Other borrowings generally consist of short-term borrowings
 
and long-term debt.
 
Short-term borrowings generally consist
of federal funds purchased and securities sold under agreements
 
to repurchase with an original maturity of one year
 
or less.
 
The Bank had available federal fund lines totaling $41.0 million
 
with none outstanding at December 31, 2020 and 2019,
respectively. Securities sold
 
under agreements to repurchase totaled $2.4 million and $1.1
 
million at December 31, 2020
and 2019, respectively.
 
The average rates paid on short-term borrowings was 0.48%
 
and 0.49% in 2020 and 2019, respectively.
 
Information
concerning the average balances, weighted average rates, and
 
maximum amounts outstanding for short-term borrowings
during the two-year period ended December 31, 2020 is included
 
in Note 9 to the accompanying consolidated financial
statements included in this annual report.
The Company had no long-term debt outstanding at December
 
31, 2020 and 2019, respectively.
 
CAPITAL ADEQUACY
 
 
The Company's consolidated stockholders' equity was $107.7
 
million and $98.3 million as of December 31, 2020 and
 
2019,
respectively.
 
The increase from December 31, 2019 was primarily driven
 
by net earnings of $7.5 million and other
comprehensive income due to the change in unrealized gains
 
on securities available-for-sale, net of tax, of $5.5
 
million,
which was partially offset by cash dividends paid of $3.6
 
million.
 
On January 1, 2015, the Company and Bank became subject
 
to the rules of the Basel III regulatory capital framework and
related Dodd-Frank Wall
 
Street Reform and Consumer Protection Act changes. The
 
rules included the implementation of a
capital conservation buffer that is added to
 
the minimum requirements for capital adequacy purposes. The capital
conservation buffer was subject
 
to a three year phase-in period that began on January 1, 2016
 
and was fully phased-in on
January 1, 2019 at 2.5%. A banking organization with a
 
conservation buffer of less than the required
 
amount will be subject
to limitations on capital distributions, including dividend payments
 
and certain discretionary bonus payments to executive
officers. At December 31, 2020,
 
the Bank’s ratio was sufficient
 
to meet the fully phased-in conservation buffer.
 
Effective March 20, 2020, the Federal Reserve and
 
the other federal banking regulators adopted an interim final rule that
amended the capital conservation buffer.
 
The interim final rule was adopted as a final rule on August
 
26, 2020. The new
rule revises the definition of “eligible retained income” for purposes
 
of the maximum payout ratio to allow banking
organizations to more freely use their capital buffers
 
to promote lending and other financial intermediation activities,
 
by
making the limitations on capital distributions more gradual.
 
The eligible retained income is now the greater of (i) net
income for the four preceding quarters, net of distributions and
 
associated tax effects not reflected in net income; and
 
(ii)
the average of all net income over the preceding four quarters.
 
The interim final rule only affects the capital buffers,
 
and
banking organizations were encouraged to make prudent
 
capital distribution decisions.
 
 
 
The Federal Reserve has treated us as a “small bank holding company’
 
under the Federal Reserve’s policy.
 
Accordingly,
our capital adequacy is evaluated at the Bank level, and not for
 
the Company and its consolidated subsidiaries. The Bank’s
tier 1 leverage ratio was 10.32%, CET1 risk-based capital ratio
 
was 17.27%, tier 1 risk-based capital ratio was 17.27%, and
total risk-based capital ratio was 18.31%
 
at December 31, 2020.
 
These ratios exceed the minimum regulatory capital
percentages of 5.0% for tier 1 leverage ratio, 6.5% for CET1
 
risk-based capital ratio, 8.0% for tier 1 risk-based capital ratio,
and 10.0% for total risk-based capital ratio to be considered
 
“well capitalized.” The Bank’s
 
capital conservation buffer was
10.31%
 
at December 31, 2020.
 
 
 
60
MARKET AND LIQUIDITY RISK MANAGEMENT
 
Management’s objective is to manage
 
assets and liabilities to provide a satisfactory,
 
consistent level of profitability within
the framework of established liquidity,
 
loan, investment, borrowing, and capital policies. The
 
Bank’s Asset Liability
Management Committee (“ALCO”) is charged with
 
the responsibility of monitoring these policies, which are designed
 
to
ensure an acceptable asset/liability composition. Two
 
critical areas of focus for ALCO are interest rate risk and liquidity
risk management.
 
Interest Rate Risk Management
 
In the normal course of business, the Company is exposed to
 
market risk arising from fluctuations in interest rates because
assets and liabilities may mature or reprice at different times.
 
For example, if liabilities reprice faster than assets, and
interest rates are generally rising, earnings will initially decline.
 
In addition, assets and liabilities may reprice at the same
time but by different amounts. For example, when the general
 
level of interest rates is rising, the Company may increase
rates paid on interest bearing demand deposit accounts and savings
 
deposit accounts by an amount that is less than the
general increase in market interest rates. Also, short-term and
 
long-term market interest rates may change by different
amounts. For example, a flattening yield curve may reduce the
 
interest spread between new loan yields and funding costs.
Further, the remaining maturity of various assets
 
and liabilities may shorten or lengthen as interest rates change.
 
For
example, if long-term mortgage interest rates decline sharply,
 
mortgage-backed securities in the securities portfolio may
prepay earlier than anticipated, which could reduce earnings.
 
Interest rates may also have a direct or indirect effect on loan
demand, loan losses, mortgage origination volume, the fair value of
 
MSRs and other items affecting earnings.
 
ALCO measures and evaluates the interest rate risk so that we can meet customer
 
demands for various types of loans and
deposits. ALCO determines the most appropriate amounts of
 
on-balance sheet and off-balance sheet items. Measurements
used to help manage interest rate sensitivity include an earnings simulation
 
and an economic value of equity model.
 
Earnings simulation
. Management believes that interest rate risk is best estimated by our
 
earnings simulation modeling.
On at least a quarterly basis, the following 12 month time period
 
is simulated to determine a baseline net interest income
forecast and the sensitivity of this forecast to changes in interest rates.
 
The baseline forecast assumes an unchanged or flat
interest rate environment. Forecasted levels of earning assets,
 
interest-bearing liabilities, and off-balance sheet financial
instruments are combined with ALCO forecasts of market interest rates
 
for the next 12 months and other factors in order to
produce various earnings simulations and estimates.
 
To help limit interest rate
 
risk, we have guidelines for earnings at risk which seek to
 
limit the variance of net interest
income from gradual changes in interest rates.
 
For changes up or down in rates from management’s
 
flat interest rate
forecast over the next 12 months, policy limits for net interest income
 
variances are as follows:
 
+/- 20% for a gradual change of 400 basis points
 
+/- 15% for a gradual change of 300 basis points
 
+/- 10% for a gradual change of 200 basis points
 
+/- 5% for a gradual change of 100 basis points
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
61
The following table reports the variance of net interest income over the next
 
12 months assuming a gradual change in
interest rates up or down when compared to the baseline net
 
interest income forecast at December 31, 2020.
 
Changes in Interest Rates
Net Interest Income % Variance
 
400 basis points
(2.42)
%
 
300 basis points
(2.27)
 
200 basis points
(1.67)
 
100 basis points
(0.86)
 
(100) basis points
2.34
 
(200) basis points
NM
 
(300) basis points
NM
 
(400) basis points
NM
NM=not meaningful
 
At December 31, 2020, our earnings simulation model indicated
 
that we were in compliance with the policy guidelines
noted above.
 
Economic Value
 
of Equity
 
 
Economic value of equity (“EVE”) measures the extent that estimated
 
economic values of our assets, liabilities and off-
balance sheet items will change as a result of interest rate changes.
 
Economic values are estimated by discounting expected
cash flows from assets, liabilities and off-balance sheet items,
 
which establishes a base case EVE. In contrast with our
earnings simulation model which evaluates interest rate risk over
 
a 12 month timeframe, EVE uses a terminal horizon
which allows for the re-pricing of all assets, liabilities, and off
 
-balance sheet items. Further, EVE
 
is measured using values
as of a point in time and does not reflect any actions that ALCO
 
might take in responding to or anticipating changes in
interest rates, or market and competitive conditions.
 
To help limit interest rate
 
risk, we have stated policy guidelines for an instantaneous
 
basis point change in interest rates,
such that our EVE should not decrease from our base case by more
 
than the following:
 
45% for an instantaneous change of +/-
 
400 basis points
 
35% for an instantaneous change of +/-
 
300 basis points
 
25% for an instantaneous change of +/-
 
200 basis points
 
15% for an instantaneous change of +/-
 
100 basis points
 
The following table reports the variance of EVE assuming an immediate
 
change in interest rates up or down when
compared to the baseline EVE at December 31, 2020.
 
Changes in Interest Rates
EVE % Variance
 
400 basis points
(22.20)
%
 
300 basis points
(15.00)
 
200 basis points
(8.25)
 
100 basis points
(2.63)
 
(100) basis points
1.17
 
(200) basis points
NM
 
(300) basis points
NM
 
(400) basis points
NM
NM=not meaningful
 
At December 31, 2020, our EVE model indicated that we were
 
in compliance with the policy guidelines noted above.
 
 
 
62
Each of the above analyses may not, on its own, be an accurate
 
indicator of how our net interest income will be affected
 
by
changes in interest rates. Income associated with interest-earning assets
 
and costs associated with interest-bearing liabilities
may not be affected uniformly by changes in interest rates.
 
In addition, the magnitude and duration of changes in interest
rates may have a significant impact on net interest income. For
 
example, although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different
 
degrees to changes in market interest rates, and other
economic and market factors, including market perceptions. Interest
 
rates on certain types of assets and liabilities fluctuate
in advance of changes in general market rates, while interest
 
rates on other types of assets and liabilities may lag behind
changes in general market rates. In addition, certain assets, such as
 
adjustable rate mortgage loans, have features (generally
referred to as “interest rate caps and floors”) which limit changes
 
in interest rates. Prepayment and early withdrawal levels
also could deviate significantly from those assumed in calculating the maturity
 
of certain instruments. The ability of many
borrowers to service their debts also may decrease during periods
 
of rising interest rates or economic stress, which may
differ across industries and economic sectors. ALCO reviews
 
each of the above interest rate sensitivity analyses along with
several different interest rate scenarios in seeking satisfactory,
 
consistent levels of profitability within the framework of the
Company’s established liquidity,
 
loan, investment, borrowing, and capital policies.
 
The Company may also use derivative financial instruments
 
to improve the balance between interest-sensitive assets and
interest-sensitive liabilities and as one tool to manage interest rate
 
sensitivity while continuing to meet the credit and
deposit needs of our customers. From time to time, the Company
 
may enter into interest rate swaps (“swaps”) to facilitate
customer transactions and meet their financing needs. These
 
swaps qualify as derivatives, but are not designated as hedging
instruments. At December 31, 2020 and 2019, the Company had
 
no derivative contracts to assist in managing interest rate
sensitivity.
 
Liquidity Risk Management
 
 
Liquidity is the Company’s ability
 
to convert assets into cash equivalents in order
 
to meet daily cash flow requirements,
primarily
 
for deposit withdrawals, loan demand and maturing obligations.
 
Without proper management of its liquidity,
 
the
Company could experience higher costs of obtaining funds due to
 
insufficient liquidity, while
 
excessive liquidity can lead
to a decline in earnings due to the cost of foregoing alternative
 
higher-yielding investment opportunities.
 
Liquidity is managed at two levels. The first is the liquidity of
 
the Company. The second
 
is the liquidity of the Bank. The
management of liquidity at both levels is essential, because the Company
 
and the Bank are separate and distinct legal
entities with different funding needs and sources, and each
 
are subject to regulatory guidelines and requirements. The
Company depends upon dividends from the Bank for liquidity to
 
pay its operating expenses, debt obligations and
dividends. The Bank’s payment of
 
dividends depends on its earnings, liquidity,
 
capital and the absence of any regulatory
restrictions.
 
The primary source of funding and liquidity for the Company has
 
been dividends received from the Bank. If needed, the
Company could also issue common stock or other securities. Primary uses
 
of funds by the Company include dividends paid
to stockholders and stock repurchases.
 
Primary sources of funding for the Bank include customer deposits,
 
other borrowings, repayment and maturity of securities,
and sale and repayment of loans.
 
The Bank has access to federal funds lines from various banks
 
and borrowings from the
Federal Reserve discount window.
 
In addition to these sources, the Bank has participated
 
in the FHLB's advance program
to obtain funding for its growth. Advances include both fixed
 
and variable terms and are taken out with varying maturities.
 
As of December 31,
 
2020, the Bank had a remaining available line of credit with the FHLB
 
totaling $281.4 million.
 
As of
December 31, 2020, the Bank also had $41.0 million of federal
 
funds lines, with none outstanding.
 
Primary uses of funds
include repayment of maturing obligations and growing the loan
 
portfolio.
 
 
 
 
 
 
 
 
 
 
 
 
63
The following table presents additional information about our
 
contractual obligations as of December 31, 2020, which by
their terms had contractual maturity and termination dates subsequent
 
to December 31, 2020:
 
Payments due by period
1 year
 
1 to 3
3 to 5
More than
(Dollars in thousands)
Total
or less
years
years
5 years
Contractual obligations:
Deposit maturities (1)
$
839,792
767,683
62,904
9,205
Operating lease obligations
811
103
201
206
301
Total
$
840,603
767,786
63,105
9,411
301
(1) Deposits with no stated maturity (demand, NOW, money market, and savings deposits) are presented in the "1
 
year or less" column
 
Management believes that the Company and the Bank have adequate
 
sources of liquidity to meet all known contractual
obligations and unfunded commitments, including loan commitments and
 
reasonable borrower, depositor,
 
and creditor
requirements over the next 12 months.
 
Off-Balance Sheet Arrangements
 
At December 31, 2020, the Bank had outstanding standby letters
 
of credit of $1.2 million and unfunded loan commitments
outstanding of $75.0 million. Because these commitments generally
 
have fixed expiration dates and many will expire
without being drawn upon, the total commitment level does not
 
necessarily represent future cash requirements. If needed
 
to
fund these outstanding commitments, the Bank has the ability to
 
liquidate federal funds sold or securities available-for-sale,
or on a short-term basis to borrow and purchase federal funds
 
from other financial institutions.
 
 
Residential mortgage lending and servicing activities
 
 
Since 2009, we have primarily sold residential mortgage loans in
 
the secondary market to Fannie Mae while retaining the
servicing of these loans. The sale agreements for these residential mortgage
 
loans with Fannie Mae and other investors
include various representations and warranties regarding the origination
 
and characteristics of the residential mortgage
loans. Although the representations and warranties vary among investors,
 
they typically cover ownership of the loan,
validity of the lien securing the loan, the absence of delinquent taxes
 
or liens against the property securing the loan,
compliance with loan criteria set forth in the applicable agreement,
 
compliance with applicable federal, state, and local
laws, among other matters.
 
 
As of December 31, 2020, the unpaid principal balance of residential
 
mortgage loans, which we have originated and sold,
but retained the servicing rights was $267.2 million. Although these
 
loans are generally sold on a non-recourse basis,
except for breaches of customary seller representations and
 
warranties, we may have to repurchase residential mortgage
loans in cases where we breach such representations or warranties or
 
the other terms of the sale, such as where we fail to
deliver required documents or the documents we deliver are defective.
 
Investors also may require the repurchase of a
mortgage loan when an early payment default underwriting review reveals
 
significant underwriting deficiencies, even if the
mortgage loan has subsequently been brought current. Repurchase demands
 
are typically reviewed on an individual loan by
loan basis to validate the claims made by the investor and to
 
determine if a contractually required repurchase event has
occurred. We
 
seek to reduce and manage the risks of potential repurchases or other claims
 
by mortgage loan investors
through our underwriting, quality assurance and servicing practices,
 
including good communications with our residential
mortgage investors.
 
The Company was not required to repurchase any loans during 2020
 
and 2019 as a result of representation and warranty
provisions contained in the Company’s
 
sale agreements with Fannie Mae, and had no pending repurchase
 
or make-whole
requests at December 31, 2020.
 
We service all residential
 
mortgage loans originated and sold by us to Fannie Mae. As servicer,
 
our primary duties are to:
(1) collect payments due from borrowers; (2) advance certain delinquent
 
payments of principal and interest; (3) maintain
and administer any hazard, title, or primary mortgage insurance policies
 
relating to the mortgage loans; (4) maintain any
required escrow accounts for payment of taxes and insurance
 
and administer escrow payments; and (5) foreclose on
defaulted mortgage loans or take other actions to mitigate the
 
potential losses to investors consistent with the agreements
governing our rights and duties as servicer.
 
 
 
64
The agreement under which we act as servicer generally specifies
 
a standard of responsibility for actions taken by us in
such capacity and provides protection against expenses and liabilities incurred
 
by us when acting in compliance with the
respective servicing agreements. However,
 
if we commit a material breach of our obligations as servicer,
 
we may be subject
to termination if the breach is not cured within a specified period
 
following notice. The standards governing servicing and
the possible remedies for violations of such standards are determined
 
by servicing guides issued by Fannie Mae as well as
the contract provisions established between Fannie Mae and
 
the Bank. Remedies could include repurchase of an affected
loan.
 
Although to date repurchase requests related to representation and
 
warranty provisions, and servicing activities have been
limited, it is possible that requests to repurchase mortgage loans may
 
increase in frequency if investors more aggressively
pursue all means of recovering losses on their purchased loans.
 
As of December 31, 2020, we believe that this exposure is
not material due to the historical level of repurchase requests
 
and loss trends, the results of our quality control reviews, and
the fact that 99% of our residential mortgage loans serviced for
 
Fannie Mae were current as of such date. We
 
maintain
ongoing communications with our investors and will continue
 
to evaluate this exposure by monitoring the level and number
of repurchase requests as well as the delinquency rates in our
 
investor portfolios.
 
Section 4021 of the CARES Act allows borrowers under 1-to
 
-4 family residential mortgage loans sold to Fannie Mae to
request forbearance to the servicer after affirming that
 
such borrower is experiencing financial hardships during the
COVID-19 emergency.
 
Except for vacant or abandoned properties, Fannie Mae servicers
 
may not initiate foreclosures on
similar procedures or related evictions or sales until December
 
31, 2020. The forbearance period has been extended,
generally, to March 31,
 
2021.
 
The Bank sells mortgage loans to Fannie Mae and services these on an
 
actual/actual basis.
As a result, the Bank is not obligated to make any advances to
 
Fannie Mae on principal and interest on such mortgage loans
where the borrower is entitled to forbearance.
 
Effects of Inflation and Changing Prices
 
 
The consolidated financial statements and related consolidated
 
financial data presented herein have been prepared in
accordance with GAAP and practices within the banking industry
 
which require the measurement of financial position and
operating results in terms of historical dollars without considering
 
the changes in the relative purchasing power of money
over time due to inflation. Unlike most industrial companies,
 
virtually all the assets and liabilities of a financial institution
are monetary in nature. As a result, interest rates have a more
 
significant impact on a financial institution’s
 
performance
than the effects of general levels of inflation.
 
 
 
 
65
CURRENT ACCOUNTING DEVELOPMENTS
 
The following ASU has been issued by the FASB
 
but is not yet effective.
 
 
 
ASU 2016-13,
Financial Instruments – Credit Losses (Topic
 
326):
 
Measurement of Credit Losses on
 
Financial
Instruments;
 
Information about this pronouncement is described in more detail
 
below.
 
ASU 2016-13,
Financial Instruments - Credit Losses (Topic
 
326): - Measurement of Credit
 
Losses on Financial
Instruments
, amends guidance on reporting credit losses for assets held at
 
amortized cost basis and available for sale debt
securities. For assets held at amortized cost basis, the new standard
 
eliminates the probable initial recognition threshold in
current GAAP and, instead, requires an entity to reflect its current estimate
 
of all expected credit losses using a broader
range of information regarding past events, current conditions and
 
forecasts assessing the collectability of cash flows. The
allowance for credit losses is a valuation account that is deducted
 
from the amortized cost basis of the financial assets to
present the net amount expected to be collected. For
 
available for sale debt securities, credit losses should be measured in a
manner similar to current GAAP,
 
however the new standard will require that credit losses be
 
presented as an allowance
rather than as a write-down. The new guidance affects entities
 
holding financial assets and net investment in leases that are
not accounted for at fair value through net income. The amendments
 
affect loans, debt securities, trade receivables, net
investments in leases, off-balance sheet credit exposures,
 
reinsurance receivables, and any other financial assets not
excluded from the scope that have the contractual right to receive
 
cash. For public business entities, the new guidance was
originally effective for annual and interim periods
 
in fiscal years beginning after December 15, 2019. The
 
Company has
developed an implementation team that is following a general
 
timeline. The team has been working with an advisory
consultant, with whom a third-party software license has been purchased.
 
The Company’s preliminary evaluation
 
indicates
the provisions of ASU No. 2016-13 are expected to impact the Company’s
 
consolidated financial statements, in particular
the level of the reserve for credit losses. The Company is continuin
 
g
 
to evaluate the extent of the potential impact and
expects that portfolio composition and economic conditions at
 
the time of adoption will be a factor.
 
On October 16, 2019,
the FASB approved
 
a previously issued proposal granting smaller reporting companies a postponement
 
of the required
implementation date for ASU 2016-13. The Company will now be
 
required to implement the new standard in January 2023,
with early adoption permitted in any period prior to that date.
 
 
 
 
 
 
 
 
 
 
 
 
 
66
Table 1
 
– Explanation of Non-GAAP Financial Measures
 
In addition to results presented in accordance with GAAP,
 
this annual report on Form 10-K includes certain designated net
interest income amounts presented on a tax-equivalent basis, a
 
non-GAAP financial measure, including the presentation of
total revenue and the calculation of the efficiency ratio.
 
The Company believes the presentation of net interest income
 
on a tax-equivalent basis provides comparability of net
interest income from both taxable and tax-exempt sources and
 
facilitates comparability within the industry.
 
Although the
Company believes these non-GAAP financial measures enhance
 
investors’ understanding of its business and performance,
these non-GAAP financial measures should not be considered
 
an alternative to GAAP.
 
The reconciliation of these non-
GAAP financial measures from GAAP to non-GAAP is presented below.
 
Year ended December 31
(In thousands)
2020
2019
2018
2017
2016
Net interest income (GAAP)
$
24,338
26,064
25,570
24,526
22,732
Tax-equivalent adjustment
492
557
613
1,205
1,276
Net interest income (Tax-equivalent)
$
24,830
26,621
26,183
25,731
24,008
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
67
Table 2
 
- Selected Financial Data
Year ended December 31
(Dollars in thousands, except per share amounts)
2020
2019
2018
2017
2016
Income statement
Tax-equivalent interest income (a)
$
28,686
30,804
29,859
29,325
28,092
Total interest expense
3,856
4,183
3,676
3,594
4,084
Tax equivalent net interest income (a)
24,830
26,621
26,183
25,731
24,008
Provision for loan losses
1,100
(250)
 
 
(300)
(485)
Total noninterest income
5,375
5,494
3,325
3,441
3,383
Total noninterest expense
19,554
19,697
17,874
16,784
15,348
Net earnings before income taxes and
 
tax-equivalent adjustment
9,551
12,668
11,634
12,688
12,528
Tax-equivalent adjustment
492
557
613
1,205
1,276
Income tax expense
1,605
2,370
2,187
3,637
3,102
Net earnings
$
7,454
9,741
8,834
7,846
8,150
Per share data:
Basic and diluted net earnings
 
$
2.09
2.72
2.42
2.15
2.24
Cash dividends declared
$
1.02
1.00
0.96
0.92
0.90
Weighted average shares outstanding
Basic and diluted
3,566,207
3,581,476
3,643,780
3,643,616
3,643,504
Shares outstanding
3,566,276
3,566,146
3,643,868
3,643,668
3,643,523
Book value
 
$
30.20
27.57
24.44
23.85
22.55
Common stock price
High
$
63.40
53.90
53.50
40.25
31.31
Low
24.11
30.61
28.88
30.75
24.56
Period-end
$
42.29
53.00
31.66
38.90
31.31
To earnings ratio
 
20.23
x
19.49
13.08
18.09
13.98
To book value
140
%
192
130
163
139
Performance ratios:
Return on average equity
 
7.12
%
10.35
10.14
9.17
9.65
Return on average assets
 
0.83
%
1.18
1.08
0.94
0.98
Dividend payout ratio
48.80
%
36.76
39.67
42.79
40.18
Average equity to average assets
11.63
%
11.39
10.63
10.30
10.14
Asset Quality:
Allowance for loan losses as a % of:
Loans
1.22
%
0.95
1.00
1.05
1.08
Nonperforming loans
1,052
%
2,345
2,691
160
196
Nonperforming assets as a % of:
Loans and other real estate owned
0.12
%
0.04
0.07
0.66
0.59
Total assets
0.06
%
0.02
0.04
0.35
0.30
Nonperforming loans as % of loans
0.12
%
0.04
0.04
0.66
0.55
Net (recoveries) charge-offs as a % of average loans
(0.03)
%
0.03
(0.01)
(0.09)
(0.19)
Capital Adequacy (c):
CET 1 risk-based capital ratio
17.27
%
17.28
16.49
16.42
16.44
Tier 1 risk-based capital ratio
17.27
%
17.28
16.49
16.98
17.00
Total risk-based capital ratio
18.31
%
18.12
17.38
17.91
17.95
Tier 1 leverage ratio
10.32
%
11.23
11.33
10.95
10.27
Other financial data:
Net interest margin (a)
2.92
%
3.43
3.40
3.29
3.05
Effective income tax rate
17.72
%
19.57
19.84
31.67
27.57
Efficiency ratio (b)
64.74
%
61.33
60.57
57.53
56.03
Selected period end balances:
Securities
$
335,177
235,902
239,801
257,697
243,572
Loans, net of unearned income
461,700
460,901
476,908
453,651
430,946
Allowance for loan losses
5,618
4,386
4,790
4,757
4,643
Total assets
956,597
828,570
818,077
853,381
831,943
Total deposits
839,792
724,152
724,193
757,659
739,143
Long-term debt
 
 
 
3,217
3,217
Total stockholders’ equity
107,689
98,328
89,055
86,906
82,177
(a) Tax-equivalent.
 
See "Table 1 - Explanation of Non-GAAP Financial Measures".
(b) Efficiency ratio is the result of noninterest expense divided by the
 
sum of noninterest income and tax-equivalent net interest income.
(c) Regulatory capital ratios presented are for the Company's
 
wholly-owned subsidiary, AuburnBank.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
68
 
Table 3
 
- Average
 
Balance and Net Interest Income Analysis
Year ended December 31
 
 
2020
2019
Interest
Interest
Average
Income/
Yield/
Average
Income/
Yield/
(Dollars in thousands)
Balance
Expense
Rate
Balance
Expense
Rate
Interest-earning assets:
 
 
Loans and loans held for sale (1)
$
465,378
$
22,055
4.74%
 
$
474,259
$
22,930
4.83%
 
Securities - taxable
234,420
3,932
1.68%
 
178,410
4,000
2.24%
 
Securities - tax-exempt (2)
63,029
2,343
3.72%
 
66,628
2,656
3.99%
 
Total securities
 
297,449
6,275
2.11%
 
245,038
6,656
2.72%
 
Federal funds sold
30,977
125
0.41%
 
20,223
423
2.09%
 
Interest bearing bank deposits
56,104
231
0.41%
 
36,869
795
2.16%
 
Total interest-earning assets
849,908
28,686
3.38%
 
776,389
30,804
3.97%
 
Cash and due from banks
13,727
14,037
Other assets
37,010
36,119
Total assets
$
900,645
$
826,545
Interest-bearing liabilities:
Deposits:
 
 
NOW
$
154,431
523
0.34%
 
$
134,430
710
0.53%
 
Savings and money market
242,485
1,071
0.44%
 
218,630
969
0.44%
 
Certificates of deposits
 
165,120
2,253
1.36%
 
170,835
2,497
1.46%
 
Total interest-bearing deposits
562,036
3,847
0.68%
 
523,895
4,176
0.80%
 
Short-term borrowings
1,864
9
0.48%
 
1,443
7
0.49%
 
Total interest-bearing liabilities
563,900
3,856
0.68%
 
525,338
4,183
0.80%
 
Noninterest-bearing deposits
227,127
 
203,828
 
Other liabilities
4,884
3,228
Stockholders' equity
104,734
 
94,151
 
Total liabilities and
and stockholders' equity
$
900,645
$
826,545
Net interest income and margin
$
24,830
2.92%
$
26,621
3.43%
 
 
 
(1) Average loan balances
 
are shown net of unearned income and loans on nonaccrual status
 
have been included
in the computation of average balances.
(2) Yields on tax-exempt securities
 
have been computed on a tax-equivalent basis using an income tax
 
rate
of 21%.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
69
Table 4
 
- Volume and
 
Rate Variance
 
Analysis
Years ended December 31, 2020 vs. 2019
Years ended December 31, 2019 vs. 2018
Net
Due to change in
Net
Due to change in
(Dollars in thousands)
Change
Rate (2)
Volume (2)
Change
Rate (2)
Volume (2)
Interest income:
 
 
 
 
 
 
Loans and loans held for sale
 
$
(875)
(455)
(420)
$
1,164
358
806
Securities - taxable
(68)
(1,010)
942
(51)
18
(69)
Securities - tax-exempt (1)
(313)
(180)
(133)
(265)
(88)
(177)
Total securities
 
(381)
(1,190)
809
(316)
(70)
(246)
Federal funds sold
(298)
(342)
44
(131)
46
(177)
Interest bearing bank deposits
(564)
(645)
81
228
109
119
Total interest income
$
(2,118)
(2,632)
514
$
945
443
502
Interest expense:
Deposits:
NOW
$
(187)
(255)
68
$
282
235
47
Savings and money market
102
(3)
105
114
124
(10)
Certificates of deposits
(244)
(166)
(78)
168
361
(193)
Total interest-bearing deposits
(329)
(424)
95
564
720
(156)
Short-term borrowings
2
2
(11)
(5)
(6)
Long-term debt
(46)
(46)
Total interest expense
(327)
(424)
97
507
715
(208)
Net interest income
$
(1,791)
(2,208)
417
$
438
(272)
710
 
(1) Yields on tax-exempt securities
 
have been computed on a tax-equivalent basis using an income
 
tax rate of 21%.
(2) Changes that are not solely a result of volume or rate have
 
been allocated to volume.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
70
Table 5
 
- Loan Portfolio Composition
December 31
(In thousands)
2020
2019
2018
2017
2016
Commercial and industrial
$
82,585
56,782
63,467
59,086
49,850
Construction and land development
33,514
32,841
40,222
39,607
41,650
Commercial real estate
255,136
270,318
261,896
239,033
220,439
Residential real estate
84,154
92,575
102,597
106,863
110,855
Consumer installment
7,099
8,866
9,295
9,588
8,712
Total loans
462,488
461,382
477,477
454,177
431,506
Less: unearned income
(788)
(481)
(569)
(526)
(560)
Loans, net of unearned income
461,700
460,901
476,908
453,651
430,946
Less: allowance for loan losses
(5,618)
(4,386)
(4,790)
(4,757)
(4,643)
Loans, net
$
456,082
456,515
472,118
448,894
426,303
 
 
 
 
 
 
 
 
 
 
 
 
 
71
Table 6
 
- Loan Maturities and Sensitivities to Changes in Interest
 
Rates
December 31, 2020
1 year
 
1 to 5
After 5
Adjustable
Fixed
(Dollars in thousands)
or less
years
years
Total
Rate
Rate
Total
Commercial and industrial
$
20,829
26,025
35,731
82,585
15,159
67,426
82,585
Construction and land development
25,461
6,160
1,893
33,514
19,915
13,599
33,514
Commercial real estate
19,534
109,706
125,896
255,136
4,798
250,338
255,136
Residential real estate
6,853
23,549
53,752
84,154
30,272
53,882
84,154
Consumer installment
1,981
4,595
523
7,099
62
7,037
7,099
Total loans
$
74,658
170,035
217,795
462,488
70,206
392,282
462,488
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
72
Table 7
 
- Allowance for Loan Losses and Nonperforming Assets
Year ended December 31
(Dollars in thousands)
2020
2019
2018
2017
2016
Allowance for loan losses:
Balance at beginning of period
$
4,386
4,790
4,757
4,643
4,289
Charge-offs:
Commercial and industrial
(7)
(364)
(52)
(449)
(97)
Commercial real estate
 
 
(38)
 
(194)
Residential real estate
 
(6)
(26)
(107)
(182)
Consumer installment
(38)
(38)
(52)
(40)
(67)
Total charge
 
-offs
(45)
(408)
(168)
(596)
(540)
Recoveries:
Commercial and industrial
94
117
70
461
29
Construction and land development
 
 
 
347
1,212
Commercial real estate
 
1
19
 
 
Residential real estate
63
109
79
115
127
Consumer installment
20
27
33
87
11
Total recoveries
177
254
201
1,010
1,379
Net recoveries (charge-offs)
132
(154)
33
414
839
Provision for loan losses
1,100
(250)
 
(300)
(485)
Ending balance
$
5,618
4,386
4,790
4,757
4,643
as a % of loans
1.22
%
0.95
1.00
1.05
1.08
as a % of nonperforming loans
1,052
%
2,345
2,691
160
196
Net (recoveries) charge-offs as % of average loans
(0.03)
%
0.03
(0.01)
(0.09)
(0.19)
Nonperforming assets:
Nonaccrual/nonperforming loans
$
534
187
178
2,972
2,370
Other real estate owned
 
 
172
 
152
Total nonperforming assets
$
534
187
350
2,972
2,522
as a % of loans and other real estate owned
0.12
%
0.04
0.07
0.66
0.59
as a % total assets
0.06
%
0.02
0.04
0.35
0.30
Nonperforming loans as a % of total loans
0.12
%
0.04
0.04
0.66
0.55
Accruing loans 90 days or more past due
$
141
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
73
Table 8
 
- Allocation of Allowance for Loan Losses
December 31
2020
2019
2018
2017
2016
(Dollars in thousands)
Amount
%*
Amount
%*
Amount
%*
Amount
%*
Amount
%*
Commercial and industrial
$
807
17.9
$
577
12.3
$
778
13.3
$
653
13.0
$
540
11.6
Construction and
land development
594
7.2
569
7.1
700
8.4
734
8.7
812
9.7
Commercial real estate
3,169
55.2
2,289
58.6
2,218
54.9
2,126
52.7
2,071
51.0
Residential real estate
944
18.2
813
20.1
946
21.5
1,071
23.5
1,107
25.7
Consumer installment
104
1.5
138
1.9
148
1.9
173
2.1
113
2.0
Total allowance for loan losses
$
5,618
$
4,386
$
4,790
$
4,757
$
4,643
* Loan balance in each category expressed as a percentage of total loans.
 
 
 
 
 
 
 
 
 
 
 
 
74
Table 9
 
- CDs and Other Time Deposits of $100,000
 
or More
(Dollars in thousands)
December 31, 2020
Maturity of:
3 months or less
$
6,417
Over 3 months through 6 months
7,965
Over 6 months through 12 months
42,978
Over 12 months
48,121
Total CDs and other
 
time deposits of $100,000 or more
$
105,481
 
 
75
ITEM 7A.
 
QUANTITATIVE
 
AND QUALITATIVE
 
DISCLOSURES ABOUT MARKET RISK
 
The information called for by ITEM 7A is set forth in ITEM
 
7 under the caption “Market and Liquidity Risk Management”
and is incorporated herein by reference.
 
ITEM 8.
 
FINANCIAL STATEMENTS
 
AND SUPPLEMENTARY
 
DATA
 
 
aubn-20201231p76i0.gif
 
 
76
 
 
 
Report of Independent Registered Public Accounting
 
Firm
 
 
The Board of Directors and Stockholders
Auburn National Bancorporation, Inc.
 
 
Opinion on the Financial Statements
We have
 
audited the accompanying
 
consolidated balance
 
sheets of Auburn
 
National Bancorporation,
 
Inc. and its
subsidiaries (the
 
“Company”)
 
as of
 
December 31,
 
2020 and
 
2019,
 
the related
 
consolidated statements
 
of earnings
 
,
comprehensive income, stockholders’ equity,
 
and cash flows for the years then ended,
 
and the related notes to the
consolidated financial
 
statements and
 
schedules (collectively,
 
the “financial
 
statements”). In
 
our opinion,
 
the financial
statements present fairly,
 
in all material
 
respects, the financial
 
position of the
 
Company as of
 
December 31, 20
 
20 and
2019,
 
and the results of
 
its operations and its
 
cash flows for the
 
years then ended, in
 
conformity with accounting principles
generally accepted in the United States of America.
 
Basis for Opinion
These financial statements are the
 
responsibility of the Comp
 
any’s management. Our
 
responsibility is to express an opinion
on the Company’s
 
consolidated financial
 
statements based on
 
our audits. We
 
are a public
 
accounting firm registered
 
with
the Public Company Accounting Oversight Board
 
(United States) (PCAOB) and are required to be
 
independent with
respect to
 
the Company
 
in accordance
 
with U.S.
 
federal securities
 
laws and
 
the applicabl
 
e
 
rules and
 
regulations of
 
the
Securities and Exchange Commission and the PCAOB.
 
We conducted
 
our audits
 
in accordance
 
with the
 
standards of
 
the PCAOB.
 
Those standards
 
require that
 
we plan
 
and
perform the audits to
 
obtain reasonable assurance
 
about whether the
 
financial statements are
 
free of material misstatement,
whether due
 
to error
 
or fraud.
 
The Company
 
is not
 
required to
 
have, nor
 
were we
 
engaged to
 
perform, an
 
audit of
 
its
internal control over financial reporting.
 
As part of our audits we
 
are required to obtain an
 
understanding of internal control
over financial
 
reporting but
 
not for
 
the purpose
 
of expressing an
 
opinion on
 
the effectiveness
 
of the
 
Company’s internal
control over financial reporting. Accordingly,
 
we express no such opinion.
 
 
Our audits included performing
 
procedures to assess the
 
risks of material misstatement
 
of the financial statements,
 
whether
due to error or fraud,
 
and performing procedures that
 
respond to those risks. Such
 
procedures included examining, on
 
a test
basis, evidence regarding
 
the amounts and
 
disclosures in the
 
financial statements. Our
 
audits also included
 
evaluating the
accounting principles
 
used and significant estimates
 
made by management, as well
 
as evaluating the overall presentation
 
of
the financial statements. We
 
believe that our audits provide a reasonable basis for our opinion.
 
Critical Audit Matter
The critical audit
 
matter communicated below
 
is a matter
 
arising from the
 
current period audit
 
of the financial
 
statements
that w
 
as communicated
 
or required
 
to be
 
communicated to
 
the audit
 
committee and
 
that: (1)
 
relates to
 
accounts or
disclosures that
 
are material
 
to the
 
financial statements
 
and (2)
 
involved especially
 
challenging, subjective,
 
or complex
judgments. The communication of the
 
critical audit matter doe
 
s
 
not alter in any way our opinion
 
on the financial
statements, taken as a whole, and we are
 
not, by communicating the critical audit matter
 
below, providing separate
 
opinions
on the critical audit matters or on the accounts or disclosures to
 
which they relate.
 
 
Allowance for Loan Losses
 
As described
 
in Note
 
5 to
 
the Company’s
 
consolidated financial
 
statements, the
 
Company has
 
a gross
 
loan portfolio
 
of
$462.5 million
 
and related
 
allowance for
 
loan losses
 
of $5.6
 
million as
 
of December
 
31, 2020.
 
As described
 
by the
Company in Note 1,
 
the evaluation of the
 
allowance for loan
 
losses is inherently
 
subjective as it requires
 
estimates that are
susceptible to significant
 
revision as more
 
information becomes available.
 
The allowance for
 
loan losses is
 
evaluated on a
regular basis and is based
 
upon the Company’s
 
review of the collectability
 
of the loans in
 
light of historical experience,
 
the
nature and volume
 
of the loan
 
portfolio, adverse situations
 
that may affect
 
the borrower’s
 
ability to repay,
 
estimated value
of any underlying collateral, and prevailing economic conditions.
 
 
 
 
77
We identified
 
the Company’s
 
estimate of
 
the allowance
 
for loan losses
 
as a critical
 
audit matter.
 
The principal
considerations for our
 
determination of the allowance
 
for loan losses
 
as a critical
 
audit matter related
 
to the high degree
 
of
subjectivity in
 
the Company’s
 
judgments in
 
determining the
 
qualitative factors.
 
Auditing these
 
complex judgments
 
and
assumptions by
 
the Company
 
involves especially
 
challenging auditor
 
judgment due
 
to the
 
nature and
 
extent of
 
audit
evidence and effort required to address these matters,
 
including the extent of specialized skill or knowledge needed.
 
 
The primary procedures we performed to address this critical audit
 
matter included:
 
 
We evaluated
 
the relevance
 
and the
 
reasonableness of
 
assumptions related
 
to evaluation
 
of the
 
loan portfolio,
current economic conditions,
 
and other risk
 
factors used in
 
development of the
 
qualitative factors
 
for collectively
evaluated loans.
 
We evaluated
 
the reasonableness
 
of assumptions
 
and data
 
used by
 
the Company
 
in developing
 
the qualitative
factors by
 
comparing these
 
data points
 
to internally
 
developed and
 
third-party sources,
 
and other
 
audit evidence
gathered.
 
 
/s/ Elliott Davis, LLC
 
We have served as the
 
Company's auditor since 2015.
 
Greenville, South Carolina
March 9, 2021
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
78
AUBURN NATIONAL
 
BANCORPORATION,
 
INC. AND SUBSIDIARIES
Consolidated Balance Sheets
 
December 31
(Dollars in thousands, except share data)
2020
2019
Assets:
Cash and due from banks
$
14,868
$
15,172
Federal funds sold
28,557
25,944
Interest bearing bank deposits
69,150
51,327
Cash and cash equivalents
112,575
92,443
Securities available-for-sale
 
335,177
235,902
Loans held for sale
3,418
2,202
Loans, net of unearned income
461,700
460,901
Allowance for loan losses
(5,618)
(4,386)
Loans, net
456,082
456,515
Premises and equipment, net
22,193
14,743
Bank-owned life insurance
19,232
19,202
Other assets
7,920
6,872
Total assets
$
956,597
$
827,879
Liabilities:
Deposits:
Noninterest-bearing
 
$
245,398
$
196,218
Interest-bearing
594,394
527,934
Total deposits
839,792
724,152
Federal funds purchased and securities sold under agreements
 
to repurchase
2,392
1,069
Accrued expenses and other liabilities
6,723
4,330
Total liabilities
848,907
729,551
Stockholders' equity:
Preferred stock of $
0.01
 
par value; authorized
 
200,000
 
shares;
issued shares - none
Common stock of $
0.01
 
par value; authorized
8,500,000
 
shares;
issued
3,957,135
 
shares
39
39
Additional paid-in capital
3,789
3,784
Retained earnings
105,617
101,801
Accumulated other comprehensive income, net
7,599
2,059
Less treasury stock, at cost -
390,859
 
shares and
390,989
 
shares
at December 31, 2020 and 2019, respectively
(9,354)
(9,355)
Total stockholders’ equity
107,690
98,328
Total liabilities and
 
stockholders’ equity
$
956,597
$
827,879
See accompanying notes to consolidated financial statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
79
AUBURN NATIONAL
 
BANCORPORATION,
 
INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
 
 
 
 
Year ended December 31
(Dollars in thousands, except share and per share data)
2020
2019
Interest income:
Loans, including fees
$
22,055
$
22,930
Securities:
Taxable
3,932
4,000
Tax-exempt
1,851
2,099
Federal funds sold and interest bearing bank deposits
356
1,218
Total interest income
28,194
30,247
Interest expense:
Deposits
3,847
4,176
Short-term borrowings
9
7
Total interest expense
3,856
4,183
Net interest income
24,338
26,064
Provision for loan losses
1,100
(250)
Net interest income after provision for
 
loan losses
23,238
26,314
Noninterest income:
Service charges on deposit accounts
585
717
Mortgage lending
2,319
866
Bank-owned life insurance
724
437
Gain from loan guarantee program
1,717
Other
1,644
1,880
Securities gains (losses), net
103
(123)
Total noninterest income
5,375
5,494
Noninterest expense:
Salaries and benefits
11,316
11,931
Net occupancy and equipment
2,511
1,907
Professional fees
1,052
1,014
FDIC and other regulatory assessments
256
181
Other
4,419
4,664
Total noninterest expense
19,554
19,697
Earnings before income taxes
9,059
12,111
Income tax expense
1,605
2,370
Net earnings
$
7,454
$
9,741
Net earnings per share:
Basic and diluted
$
2.09
$
2.72
Weighted average shares
 
outstanding:
Basic and diluted
3,566,207
3,581,476
See accompanying notes to consolidated financial statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
80
AUBURN NATIONAL
 
BANCORPORATION,
 
INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
 
 
 
Year ended December 31
(Dollars in thousands)
2020
2019
Net earnings
$
7,454
$
9,741
Other comprehensive income, net of tax:
Unrealized net holding gain on securities
5,617
5,730
Reclassification adjustment for net (gain) loss on securities
 
recognized in net earnings
(77)
92
Other comprehensive income
5,540
5,822
Comprehensive income
$
12,994
$
15,563
See accompanying notes to consolidated financial statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
81
AUBURN NATIONAL
 
BANCORPORATION,
 
INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
 
 
 
 
Accumulated
Common
Additional
other
Shares
Common
paid-in
Retained
 
comprehensive
Treasury
 
(Dollars in thousands, except share data)
Outstanding
Stock
capital
earnings
(loss) income
stock
Total
Balance, December 31, 2018
3,643,868
$
39
3,779
95,635
(3,763)
(6,635)
$
89,055
Net earnings
9,741
9,741
Other comprehensive income
5,822
5,822
Cash dividends paid ($
1.00
 
per share)
(3,575)
(3,575)
Stock repurchases
(77,907)
(2,721)
(2,721)
Sale of treasury stock
185
5
1
6
Balance, December 31, 2019
3,566,146
$
39
$
3,784
$
101,801
$
2,059
$
(9,355)
$
98,328
Net earnings
7,454
7,454
Other comprehensive income
5,540
5,540
Cash dividends paid ($
0.96
 
per share)
(3,638)
(3,638)
Sale of treasury stock
130
5
1
6
Balance, December 31, 2020
3,566,276
$
39
$
3,789
$
105,617
$
7,599
$
(9,354)
$
107,690
See accompanying notes to consolidated financial statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
82
AUBURN NATIONAL
 
BANCORPORATION,
 
INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
 
 
 
Year ended December 31
(In thousands)
2020
2019
Cash flows from operating activities:
Net earnings
$
7,454
$
9,741
Adjustments to reconcile net earnings to net cash provided
 
by
operating activities:
Provision for loan losses
1,100
(250)
Depreciation and amortization
1,666
1,157
Premium amortization and discount accretion, net
2,862
1,853
Deferred tax benefit
(330)
(153)
Net (gain) loss on securities available for sale
(103)
123
Net gain on sale of loans held for sale
(2,300)
(545)
Net gain on other real estate owned
(52)
(59)
Loans originated for sale
(82,726)
(30,407)
Proceeds from sale of loans
83,138
28,892
Increase in cash surrender value of bank owned life insurance
(442)
(437)
Income recognized from death benefit on bank-owned life insurance
(282)
Net increase in other assets
(2,656)
(872)
Net increase in accrued expenses and other liabilities
2,399
1,807
Net cash provided by operating activities
$
9,728
$
10,850
Cash flows from investing activities:
Proceeds from sales of securities available-for-sale
21,029
36,462
Proceeds from maturities of securities available-for-sale
62,021
55,078
Purchase of securities available-for-sale
(177,686)
(81,843)
(Increase) decrease in loans, net
(766)
15,771
Net purchases of premises and equipment
(8,355)
(1,809)
(Increase) decrease in FHLB stock
(9)
32
Proceeds from bank-owned life insurance death benefit
694
Proceeds from sale of other real estate owned
151
394
Net cash (used in) provided by investing activities
$
(102,921)
$
24,085
Cash flows from financing activities:
Net increase (decrease) in noninterest-bearing deposits
49,180
(5,430)
Net increase in interest-bearing deposits
66,460
5,389
Net increase (decrease) in federal funds purchased and securities sold
 
under agreements to repurchase
1,323
(1,231)
Stock repurchases
(2,721)
Dividends paid
(3,638)
(3,575)
Net cash provided by (used in) financing activities
$
113,325
$
(7,568)
Net change in cash and cash equivalents
$
20,132
$
27,367
Cash and cash equivalents at beginning of period
92,443
65,076
Cash and cash equivalents at end of period
$
112,575
$
92,443
Supplemental disclosures of cash flow
 
information:
Cash paid (received) during the period for:
Interest
$
4,055
$
4,092
Income taxes
678
2,295
Gain from loan guarantee program
(1,717)
Supplemental disclosure of non-cash transactions:
Initial recognition of operating lease right of use assets
$
$
891
Initial recognition of operating lease liabilities
889
Real estate acquired through foreclosure
99
82
See accompanying notes to consolidated financial statements
 
 
83
AUBURN NATIONAL
 
BANCORPORATION,
 
INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
 
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING
 
POLICIES
 
 
Nature of Business
 
Auburn National Bancorporation, Inc. (the “Company”) is a bank holding
 
company whose primary business is conducted
by its wholly-owned subsidiary,
 
AuburnBank (the “Bank”). AuburnBank is a commercial bank located
 
in Auburn,
Alabama. The Bank provides a full range of banking services in its
 
primary market area, Lee County,
 
which includes the
Auburn-Opelika Metropolitan Statistical Area.
 
Basis of Presentation
 
The consolidated financial statements include the accounts of
 
the Company and its wholly-owned subsidiaries. Significant
intercompany transactions and accounts are eliminated in consolidation.
 
COVID-19 Uncertainty
 
COVID-19 has adversely affected, and may continue to
 
adversely affect economic activity globally,
 
nationally and locally.
Following the COVID-19 outbreak in December 2019 and January
 
2020, market interest rates declined significantly.
 
The
federal banking agencies encouraged financial institutions to
 
prudently work with borrowers and passed legislation to
provide relief from reporting loan classifications due to modifications
 
related to the COVID-19 outbreak. The spread
 
of
COVID-19 has caused us to modify our business practices, including
 
employee travel, employee work locations, and
cancellation of physical participation in meetings, events and
 
conferences. The rapid development and fluidity of this
situation precludes any predication as to the ultimate impact
 
of the COVID-19 outbreak. Nevertheless, the outbreak
presents uncertainty and risk with respect to the Company,
 
its performance, and its financial results.
 
 
Revenue Recognition
 
 
On January 1, 2018, the Company implemented ASU 2014
 
-09,
 
Revenue from Contracts with Customers
, codified
at
 
ASC
 
606. The Company adopted ASC 606 using the modified retrospective
 
transition
 
method. The majority of the
Company’s revenue stream is generated
 
from interest income on loans and deposits which are outside
 
the scope of ASC
606.
 
 
The Company’s sources of income that
 
fall within the scope of ASC 606 include service charges
 
on deposits, investment
services, interchange fees and gains and losses on sales of other
 
real estate, all of which are presented as components of
noninterest income. The following is a summary of the revenue streams
 
that fall within the scope of ASC 606:
 
Service charges on deposits, investment services, ATM
 
and interchange fees – Fees from these services are either
transaction-based, for which the performance obligations are satisfied
 
when the individual transaction is processed, or set
periodic service charges, for which the performance obligations
 
are satisfied over the period the service is provided.
Transaction-based fees are recognized at the time
 
the transaction is processed, and periodic service charges
 
are recognized
over the service period.
 
Gains on sales of other real estate
 
A gain on sale should be recognized when a contract for sale exists and
 
control of the
asset has been transferred to the buyer.
 
ASC 606 lists several criteria required to conclude that a contract
 
for sale exists,
including a determination that the institution will collect substantially
 
all of the consideration to which it is entitled. In
addition to the loan-to-value, the analysis is based on various other
 
factors, including the credit quality of the borrower,
 
the
structure of the loan, and any other factors that may affect
 
collectability.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S.
 
generally accepted accounting principles requires
management to make estimates and assumptions that affect
 
the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities as of the balance sheet date
 
and the reported amounts of income and expense during the
reporting period. Actual results could differ from those
 
estimates. Material estimates that are particularly susceptible to
significant change in the near term include the determination
 
of the allowance for loan losses, fair value measurements,
valuation of other real estate owned, and valuation of deferred
 
tax assets.
 
 
 
84
Change in Accounting Estimate
 
 
During the fourth quarter of 2019, the Company reassessed its estimate
 
of the useful lives of certain fixed assets. The
Company revised its original useful life estimate for certain land improvements,
 
buildings and improvements
 
and furniture,
fixtures and equipment, with a carrying value of $
0.5
 
million at December 31, 2019, to correspond with estimated
demolition dates planned as part of the redevelopment project
 
for our main campus.
 
This is considered a change in
accounting estimate, per ASC 250-10, where adjustments should
 
be made prospectively. The effects
 
of this change in
accounting estimate on the 2020 and 2019 consolidated
 
financial statements, respectively, was
 
a decrease in net earnings of
$
342
 
thousand, or $
0.10
 
per share and $
161
 
thousand, or $
0.04
 
per share.
 
Reclassifications
 
 
Certain amounts reported in the prior period have been reclassified
 
to conform to the current-period presentation. These
reclassifications had no impact on the Company’s
 
previously reported net earnings or total stockholders’ equity.
 
Subsequent Events
 
 
The Company has evaluated the effects of events
 
or transactions through the date of this filing that ha
 
ve occurred
subsequent to December 31, 2020. The Company does not believe
 
there are any material subsequent events that would
require further recognition or disclosure.
 
Accounting
 
Standards Adopted in 2020
 
In 2020, the Company adopted new guidance related to the following
 
Accounting Standards Update (“Update” or “ASU”):
 
 
ASU 2018-13,
Fair Value
 
Measurement (Topic
 
820): Disclosure Framework – Changes
 
to the Disclosure
Requirements for Fair Value
 
Measurement
; and
 
 
ASU 2018-15,
Intangibles – Goodwill and Other – Internal Use Software
 
(Subtopic 350-40): Customer’s
Accounting for Implementation Costs Incurred
 
in a Cloud Computing Arrangement that is a Service Contract.
 
 
Information about these pronouncements is described in more
 
detail below.
 
 
ASU 2018-13,
Fair Value
 
Measurement (Topic
 
820): Disclosure Framework – Changes
 
to the Disclosure Requirements
 
for
Fair Value
 
Measurement,
improves the disclosure requirements on fair value measurements
 
by eliminating the
requirements to disclose (i) the amount of and reasons for transfers
 
between Level 1 and Level 2 of the fair value hierarchy;
(ii) the policy for timing of transfers between levels; and (iii)
 
the valuation processes for Level 3 fair value measurements.
This ASU also added specific disclosure requirements for fair
 
value measurements for public entities including the
requirement to disclose the changes in unrealized gains and
 
losses for the period included in other comprehensive income
for recurring Level 3 fair value measurements and the range and
 
weighted average of significant unobservable inputs used
to develop Level 3 fair value measurements.
 
 
 
The amendments in this ASU are effective for all
 
entities for fiscal years beginning after December 15,
 
2019, and all
interim periods within those fiscal years. Early adoption was permitted
 
upon issuance of the ASU. Entities are permitted to
early adopt amendments that remove or modify disclosures and
 
delay the adoption of the additional disclosures until their
effective date. The Company adopted this ASU on January
 
1, 2020. Adoption of this guidance did not have a material
impact on the Company’s consolidated
 
financial statements.
 
 
 
 
 
85
ASU 2018-15,
Intangibles – Goodwill and Other – Internal Use Software
 
(Subtopic 350-40): Customer’s
 
Accounting for
Implementation Costs Incurred in
 
a Cloud Computing Arrangement that is a Service Contract
aligns the requirements for
capitalizing implementation costs incurred in a hosting arrangement that
 
is a service contract with the requirements for
capitalizing implementation costs incurred to develop or
 
obtain internal-use software (and hosting arrangements that
include internal-use software license). This ASU requires entities to
 
use the guidance in FASB
 
ASC 350-40, Intangibles -
Goodwill and Other - Internal Use Software, to determine whether
 
to capitalize or expense implementation costs related to
the service contract. This ASU also requires entities to (i) expense capitalized
 
implementation costs of a hosting
arrangement that is a service contract over the term of the hosting
 
arrangement; (ii) present the expense related to the
capitalized implementation costs in the same line item on the
 
income statement as fees associated with the hosting element
of the arrangement; (iii) classify payments for capitalized implementation
 
costs in the statement of cash flows in the same
manner as payments made for fees associated with the hosting
 
element; and (iv) present the capitalized implementation
costs in the same balance sheet line item that a prepayment for
 
the fees associated with the hosting arrangement would be
presented.
 
 
 
The amendments in this ASU are effective for fiscal years
 
beginning after December 15, 2019 and interim periods
 
within
those fiscal years. Early adoption was permitted. The Company adopted
 
this ASU on January 1, 2020. Adoption of this
guidance did not have a material impact on the Company’s
 
consolidated financial statements.
 
 
Cash Equivalents
 
Cash equivalents include cash on hand, cash items in process
 
of collection, amounts due from banks, including interest
bearing deposits with other banks, and federal funds sold.
 
Securities
 
Securities are classified based on management’s
 
intention at the date of purchase. At December 31, 2020,
 
all of the
Company’s securities were classified
 
as available-for-sale. Securities available-for
 
-sale are used as part of the Company’s
interest rate risk management strategy,
 
and they may be sold in response to changes in interest rates,
 
changes in prepayment
risks or other factors. All securities classified as available-for-sale
 
are recorded at fair value with any unrealized gains and
losses reported in accumulated other comprehensive income
 
(loss), net of the deferred income tax effects. Interest and
dividends on securities, including the amortization of premiums and
 
accretion of discounts are recognized in interest
income using the effective interest method.
 
Premiums are amortized to the earliest call date while discounts are
 
accreted
over the estimated life of the security.
 
Realized gains and losses from the sale of securities are
 
determined using the
specific identification method.
 
 
On a quarterly basis, management makes an assessment to determine
 
whether there have been events or economic
circumstances to indicate that a security on which there is an
 
unrealized loss is other-than-temporarily impaired.
 
 
For debt securities with an unrealized loss, an other-than
 
-temporary impairment write-down is triggered when (1)
 
the
Company has the intent to sell a debt security,
 
(2) it is more likely than not that the Company will be required
 
to sell the
debt security before recovery of its amortized cost basis, or
 
(3) the Company does not expect to recover the entire amortized
cost basis of the debt security.
 
If the Company has the intent to sell a debt security or if it is more
 
likely than not that it will
be required to sell the debt security before recovery,
 
the other-than-temporary write-down is equal to the entire
 
difference
between the debt security’s amortized
 
cost and its fair value.
 
If the Company does not intend to sell the security or it is not
more likely than not that it will be required to sell the security
 
before recovery, the other
 
-than-temporary impairment write-
down is separated into the amount that is credit related (credit loss component)
 
and the amount due to all other factors.
 
The
credit loss component is recognized in earnings, as a realized
 
loss in securities gains (losses), and is the difference between
the security’s amortized cost basis and
 
the present value of its expected future cash flows.
 
The remaining difference
between the security’s fair value and
 
the present value of future expected cash flows is due to
 
factors that are not credit
related and is recognized in other comprehensive income, net
 
of applicable taxes.
 
Loans held for sale
 
Loans originated and intended for sale in the secondary market are
 
carried at the lower of cost or estimated fair value in the
aggregate.
 
Loan sales are recognized when the transaction closes, the proceeds
 
are collected, and ownership is transferred.
 
Continuing involvement, through the sales agreement, consists of the
 
right to service the loan for a fee for the life of the
loan, if applicable.
 
Gains on the sale of loans held for sale are recorded net of related
 
costs, such as commissions, and
reflected as a component of mortgage lending income in the consolidated
 
statements of earnings.
 
 
 
 
86
In the course of conducting the Bank’s
 
mortgage lending activities of originating mortgage loans and selling those
 
loans in
the secondary market, the Bank makes various representations and
 
warranties to the purchaser of the mortgage loans.
 
Every loan closed by the Bank’s
 
mortgage center is run through a government agency automated
 
underwriting system.
 
Any exceptions noted during this process are remedied prior to
 
sale.
 
These representations and warranties also apply to
underwriting the real estate appraisal opinion of value for the
 
collateral securing these loans.
 
Failure by the Company to
comply with the underwriting and/or appraisal standards could
 
result in the Company being required to repurchase the
mortgage loan or to reimburse the investor for losses incurred
 
(make whole requests) if such failure cannot be cured by the
Company within the specified period following discovery.
 
Loans
 
Loans are reported at their outstanding principal balances, net
 
of any unearned income, charge-offs, and any
 
deferred fees
or costs on originated loans.
 
Interest income is accrued based on the principal balance outstanding.
 
Loan origination fees,
net of certain loan origination costs, are deferred and recognized
 
in interest income over the contractual life of the loan
using the effective interest method. Loan commitment fees
 
are generally deferred and amortized on a straight-line basis
over the commitment period, which results in a recorded
 
amount that approximates fair value.
 
The accrual of interest on loans is discontinued when there is
 
a significant deterioration in the financial condition of the
borrower and full repayment of principal and interest is not expected
 
or the principal or interest is more than 90 days past
due, unless the loan is both well-collateralized and in the process
 
of collection. Generally,
 
all interest accrued but not
collected for loans that are placed on nonaccrual status is reversed
 
against current interest income. Interest collections on
nonaccrual loans are generally applied as principal reductions.
 
The Company determines past due or delinquency status of
 
a
loan based on contractual payment terms.
 
A loan is considered impaired when it is probable the Company
 
will be unable to collect all principal and interest payments
due according to the contractual terms of the loan agreement.
 
Individually identified impaired loans are measured based on
the present value of expected payments using the loan’s
 
original effective rate as the discount rate, the
 
loan’s observable
market price, or the fair value of the collateral if the loan is collateral
 
dependent. If the recorded investment in the impaired
loan exceeds the measure of fair value, a valuation allowance may be
 
established as part of the allowance for loan losses.
Changes to the valuation allowance are recorded as
 
a component of the provision for loan losses.
 
Impaired loans also include troubled debt restructurings (“TD
 
Rs”). In the normal course of business, management may
grant concessions to borrowers who are experiencing financial
 
difficulty. The
 
concessions granted most frequently for
TDRs involve reductions or delays in required payments of principal
 
and interest for a specified time, the rescheduling of
payments in accordance with a bankruptcy plan or the charge
 
-off of a portion of the loan. In most cases, the conditions
 
of
the credit also warrant nonaccrual status, even after the restructuring
 
occurs. As part of the credit approval process, the
restructured loans are evaluated for adequate collateral
 
protection in determining the appropriate accrual status at the time
of restructuring. TDR loans may be returned to accrual status
 
if there has been at least a six-month sustained period
 
of
repayment performance by the borrower.
 
The Company began offering short-term loan modifications
 
to assist borrowers during the COVID-19 pandemic.
 
If the
modification meets certain conditions, the modification does not
 
need to be accounted for as a TDR.
 
For more information,
please refer to Note 5, Loans and Allowance for Loan Losses.
 
Allowance for Loan Losses
 
The allowance for loan losses is maintained at a level that manage
 
ment believes is adequate to absorb probable losses
inherent in the loan portfolio. Loan losses are charged
 
against the allowance when they are known. Subsequent recoveries
are credited to the allowance. Management’s
 
determination of the adequacy of the allowance is based on
 
an evaluation of
the portfolio, current economic conditions, growth, composition
 
of the loan portfolio, homogeneous pools of loans, risk
ratings of specific loans, historical loan loss factors, identified
 
impaired loans and other factors
 
related to the portfolio. This
evaluation is performed quarterly and is inherently subjective,
 
as it requires various material estimates that are susceptible
to significant change, including the amounts and timing of future cash
 
flows expected to be received on any impaired loans.
In addition, regulatory agencies, as an integral part of their examination
 
process, will periodically review the Company’s
allowance for loan losses, and may require the Company to record
 
additions to the allowance based on their judgment about
information available to them at the time of their examinations.
 
 
 
87
Premises and Equipment
 
Land is carried at cost. Land improvements, buildings and improvements,
 
and furniture, fixtures, and equipment are carried
at cost, less accumulated depreciation computed on a straight
 
-line method over the useful lives of the assets or the expected
terms of the leases, if shorter. Expected
 
terms include lease option periods to the extent that the exercise
 
of such options is
reasonably assured.
 
 
Nonmarketable equity investments
 
Nonmarketable equity investments include equity securities that are
 
not publicly traded and securities acquired for various
purposes. The Bank is required to maintain certain minimum levels
 
of equity investments with certain regulatory and other
entities in which the Bank has an ongoing business relationship
 
based on the Bank’s common stock
 
and surplus (with
regard to the relationship with the Federal Reserve Bank) or outstanding
 
borrowings (with regard to the relationship with
the Federal Home Loan Bank of Atlanta). These nonmarketable
 
equity securities are accounted for at cost which equals par
or redemption value. These securities do not have a readily determinable
 
fair value as their ownership is restricted and there
is no market for these securities. These securities can only be
 
redeemed or sold at their par value and only to the respective
issuing government supported institution or to another member
 
institution. The Company records these nonmarketable
equity securities as a component of other assets, which are periodically
 
evaluated for impairment. Management considers
these nonmarketable equity securities to be long-term investments.
 
Accordingly, when evaluating these
 
securities for
impairment, management considers the ultimate recoverability
 
of the par value rather than by recognizing temporary
declines in value.
 
Transfers of Financial
 
Assets
 
Transfers of an entire financial asset (i.e. loan
 
sales), a group of entire financial assets, or a participating interest
 
in an entire
financial asset (i.e. loan participations sold) are accounted for
 
as sales when control over the assets have been surrendered.
Control over transferred assets is deemed to be surrendered
 
when (1) the assets have been isolated from the Company,
(2) the transferee obtains the right (free of conditions that constrain
 
it from taking that right) to pledge or exchange the
transferred assets, and (3) the Company does not maintain effective
 
control over the transferred assets through an
agreement to repurchase them before their maturity.
 
 
Mortgage Servicing Rights
 
The Company recognizes as assets the rights to service mortgage loans
 
for others, known as MSRs. The Company
determines the fair value of MSRs at the date the loan is transferred.
 
An estimate of the Company’s
 
MSRs is determined
using assumptions that market participants would use in estimating
 
future net servicing income, including estimates of
prepayment speeds, discount rate, default rates, cost to service,
 
escrow account earnings, contractual servicing fee income,
ancillary income, and late fees.
 
 
Subsequent to the date of transfer, the Company
 
has elected to measure its MSRs under the amortization method.
 
Under
the amortization method, MSRs are amortized in proportion
 
to, and over the period of, estimated net servicing income.
 
The
amortization of MSRs is analyzed monthly and is adjusted to reflect
 
changes in prepayment speeds, as well as other factors.
 
MSRs are evaluated for impairment based on the fair value of those
 
assets.
 
Impairment is determined by stratifying MSRs
into groupings based on predominant risk characteristics, such
 
as interest rate and loan type.
 
If, by individual stratum, the
carrying amount of the MSRs exceeds fair value, a valuation
 
allowance is established through a charge to earnings.
 
The
valuation allowance is adjusted as the fair value changes.
 
MSRs are included in the other assets category in the
accompanying consolidated balance sheets.
 
Securities sold under agreements to repurchase
 
 
Securities sold under agreements to repurchase generally mature
 
less than one year from the transaction date. Securities
sold under agreements to repurchase are reflected as a secured
 
borrowing in the accompanying consolidated balance sheets
at the amount of cash received in connection with each transaction.
 
 
 
 
 
 
 
 
 
 
 
 
 
88
Income Taxes
 
 
Deferred tax assets and liabilities are the expected future tax amounts
 
for the temporary differences between carrying
amounts and tax bases of assets and liabilities, computed using enacted
 
tax rates. A valuation allowance, if needed, reduces
deferred tax assets to the amount expected to be realized.
 
The net deferred tax asset is reflected as a component of other
assets in the accompanying consolidated balance sheets.
 
Income tax expense or benefit for the year is allocated among continuing
 
operations and other comprehensive income
(loss), as applicable. The amount allocated to continuing operations
 
is the income tax effect of the pretax income or loss
from continuing operations that occurred during the year,
 
plus or minus income tax effects of (1) changes
 
in certain
circumstances that cause a change in judgment about the realization
 
of deferred tax assets in future years, (2) changes in
income tax laws or rates, and (3) changes in income tax status,
 
subject to certain exceptions.
 
The amount allocated to other
comprehensive income (loss) is related solely to changes in the valuation
 
allowance on items that are normally accounted
for in other comprehensive income (loss) such as unrealized
 
gains or losses on available-for-sale securities.
 
In accordance with ASC 740,
Income Taxes
, a tax position is recognized as a benefit only if it is “more likely than not”
 
that
the tax position would be sustained in a tax examination, with a tax examination
 
being presumed to occur.
 
The amount
recognized is the largest amount of tax benefit that
 
is greater than 50% likely of being realized on examination.
 
For tax
positions not meeting the “more likely than not” test, no tax benefit
 
is recorded. It is the Company’s
 
policy to recognize
interest and penalties related to income tax matters in income
 
tax expense. The Company and its wholly-owned subsidiaries
file a consolidated income tax return.
 
 
Fair Value
 
Measurements
 
 
ASC 820,
Fair Value
 
Measurements,
which defines fair value, establishes a framework for measuring fair value
 
in U.S.
generally accepted accounting principles and expands disclosures about
 
fair value measurements. ASC 820 applies only to
fair-value measurements that are already required
 
or permitted by other accounting standards.
 
The definition of fair value
focuses on the exit price, i.e., the price
 
that would be received to sell an asset or paid to transfer a liability in
 
an orderly
transaction between market participants at the measurement date,
 
not the entry price, i.e., the price that would be paid to
acquire the asset or received to assume the liability at the measurement
 
date. The statement emphasizes that fair value is a
market-based measurement; not an entity-specific measurement.
 
Therefore, the fair value measurement should be
determined based on the assumptions that market participants
 
would
 
use in pricing the asset or liability.
 
For more
information related to fair value measurements, please refer
 
to Note 15, Fair Value.
 
NOTE 2: BASIC AND DILUTED NET EARNINGS PER SHARE
 
 
Basic net earnings per share is computed by dividing net earnings
 
by the weighted average common shares outstanding for
the year.
 
Diluted net earnings per share reflect the potential dilution that could
 
occur upon exercise of securities or other
rights for, or convertible into, shares of
 
the Company’s common stock.
 
As of December 31, 2020 and 2019, respectively,
the Company had no such securities or other rights issued or
 
outstanding, and therefore, no dilutive effect to consider
 
for
the diluted net earnings per share calculation.
 
 
The basic and diluted net earnings per share computations for
 
the respective years are presented below.
 
 
Year ended December 31
(Dollars in thousands, except share and per share data)
2020
2019
Basic and diluted:
Net earnings
$
7,454
$
9,741
Weighted average common
 
shares outstanding
3,566,207
3,581,476
Net earnings per share
$
2.09
$
2.72
 
NOTE 3: RESTRICTED CASH BALANCES
 
Regulation D of the Federal Reserve Act requires that banks
 
maintain reserve balances with the Federal Reserve Bank
(“FRB”) based principally on the type and amount of their deposits.
 
Effective March 26, 2020, the FRB no longer requires
banks to maintain reserve balances on deposit with the FRB.
 
The Bank did not have a required reserve balance at the FRB
at December 31, 2019.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
89
NOTE 4: SECURITIES
 
 
At December 31, 2020 and 2019, respectively,
 
all securities within the scope of ASC 320,
Investments – Debt and Equity
Securities
were classified as available-for-sale.
 
The fair value and amortized cost for securities available-for-sale
 
by
contractual maturity at December 31, 2020 and 2019, respectively,
 
are presented below.
 
1 year
1 to 5
5 to 10
After 10
Fair
Gross Unrealized
 
Amortized
(Dollars in thousands)
or less
years
years
years
Value
Gains
Losses
Cost
December 31, 2020
Agency obligations (a)
$
5,048
24,834
55,367
12,199
97,448
3,156
98
$
94,390
Agency MBS (a)
1,154
20,502
141,814
163,470
3,245
133
160,358
State and political subdivisions
477
632
8,405
64,745
74,259
3,988
11
70,282
Total available-for-sale
$
5,525
26,620
84,274
218,758
335,177
10,389
242
$
325,030
December 31, 2019
Agency obligations (a)
$
4,993
27,245
18,470
50,708
215
98
$
50,591
Agency MBS (a)
560
4,510
118,207
123,277
798
261
$
122,740
State and political subdivisions
1,355
6,166
54,396
61,917
2,104
9
$
59,822
Total available-for-sale
$
4,993
29,160
29,146
172,603
235,902
3,117
368
$
233,153
(a) Includes securities issued by U.S. government agencies or
 
government sponsored entities.
 
Expected maturities of
these securities may differ from contractual maturities because
 
issues may have the right to call or repay obligations
with or without prepayment penalties.
 
Securities with aggregate fair values of $
166.9
 
million and $
147.8
 
million at December 31, 2020 and 2019, respectively,
were pledged to secure public deposits, securities sold under
 
agreements to repurchase, Federal Home Loan Bank
(“FHLB”) advances, and for other purposes required or permitted
 
by law.
 
 
Included in other assets on the accompanying consolidated balance sheets
 
are nonmarketable equity investments.
 
The
carrying amounts of nonmarketable equity investments were
 
$
1.4
 
million at December 31, 2020 and 2019, respectively.
 
Nonmarketable equity investments include FHLB of Atlanta
 
stock, Federal Reserve Bank (“FRB”) stock, and stock in a
privately held financial institution.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
90
Gross Unrealized Losses and Fair Value
 
The fair values and gross unrealized losses on securities at December
 
31, 2020 and 2019, respectively,
 
segregated by those
securities that have been in an unrealized loss position for
 
less than 12 months and 12 months or more are presented below.
 
 
Less than 12 Months
12 Months or Longer
Total
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
(Dollars in thousands)
Value
Losses
Value
Losses
Value
Losses
December 31, 2020:
Agency obligations
 
$
15,416
98
15,416
$
98
Agency MBS
41,488
133
41,488
133
State and political subdivisions
2,945
11
2,945
11
Total
 
$
59,849
242
59,849
$
242
December 31, 2019:
Agency obligations
 
$
24,734
97
4,993
1
29,727
$
98
Agency MBS
40,126
98
21,477
163
61,603
261
State and political subdivisions
2,741
9
2,741
9
Total
 
$
67,601
204
26,470
164
94,071
$
368
 
For the securities in the previous table, the Company does not
 
have the intent to sell and has determined it is not more likely
than not that the Company will be required to sell the security
 
before recovery of the amortized cost basis, which may be
maturity. On a quarterly basis,
 
the Company assesses each security for credit impairment. For
 
debt securities, the Company
evaluates, where necessary,
 
whether credit impairment exists by comparing the present value
 
of the expected cash flows to
the securities’ amortized cost basis.
 
In determining whether a loss is temporary,
 
the Company considers all relevant information including:
 
 
 
the length of time and the extent to which the fair value has been
 
less than the amortized cost basis;
 
 
adverse conditions specifically related to the security,
 
an industry, or a geographic
 
area (for example, changes in
the financial condition of the issuer of the security,
 
or in the case of an asset-backed debt security,
 
in the financial
condition of the underlying loan obligors, including changes in technology
 
or the discontinuance of a segment of
the business that may affect the future earnings potential of
 
the issuer or underlying loan obligors of the security or
changes in the quality of the credit enhancement);
 
the historical and implied volatility of the fair value of the security;
 
 
the payment structure of the debt security and the likelihood of the issuer
 
being able to make payments that
increase in the future;
 
 
failure of the issuer of the security to make scheduled interest
 
or principal payments;
 
 
any changes to the rating of the security by a rating agency; and
 
recoveries or additional declines in fair value subsequent to the
 
balance sheet date.
 
Agency obligations
 
 
The unrealized losses associated with agency obligations were
 
primarily driven by changes in interest rates and not due to
the credit quality of the securities. These securities were issued
 
by U.S. government agencies or government-sponsored
entities and did not have any credit losses given the explicit government
 
guarantee or other government support.
 
Agency mortgage-backed securities (“MBS”)
 
 
The unrealized losses associated with agency MBS were primarily
 
driven by changes in interest rates and not due to the
credit quality of the securities. These securities were issued by U.S.
 
government agencies or government-sponsored entities
and did not have any credit losses given the explicit government guarantee
 
or other government support.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
91
Securities of U.S. states and political subdivisions
 
 
The unrealized losses associated with securities of U.S. states and
 
political subdivisions were primarily driven by changes
in interest rates and were not due to the credit quality of the securities.
 
Some of these securities are guaranteed by a bond
insurer, but management did not rely on the
 
guarantee in making its investment decision. These securities
 
will continue to
be monitored as part of the Company’s
 
quarterly impairment
 
analysis, but are expected to perform even if the rating
agencies reduce the credit rating of the bond insurers. As a result, the
 
Company expects to recover the entire amortized cost
basis of these securities.
 
 
The carrying values of the Company’s
 
investment securities could decline in the future if the financial
 
condition of an
issuer deteriorates and the Company determines it is probable
 
that it will not recover the entire amortized cost basis for the
security. As a result, there is
 
a risk that other-than-temporary impairment charges
 
may occur in the future.
 
Other-Than-Temporarily
 
Impaired Securities
 
Credit-impaired debt securities are debt securities where the Company
 
has written down the amortized cost basis of a
security for other-than-temporary impairment and the credit
 
component of the loss is recognized in earnings. At
December 31,
 
2020 and 2019, respectively, the Company
 
had no credit-impaired debt securities and there were no additions
or reductions in the credit loss component of credit-impaired
 
debt securities during the years ended December 31, 2020
 
and
2019, respectively.
 
 
Realized Gains and Losses
 
The following table presents the gross realized gains and losses on sales
 
related to securities.
Year ended December 31
(Dollars in thousands)
2020
2019
Gross realized gains
$
184
120
Gross realized losses
(81)
(243)
Realized gains (losses), net
$
103
(123)
 
NOTE 5: LOANS AND ALLOWANCE
 
FOR LOAN LOSSES
 
December 31
(In thousands)
2020
2019
Commercial and industrial
$
82,585
$
56,782
Construction and land development
33,514
32,841
Commercial real estate:
Owner occupied
54,033
48,860
Hotel/motel
42,900
43,719
Multifamily
40,203
44,839
Other
118,000
132,900
Total commercial real estate
255,136
270,318
Residential real estate:
Consumer mortgage
35,027
48,923
Investment property
49,127
43,652
Total residential real estate
84,154
92,575
Consumer installment
7,099
8,866
Total loans
462,488
461,382
Less: unearned income
(788)
(481)
Loans, net of unearned income
$
461,700
$
460,901
 
Loans secured by real estate were approximately
80.6
% of the total loan portfolio at December 31, 2020.
 
At December 31,
2020, the Company’s geographic
 
loan distribution was concentrated primarily in Lee County,
 
Alabama and surrounding
areas.
 
 
92
 
In accordance with ASC 310,
Receivables
, a portfolio segment is defined as the level at which an entity develops
 
and
documents a systematic method for determining its allowance
 
for loan losses. As part of the Company’s
 
quarterly
assessment of the allowance, the loan portfolio is disaggregated
 
into the following portfolio segments:
 
commercial and
industrial, construction and land development, commercial real
 
estate, residential real estate and consumer installment.
Where appropriate, the Company’s
 
loan portfolio segments are further disaggregated into classes. A class
 
is generally
determined based on the initial measurement attribute, risk characteristics
 
of the loan, and an entity’s method
 
for
monitoring and determining credit risk.
 
The following describe the risk characteristics relevant to each
 
of the portfolio segments and classes.
 
Commercial and industrial (“C&I”) —
includes loans to finance business operations, equipment purchases,
 
or other needs
for small and medium-sized commercial customers. Also
 
included in this category are loans to finance agricultural
production.
 
Generally, the primary source
 
of repayment is the cash flow from business operations and activities
 
of the
borrower.
 
We are
 
a participating lender in the PPP.
 
PPP loans are forgivable in whole or in part, if the proceeds
 
are used
for payroll and other permitted purposes in accordance with
 
the requirements of the PPP.
 
As of December 31, 2020, the
Company has
265
 
PPP loans with an aggregate outstanding principal balance of $
19.0
 
million included in this category.
 
 
Construction and land development (“C&D”) —
includes both loans and credit lines for the purpose of purchasing,
carrying and developing land into commercial developments or
 
residential subdivisions. Also included are loans and lines
for construction of residential, multi-family and commercial buildings.
 
Generally the primary source of repayment is
dependent upon the sale or refinance of the real estate collateral.
 
Commercial real estate
 
(“CRE”) —
includes loans disaggregated into three classes: (1) owner occupied
 
(2) multi-family
and (3) other.
 
 
 
Owner occupied
 
– includes loans secured by business facilities to finance business operations,
 
equipment and
 
owner-occupied facilities primarily for small and medium-sized
 
commercial customers.
 
Generally the primary source
 
of repayment is the cash flow from business operations and activities of the borrower,
 
who owns the property.
 
 
 
Hotel/motel
– includes loans for hotels and motels.
 
Generally, the primary
 
source of repayment is dependent upon
 
income generated from the real estate collateral.
 
The underwriting of these loans takes into consideration the
 
 
occupancy and rental rates, as well as the financial health of the borrower.
 
 
Multifamily
 
– primarily includes loans to finance income-producing multi-family
 
properties. Loans in this class include
 
loans for 5 or more unit residential property and apartments leased
 
to residents. Generally, the primary
 
source of
 
repayment is dependent upon income generated from the real
 
estate collateral. The underwriting of these loans takes
 
into consideration the occupancy and rental rates, as well as the financial
 
health of the borrower.
 
 
Other
 
– primarily includes loans to finance income-producing commercial properties.
 
Loans in this class include loans
 
for neighborhood retail centers, hotels, medical and professional offices,
 
single retail stores, industrial buildings,
 
and
 
warehouses leased generally to local businesses and residents. Generally the
 
primary source of repayment is dependent
 
upon income generated from the real estate collateral. The underwriting
 
of these loans takes into consideration the
 
occupancy and rental rates as well as the financial health of the borrower.
 
 
Residential real estate (“RRE”) —
includes loans disaggregated into two classes: (1) consumer mortgage
 
and (2)
investment property.
 
 
Consumer mortgage
 
– primarily includes first or second lien mortgages and home equity
 
lines to consumers that are
 
secured by a primary residence or second home. These loans are underwritten in
 
accordance with the Bank’s general
 
loan policies and procedures which require, among other things, proper
 
documentation of each borrower’s financial
 
condition, satisfactory credit history and property value.
 
 
Investment property
 
– primarily includes loans to finance income-producing 1-4 family
 
residential properties.
 
Generally, the primary source
 
of repayment is dependent upon income generated from leasing the
 
property securing the
 
loan. The underwriting of these loans takes into consideration the rental
 
rates as well as the financial health of the
 
borrower.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
93
Consumer installment —
includes loans to individuals both secured by personal property
 
and unsecured.
 
Loans include
personal lines of credit, automobile loans, and other retail loans.
 
These loans are underwritten in accordance with the
Bank’s general loan policies and
 
procedures which require, among other things, proper
 
documentation of each borrower’s
financial condition, satisfactory credit history,
 
and if applicable, property value.
 
The following is a summary of current, accruing past due and
 
nonaccrual loans by portfolio class as of December 31,
 
2020
and 2019.
 
Accruing
Accruing
Total
30-89 Days
Greater than
Accruing
Non-
Total
 
(In thousands)
Current
Past Due
90 days
Loans
Accrual
Loans
December 31, 2020:
Commercial and industrial
$
82,355
230
82,585
$
82,585
Construction and land development
33,453
61
33,514
33,514
Commercial real estate:
Owner occupied
54,033
54,033
54,033
Hotel/motel
42,900
42,900
42,900
Multifamily
40,203
40,203
40,203
Other
117,759
29
117,788
212
118,000
Total commercial real estate
254,895
29
254,924
212
255,136
Residential real estate:
Consumer mortgage
33,169
1,503
140
34,812
215
35,027
Investment property
49,014
6
49,020
107
49,127
Total residential real estate
82,183
1,509
140
83,832
322
84,154
Consumer installment
7,069
29
1
7,099
7,099
Total
$
459,955
1,858
141
461,954
534
$
462,488
December 31, 2019:
Commercial and industrial
$
56,758
24
56,782
$
56,782
Construction and land development
32,385
456
32,841
32,841
Commercial real estate:
Owner occupied
48,860
48,860
48,860
Hotel/motel
43,719
43,719
43,719
Multifamily
44,839
44,839
44,839
Other
132,900
132,900
132,900
Total commercial real estate
270,318
270,318
270,318
Residential real estate:
Consumer mortgage
47,151
1,585
48,736
187
48,923
Investment property
43,629
23
43,652
43,652
Total residential real estate
90,780
1,608
92,388
187
92,575
Consumer installment
8,802
64
8,866
8,866
Total
$
459,043
2,152
461,195
187
$
461,382
 
The gross interest income which would have been recorded
 
under the original terms of those nonaccrual loans had they
been accruing interest, amounted to approximately $
20
 
thousand and $
9
 
thousand for the years ended December 31, 2020
and 2019, respectively.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
94
Allowance for Loan Losses
 
The allowance for loan losses as of and for the years ended December
 
31, 2020 and 2019, is presented below.
 
Year ended December 31
(In thousands)
2020
2019
Beginning balance
$
4,386
$
4,790
Charged-off loans
(45)
(408)
Recovery of previously charged-off loans
177
254
Net recoveries (charge-offs)
132
(154)
Provision for loan losses
1,100
(250)
Ending balance
$
5,618
$
4,386
 
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, 2020 and 2019, 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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
95
The estimated loan loss allocation for all five loan portfolio segments
 
is then adjusted for management’s
 
estimate of
probable losses for several “qualitative and environmental” factors.
 
The allocation for qualitative and environmental factors
is particularly subjective and does not lend itself to exact mathematical
 
calculation. This amount represents estimated
probable inherent credit losses which exist, but have not yet been
 
identified, as of the balance sheet date, and are based
upon quarterly trend assessments in delinquent and nonaccrual
 
loans, credit concentration changes, prevailing economic
conditions, changes in lending personnel experience, changes
 
in lending policies or procedures and other influencing
factors. These qualitative and environmental factors are considered
 
for each of the five loan segments and the allowance
allocation, as determined by the processes noted above, is increased
 
or decreased based on the incremental assessment of
these factors.
 
The Company regularly re-evaluates its practices in determining the
 
allowance for loan losses. Since the fourth quarter of
2016, the Company has increased its look-back period each quarter
 
to incorporate the effects of at least one economic
downturn in its loss history. The
 
Company believes the extension of its look-back period
 
is appropriate due to the risks
inherent in the loan portfolio. Absent this extension, the early
 
cycle periods in which the Company experienced significant
losses would be excluded from the determination of the allowance for
 
loan losses and its balance would decrease. For the
year ended December 31, 2020, the Company increased its look
 
-back period to 47 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.
 
Further adjustments may be made in the future as a result of the ongoing COVID
 
-19 pandemic.
 
The following table details the changes in the allowance for loan
 
losses by portfolio segment for the years ended December
31, 2020 and 2019.
 
 
(in thousands)
Commercial
and industrial
Construction
and land
Development
Commercial
Real Estate
Residential
Real Estate
Consumer
Installment
Total
Balance, December 31, 2018
$
778
700
2,218
946
148
$
4,790
Charge-offs
(364)
(6)
(38)
(408)
Recoveries
117
1
109
27
254
Net (charge-offs) recoveries
(247)
1
103
(11)
(154)
Provision
46
(131)
70
(236)
1
(250)
Balance, December 31, 2019
$
577
569
2,289
813
138
$
4,386
Charge-offs
(7)
(38)
(45)
Recoveries
94
63
20
177
Net recoveries (charge-offs)
87
63
(18)
132
Provision
143
25
880
68
(16)
1,100
Balance, December 31, 2020
$
807
594
3,169
944
104
$
5,618
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
96
The following table presents an analysis of the allowance for
 
loan losses and recorded investment in loans by portfolio
segment and impairment methodology as of December 31, 2020
 
and 2019.
 
Collectively evaluated (1)
Individually evaluated (2)
Total
Allowance
Recorded
Allowance
Recorded
Allowance
Recorded
for loan
investment
for loan
investment
for loan
investment
(In thousands)
losses
in loans
losses
in loans
losses
in loans
December 31, 2020:
Commercial and industrial
$
807
82,585
807
82,585
Construction and land development
594
33,514
594
33,514
Commercial real estate
3,169
254,920
216
3,169
255,136
Residential real estate
944
84,047
107
944
84,154
Consumer installment
104
7,099
104
7,099
Total
$
5,618
462,165
323
5,618
462,488
December 31, 2019:
Commercial and industrial
$
577
56,683
99
577
56,782
Construction and land development
569
32,841
569
32,841
Commercial real estate
2,289
270,318
2,289
270,318
Residential real estate
813
92,575
813
92,575
Consumer installment
138
8,866
138
8,866
Total
$
4,386
461,283
99
4,386
461,382
(1) Represents loans collectively evaluated for impairment in accordance
 
with ASC 450-20,
Loss Contingencies
(formerly FAS 5), and pursuant to amendments by ASU 2010-20 regarding allowance for unimpaired loans.
(2) Represents loans individually evaluated for impairment in accordance
 
with ASC 310-30,
Receivables
(formerly
 
FAS 114), and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.
 
Credit Quality Indicators
 
The credit quality of the loan portfolio is summarized no less frequently
 
than quarterly using categories similar to the
standard asset classification system used by the federal banking agencies.
 
The following table presents credit quality
indicators for the loan portfolio segments and classes. These
 
categories are utilized to develop the associated allowance for
loan losses using historical losses adjusted for qualitative and
 
environmental factors and are defined as follows:
 
 
 
Pass – loans which are well protected by the current net worth
 
and paying capacity of the obligor (or guarantors, if
any) or by the fair value, less cost to acquire and sell, of any underlying
 
collateral.
 
 
 
Special Mention – loans with potential weakness that may,
 
if not reversed or corrected, weaken the credit or
inadequately protect the Company’s
 
position at some future date. These loans are not adversely classified
 
and do
not expose an institution to sufficient risk to warrant an
 
adverse classification.
 
 
Substandard Accruing – loans that exhibit a well-defined weakness which
 
presently jeopardizes debt repayment,
even though they are currently performing. These loans are characterized
 
by the distinct possibility that the
Company may incur a loss in the future if these weaknesses are
 
not corrected.
 
 
Nonaccrual – includes loans where management has determined
 
that full payment of principal and interest is in
doubt.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
97
(In thousands)
 
Pass
 
Special
Mention
Substandard
Accruing
Nonaccrual
Total loans
December 31, 2020
Commercial and industrial
$
79,984
2,383
218
$
82,585
Construction and land development
33,260
254
33,514
Commercial real estate:
Owner occupied
51,265
2,627
141
54,033
Hotel/motel
35,084
7,816
42,900
Multifamily
36,673
3,530
40,203
Other
116,498
1,243
47
212
118,000
Total commercial real estate
239,520
15,216
188
212
255,136
Residential real estate:
Consumer mortgage
32,518
397
1,897
215
35,027
Investment property
48,501
187
332
107
49,127
Total residential real estate
81,019
584
2,229
322
84,154
Consumer installment
7,069
7
23
7,099
Total
$
440,852
18,190
2,912
534
$
462,488
December 31, 2019
Commercial and industrial
$
54,340
2,176
266
$
56,782
Construction and land development
31,798
1,043
32,841
Commercial real estate:
Owner occupied
47,865
917
78
48,860
Hotel/motel
43,719
43,719
Multifamily
44,839
44,839
Other
132,030
849
21
132,900
Total commercial real estate
268,453
1,766
99
270,318
Residential real estate:
Consumer mortgage
45,247
962
2,527
187
48,923
Investment property
42,331
949
372
43,652
Total residential real estate
87,578
1,911
2,899
187
92,575
Consumer installment
8,742
60
64
8,866
Total
$
450,911
5,913
4,371
187
$
461,382
 
During the fourth quarter of 2019, the Company recognized a
 
gain of $1.7 million resulting from the termination of a Loan
Guarantee Program (the “Program”) operated by the State of
 
Alabama. The payment of $1.7
 
million received by the
Company in October 2019 was recorded as a gain and included
 
in noninterest income on the accompanying consolidated
statements of earnings.
 
The Program required a 1% fee on the commitment balance at
 
origination and in return the
Company received a guarantee of up to 50% of losses in the
 
event of the borrower's default. The Company had
5
 
loans
outstanding totaling $
10.3
 
million that were enrolled in the Program prior to its termination by the
 
State of Alabama.
 
Despite being enrolled in the Program, these loans would have met the
 
Company's normal loan underwriting criteria at
origination.
 
All of these loans were categorized as Pass within the Company's
 
credit quality asset classification at the date
of the Program’s termination.
 
Impaired loans
 
 
The following table presents details related to the Company’s
 
impaired loans. Loans which have been fully charged
 
-off do
not appear in the following table. The related allowance generally
 
represents the following components which correspond
to impaired loans:
 
 
 
Individually evaluated impaired loans equal to or greater than $500
 
thousand secured by real estate (nonaccrual
construction and land development, commercial real estate, and
 
residential real estate).
 
 
Individually evaluated impaired loans equal to or greater than $250
 
thousand not secured by real estate
(nonaccrual commercial and industrial and consumer loans).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
98
The following table sets forth certain information regarding the
 
Company’s impaired loans
 
that were individually evaluated
for impairment at December 31, 2020 and 2019.
 
 
December 31, 2020
(In thousands)
Unpaid
 
principal
 
balance (1)
Charge-offs
 
and payments
 
applied (2)
Recorded
investment (3)
Related
allowance
With no allowance recorded:
Commercial real estate:
Other
$
216
(4)
212
$
Total commercial real estate
216
(4)
212
Residential real estate:
Investment property
109
(2)
107
Total residential real estate
109
(2)
107
Total
 
impaired loans
$
325
(6)
319
$
(1) Unpaid principal balance represents the contractual obligation due
 
from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments
 
that have been
applied against the outstanding principal balance.
(3) Recorded investment represents the unpaid principal balance less
 
charge-offs and payments applied; it is shown before
 
any related allowance for loan losses.
 
December 31, 2019
(In thousands)
Unpaid
 
principal
 
balance (1)
Charge-offs
 
and payments
 
applied (2)
Recorded
investment (3)
Related
allowance
With no allowance recorded:
Commercial and industrial
$
335
(236)
99
$
Total
 
impaired loans
$
335
(236)
99
$
(1) Unpaid principal balance represents the contractual obligation due
 
from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments
 
that have been
applied against the outstanding principal balance.
(3) Recorded investment represents the unpaid principal balance less
 
charge-offs and payments applied; it is shown before
 
any related allowance for loan losses.
 
The following table provides the average recorded investment in impaired
 
loans and the amount of interest income
recognized on impaired loans after impairment by portfolio segment
 
and class.
 
Year ended December 31, 2020
Year ended December 31, 2019
Average
Total interest
Average
Total interest
recorded
income
recorded
income
(In thousands)
investment
recognized
investment
recognized
Impaired loans:
Commercial and industrial
$
$
8
Commercial real estate:
Owner occupied
24
9
Other
116
Total commercial real estate
116
24
9
Residential real estate:
Investment property
59
Total residential real estate
59
Total
 
$
175
$
32
9
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
99
Troubled Debt
 
Restructurings
 
 
Impaired loans also include troubled debt restructurings (“TDRs”).
 
Section 4013 of the CARES Act, “Temporary
 
Relief
From Troubled Debt Restructurings,” provides
 
banks the option to temporarily suspend certain requirements
 
under ASC
340-10 TDR classifications for a limited period of time to account
 
for the effects of COVID-19. In addition, the Interagency
Statement on COVID-19 Loan Modifications, encourages banks
 
to work prudently with borrowers and describes the
agencies’ interpretation of how accounting rules under ASC
 
310-40, “Troubled Debt Restructurings by Creditors,”
 
apply to
certain COVID-19-related modifications. The Interagency Statement
 
on COVID-19 Loan Modifications was supplemented
on June 23, 2020 by the Interagency Examiner Guidance for Assessing
 
Safety and Soundness Considering the Effect of the
COVID-19 Pandemic on Institutions.
 
If a loan modification is eligible, a bank may elect to account for
 
the loan under
section 4013 of the CARES Act. If a loan modification is not
 
eligible under section 4013, or if the bank elects not to
account for the loan modification under section 4013, the Revised Statement
 
includes criteria when a bank may presume a
loan modification is not a TDR in accordance with ASC 310
 
-40.
 
The Company evaluates loan extensions or modifications not
 
qualified under Section 4013 of the CARES Act or under the
Interagency Statement on COVID-19 Loan Modifications in accordance
 
with FASB ASC 340
 
-10 with respect to the
classification of the loan as a TDR.
 
In the normal course of business, management may grant concessions
 
to borrowers that
are experiencing financial difficulty.
 
A concession may include, but is not limited to, delays in required
 
payments of
principal and interest for a specified period, reduction of the stated
 
interest rate of the loan, reduction of accrued interest,
extension of the maturity date, or reduction of the face amount or
 
maturity amount of the debt.
 
A concession has been
granted when, as a result of the restructuring, the Bank does not expect
 
to collect, when due, all amounts owed, including
interest at the original stated rate.
 
A concession may have also been granted if the debtor is not able
 
to access funds
elsewhere at a market rate for debt with similar risk characteristics
 
as the restructured debt.
 
In making the determination of
whether a loan modification is a TDR, the Company considers
 
the individual facts and circumstances surrounding each
modification.
 
As part of the credit approval process, the restructured loans are evaluated
 
for adequate collateral protection
in determining the appropriate accrual status at the time of restructure.
 
 
Similar to other impaired loans, TDRs are measured for impairment
 
based on the present value of expected payments using
the loan’s original effective
 
interest rate as the discount rate, or the fair value of the collateral,
 
less selling costs if the loan is
collateral dependent. If the recorded investment in the loan exceeds
 
the measure of fair value, impairment is recognized by
establishing a valuation allowance as part of the allowance for
 
loan losses or a charge-off to the allowance for
 
loan losses.
 
In periods subsequent to the modification, all TDRs are evaluated
 
individually, including
 
those that have payment defaults,
for possible impairment.
 
At December 31, 2019 the Company had no TDRs.
 
The following is a summary of accruing and nonaccrual TDRs
 
and the
related loan losses, by portfolio segment and class at December
 
31, 2020.
 
TDRs
Related
(In thousands)
Accruing
Nonaccrual
Total
Allowance
December 31, 2020
Commercial real estate:
Other
$
212
212
Total commercial real estate
212
212
Investment property
107
107
Total residential real estate
107
107
Total
 
$
319
319
$
 
At December 31, 2020, there were no significant outstanding commitments
 
to advance additional funds to customers whose
loans had been restructured.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
100
There were no loans modified in a TDR during the year ended
 
December 31, 2019.
 
The following table summarizes loans
modified in a TDR during the year ended December 31,
 
2020 both before and after modification.
 
Pre-
Post-
modification
modification
outstanding
outstanding
Number of
recorded
recorded
($ in thousands)
contracts
investment
investment
December 31, 2020
Commercial real estate:
Other
1
$
216
216
Total commercial real estate
1
216
216
Investment property
3
111
111
Total residential real estate
3
111
111
Total
 
4
$
327
327
 
Four loans were modified in a TDR during the year ended December
 
31, 2020.
 
The only concession granted by the
Company was related to a delay in the required payment of principal
 
and/or interest.
 
During the years ended December 31, 2020 and 2019,
 
respectively, the Company had
 
no loans modified in a TDR within
the previous 12 months for which there was a payment default
 
(defined as 90 days or more past due).
 
NOTE 6: PREMISES AND EQUIPMENT
 
Premises and equipment at December 31, 2020
 
and 2019 is presented below
 
.
December 31
(Dollars in thousands)
2020
2019
Land and improvements
$
9,829
9,874
Buildings and improvements
7,436
9,987
Furniture, fixtures, and equipment
2,715
3,109
Construction in progress
8,171
107
Total premises and equipment
28,151
23,077
Less:
 
accumulated depreciation
(5,958)
(8,334)
Premises and equipment, net
$
22,193
14,743
 
Depreciation expense was approximately $
905
 
thousand and $
662
 
thousand for the years ended December 31, 2020 and
2019, respectively, and is a component
 
of net occupancy and equipment expense in the consolidated
 
statements of earnings.
 
NOTE 7: MORTGAGE SERVICING RIGHTS,
 
NET
 
 
MSRs are recognized based
 
on the fair value
 
of the servicing rights
 
on the date the
 
corresponding mortgage loans
 
are sold.
 
An estimate
 
of the
 
Company’s MSRs
 
is determined
 
using assumptions
 
that market
 
participants would
 
use in
 
estimating
future net servicing
 
income, including estimates
 
of prepayment speeds,
 
discount rate, default
 
rates, cost to
 
service, escrow
account earnings, contractual
 
servicing fee income,
 
ancillary income, and
 
late fees.
 
Subsequent to the
 
date of transfer,
 
the
Company has
 
elected to
 
measure its
 
MSRs under
 
the amortization
 
method.
 
Under the
 
amortization method,
 
MSRs are
amortized in proportion
 
to, and over the
 
period of, estimated
 
net servicing income. Servicing
 
fee income is recorded
 
net of
related amortization expense and recognized in earnings as part
 
of mortgage lending income.
 
 
 
The Company has recorded MSRs related to loans sold without
 
recourse to Fannie Mae.
 
The Company generally sells
conforming, fixed-rate, closed-end, residential mortgages to Fannie
 
Mae.
 
MSRs are included in other assets on the
accompanying consolidated balance sheets.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101
The Company evaluates MSRs for impairment on a quarterly basis.
 
Impairment is determined by stratifying MSRs into
groupings based on predominant risk characteristics, such as interest
 
rate and loan type.
 
If, by individual stratum, the
carrying amount of the MSRs exceeds fair value, a valuation
 
allowance is established. The valuation allowance is adjusted
as the fair value changes.
 
Changes in the valuation allowance are recognized
 
in earnings as a component of mortgage
lending income.
 
The following table details the changes in amortized MSRs and
 
the related valuation allowance for the years ended
December 31, 2020 and 2019.
 
Year ended December 31
(Dollars in thousands)
2020
2019
Beginning balance
$
1,299
1,441
Additions, net
671
241
Amortization expense
(640)
(383)
Ending balance
$
1,330
1,299
Valuation
 
allowance included in MSRs, net:
Beginning of period
$
End of period
Fair value of amortized MSRs:
Beginning of period
$
2,111
2,697
End of period
1,489
2,111
 
Data and assumptions used in the fair value calculation related
 
to MSRs at December 31,
 
2020 and 2019, respectively,
 
are
presented below.
 
December 31
(Dollars in thousands)
2020
2019
Unpaid principal balance
$
265,964
274,227
Weighted average prepayment
 
speed (CPR)
20.7
%
11.6
Discount rate (annual percentage)
10.0
%
10.0
Weighted average coupon
 
interest rate
3.6
%
3.9
Weighted average remaining
 
maturity (months)
253
255
Weighted average servicing
 
fee (basis points)
25.0
25.0
 
At December 31, 2020, the weighted average amortization period
 
for MSRs was
3.7
 
years.
 
Estimated amortization expense
for each of the next five years is presented below.
 
(Dollars in thousands)
December 31, 2020
2021
$
308
2022
227
2023
170
2024
129
2025
101
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
102
NOTE 8:
 
DEPOSITS
 
At December 31, 2020, the scheduled maturities of certificates
 
of deposit and other time deposits are presented below.
 
(Dollars in thousands)
December 31, 2020
2021
$
88,292
2022
50,332
2023
12,572
2024
5,842
2025
3,363
Thereafter
 
Total certificates of deposit
 
and other time deposits
 
$
160,401
 
Additionally, at December
 
31, 2020 and 2019, approximately $
55.0
 
million and $
57.4
 
million, respectively, of certificates
of deposit and other time deposits were issued in denominations
 
greater than $250 thousand.
 
At December 31, 2020 and 2019, the amount of deposit accounts in
 
overdraft status that were reclassified to loans on the
accompanying consolidated balance sheets was not material.
 
NOTE 9:
 
SHORT-TERM BORROWINGS
 
At December 31, 2020 and 2019, the composition of short-term borrowings
 
is presented below.
 
2020
2019
Weighted
Weighted
(Dollars in thousands)
Amount
Avg. Rate
Amount
Avg. Rate
Federal funds purchased:
As of December 31
$
$
Average during the year
1
0.78
%
1
2.58
%
Maximum outstanding at
 
any month-end
Securities sold under
 
 
agreements to repurchase:
As of December 31
$
2,392
0.50
%
$
1,069
0.50
%
Average during the year
1,822
0.50
%
1,442
0.50
%
Maximum outstanding at
 
any month-end
2,496
2,261
 
Federal funds purchased represent unsecured overnight borrowings
 
from other financial institutions by the Bank.
 
The Bank
had available federal fund lines totaling $
41
.0 million with none outstanding at December 31, 2020.
 
Securities sold under agreements to repurchase represent short
 
-term borrowings with maturities less than one year
collateralized by a portion of the Company’s
 
securities portfolio.
 
Securities with an aggregate carrying value of $
5.7
million and $
2.6
 
million at December 31, 2020 and 2019, respectively,
 
were pledged to secure securities sold under
agreements to repurchase.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
103
NOTE 10: LEASE COMMITMENTS
 
We lease certain
 
office facilities and equipment under operating leases.
 
Rent expense for all operating leases totaled $
0.2
million for both the years ended December 31, 2020 and 2019.
 
On January 1, 2019, we adopted a new accounting standard
which required the recognition of certain operating leases on our
 
balance sheet as lease right of use assets (reported as
component of other assets) and related lease liabilities (reported
 
as a component of accrued expenses and other liabilities).
 
Aggregate lease right of use assets were $
788
 
thousand and $
785
 
thousand at December 31, 2020 and 2019, respectively.
 
Aggregate lease liabilities were $
811
 
thousand and $
788
 
thousand at December 31, 2020 and 2019, respectively.
 
Rent
expense includes amounts related to items that are not included
 
in the determination of lease right of use assets including
expenses related to short-term leases totaling $
0.1
 
million for the year ended December 31, 2020.
 
Lease payments under operating leases that were applied to
 
our operating lease liability totaled $
112
 
thousand during the
year ended December 31, 2020. The following table reconciles
 
future undiscounted lease payments due under non-
cancelable operating leases (those amounts subject to recognition) to
 
the aggregate operating lease liability as of December
31, 2020.
 
Future lease
(Dollars in thousands)
payments
2021
$
127
2022
120
2023
120
2024
120
2025
111
Thereafter
300
Total undiscounted operating
 
lease liabilities
$
898
Imputed interest
87
Total operating lease liabilities
 
included in the accompanying consolidated balance sheets
$
811
Weighted-average
 
lease terms in years
7.68
Weighted-average
 
discount rate
3.02
%
 
NOTE 11:
 
OTHER COMPREHENSIVE INCOME (LOSS)
 
Comprehensive income
 
is defined as
 
the change in
 
equity from all
 
transactions other
 
than those with
 
stockholders, and
 
it
includes net
 
earnings and
 
other comprehensive
 
income (loss).
 
Other comprehensive
 
income (loss)
 
for the
 
years ended
December 31, 2020 and 2019, is presented below.
 
Pre-tax
Tax benefit
Net of
 
(Dollars in thousands)
amount
(expense)
tax amount
2020:
Unrealized net holding gain on securities
$
7,501
(1,884)
5,617
Reclassification adjustment for net gain on securities recognized
 
in net earnings
(103)
26
(77)
Other comprehensive income
$
7,398
(1,858)
5,540
2019:
Unrealized net holding gain on securities
$
7,651
(1,921)
5,730
Reclassification adjustment for net loss on securities recognized
 
in net earnings
123
(31)
92
Other comprehensive loss
$
7,774
(1,952)
5,822
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
104
NOTE 12:
 
INCOME TAXES
 
For the years ended December 31, 2020 and 2019 the components
 
of income tax expense from continuing operations are
presented below.
 
Year ended December 31
(Dollars in thousands)
2020
2019
Current income tax expense:
Federal
$
1,459
1,939
State
476
584
Total current income tax expense
1,935
2,523
Deferred income tax benefit:
Federal
(262)
(136)
State
(68)
(17)
Total deferred
 
income tax benefit
(330)
(153)
Total income tax expense
 
$
1,605
2,370
 
Total income tax expense
 
differs from the amounts computed by applying the
 
statutory federal income tax rate of 21% to
earnings before income taxes.
 
A reconciliation of the differences for the years ended
 
December 31,
 
2020 and 2019, is
presented below.
 
2020
2019
Percent of
Percent of
pre-tax
pre-tax
(Dollars in thousands)
Amount
earnings
Amount
earnings
Earnings before income taxes
$
9,059
12,111
Income taxes at statutory rate
1,902
21.0
%
2,543
21.0
%
Tax-exempt interest
(489)
(5.4)
(508)
(4.1)
State income taxes, net of
 
federal tax effect
345
3.8
440
3.6
Bank-owned life insurance
(152)
(1.7)
(92)
(0.8)
Other
(1)
(13)
(0.1)
Total income tax expense
 
$
1,605
17.7
%
2,370
19.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
105
The Company had a net deferred tax liability of $1.5
 
million and $9 thousand included in other liabilities ts on the
consolidated balance sheets at December 31, 2020
 
and 2019, respectively.
 
The tax effects of temporary differences
 
that
give rise to significant portions of the deferred tax assets and
 
deferred tax liabilities at December 31,
 
2020 and 2019 are
presented below.
 
December 31
(Dollars in thousands)
2020
2019
Deferred tax assets:
Allowance for loan losses
$
1,411
1,102
Accrued bonus
 
183
296
Right of use liability
204
198
Other
91
88
Total deferred
 
tax assets
1,889
1,684
Deferred tax liabilities:
Premises and equipment
199
315
Unrealized gain on securities
2,548
690
Originated mortgage servicing rights
334
326
Right of use asset
198
197
Other
147
165
Total deferred
 
tax liabilities
3,426
1,693
Net deferred tax liability
$
(1,537)
(9)
 
A valuation allowance is recognized for a deferred tax asset if, based
 
on the weight of available evidence, it is more-likely-
than-not that some portion of the entire deferred tax asset will not be
 
realized.
 
The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during
 
the periods in which those temporary differences
become deductible.
 
Management considers the scheduled reversal of deferred
 
tax liabilities, projected future taxable
income and tax planning strategies in making this assessment.
 
Based upon the level of historical taxable income and
projection for future taxable income over the periods which the
 
temporary differences resulting in the remaining
 
deferred
tax assets are deductible, management believes it is more-likely
 
-than-not that the Company will realize the benefits of
 
these
deductible differences at December 31,
 
2020.
 
The amount of the deferred tax assets considered realizable,
 
however, could
be reduced in the near term if estimates of future taxable income are
 
reduced.
 
 
The change in the net deferred tax asset for the years ended December
 
31, 2020 and 2019, is presented
 
below.
 
Year ended December 31
(Dollars in thousands)
2020
2019
Net deferred tax (liability) asset:
Balance, beginning of year
$
(9)
1,790
Deferred tax benefit (expense) related to continuing operations
330
153
Stockholders' equity, for
 
accumulated other comprehensive (income) loss
(1,858)
(1,952)
Balance, end of year
$
(1,537)
(9)
 
ASC 740,
Income Taxes,
 
defines the threshold for recognizing the benefits of tax return positions in
 
the financial statements
as “more-likely-than-not” to be sustained by the taxing authority.
 
This section also provides guidance on the de-
recognition, measurement, and classification of income tax uncertainties
 
in interim periods.
 
As of December 31, 2020, the
Company had no unrecognized tax benefits related to federal or
 
state income tax matters.
 
The Company does not anticipate
any material increase or decrease in unrecognized tax benefits during
 
2021 relative to any tax positions taken prior to
December 31, 2020.
 
As of December 31, 2020, the Company has accrued no interest and no
 
penalties related to uncertain
tax positions.
 
It is the Company’s policy to
 
recognize interest and penalties related to income tax matters
 
in income tax
expense.
 
 
The Company and its subsidiaries file consolidated U.S. federal
 
and State of Alabama income tax returns.
 
The Company is
currently open to audit under the statute of limitations by the Internal Revenue
 
Service and the State of Alabama for the
years ended December 31, 2017 through 2020.
 
 
 
 
 
 
 
 
106
 
NOTE 13:
 
EMPLOYEE BENEFIT PLAN
 
The Company sponsors a qualified defined contribution retirement
 
plan, the Auburn National Bancorporation, Inc. 401(k)
Plan (the "Plan").
 
Eligible employees may contribute up to 100% of eligible compensation,
 
subject to statutory limits upon
completion of 2 months of service.
 
Furthermore, the Company allows employer Safe Harbor
 
contributions. Participants are
immediately vested in employer Safe Harbor contributions. T
 
he Company's matching contributions on behalf of
participants were equal to $1.00 for each $1.00 contributed
 
by participants, up to 3% of the participants' eligible
compensation, and $0.50 for every $1.00 contributed by participants,
 
up to 5% of the participants' eligible compensation,
for a maximum matching contribution of 4% of the participants' eligible
 
compensation. Company matching contributions to
the Plan were $
304
 
thousand and $
264
 
thousand for the years ended December 31, 2020 and 2019,
 
respectively, and are
included in salaries and benefits expense.
 
NOTE 14:
 
COMMITMENTS AND CONTINGENT LIABILITIES
 
Credit-Related Financial Instruments
 
The Company is party to credit related financial instruments with
 
off-balance sheet risk in the normal course of business
 
to
meet the financing needs of its customers.
 
These financial instruments include commitments to extend credit
 
and standby
letters of credit.
 
Such commitments involve, to varying degrees, elements of credit
 
and interest rate risk in excess of the
amount recognized in the consolidated balance sheets.
 
 
The Company’s exposure to
 
credit loss is represented by the contractual amount of these commitments.
 
The Company
follows the same credit policies in making commitments as it
 
does for on-balance sheet instruments.
 
 
At December 31, 2020 and 2019, the following financial instruments
 
were outstanding whose contract amount represents
credit risk.
 
 
December 31
(Dollars in thousands)
2020
2019
Commitments to extend credit
$
74,970
$
60,564
Standby letters of credit
1,237
1,921
 
Commitments to extend credit are agreements to lend to a customer
 
as long as there is no violation of any condition
established in the agreement.
 
Commitments generally have fixed expiration dates or other termination
 
clauses and may
require payment of a fee.
 
The commitments for lines of credit may expire
 
without being drawn upon.
 
Therefore, total
commitment amounts do not necessarily represent future cash
 
requirements.
 
The amount of collateral obtained, if it is
deemed necessary by the Company,
 
is based on management’s credit
 
evaluation of the customer.
 
Standby letters of credit are conditional commitments issued by
 
the Company to guarantee the performance of a customer
to a third party.
 
The credit risk involved in issuing letters of credit
 
is essentially the same as that involved in extending loan
facilities to customers.
 
The Company holds various assets as collateral, including
 
accounts receivable, inventory,
equipment, marketable securities, and property to support
 
those commitments for which collateral is deemed necessary.
 
The Company has recorded a liability for the estimated fair
 
value of these standby letters of credit in the amount of $
25
thousand and $
39
 
thousand at December 31, 2020 and 2019, respectively.
 
Other Commitments
 
At December 31, 2020, the Company has a contract with a construction
 
company for $
25.3
 
million to construct a new bank
headquarters in Auburn, Alabama.
 
Contingent Liabilities
 
The Company and the Bank are involved in various legal proceedings,
 
arising in connection with their business.
 
In the
opinion of management, based upon consultation with legal counsel,
 
the ultimate resolution of these proceeding will not
have a material adverse effect upon the consolidated
 
financial condition or results of operations of the Company
 
and the
Bank.
 
 
 
107
NOTE 15: FAIR VALUE
 
 
Fair Value
 
Hierarchy
 
 
“Fair value” is defined by ASC 820,
Fair Value
 
Measurements and Disclosures
, as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction occurring
 
in the principal market (or most advantageous
market in the absence of a principal market) for an asset or
 
liability at the measurement date.
 
GAAP establishes a fair
value hierarchy for valuation inputs that gives the highest priority to
 
quoted prices in active markets for identical assets or
liabilities and the lowest priority to unobservable inputs.
 
The fair value hierarchy is as follows:
 
Level 1—inputs to the valuation methodology are quoted prices, unadjusted,
 
for identical assets or liabilities in active
markets.
 
 
Level 2—inputs to the valuation methodology include quoted
 
prices for similar assets and liabilities in active markets,
quoted prices for identical or similar assets or liabilities in markets
 
that are not active, or inputs that are observable for the
asset or liability, either directly
 
or indirectly.
 
 
Level 3—inputs to the valuation methodology are unobservable
 
and reflect the Company’s own assumptions
 
about the
inputs market participants would use in pricing the asset or liability.
 
 
Level changes in fair value measurements
 
 
Transfers between levels of the fair value hierarchy
 
are generally recognized at the end of the reporting period.
 
The
Company monitors the valuation techniques utilized for each
 
category of financial assets and liabilities to ascertain when
transfers between levels have been affected.
 
The nature of the Company’s financial
 
assets and liabilities generally is such
that transfers in and out of any level are expected to be infrequent.
 
For the years ended December 31, 2020 and
 
2019, there
were no transfers between levels and no changes in valuation techniques
 
for the Company’s financial
 
assets and liabilities.
 
Assets and liabilities measured at fair value
 
on a recurring basis
 
Securities available-for-sale
 
Fair values of securities available for sale were primarily measured
 
using Level 2 inputs.
 
For these securities, the Company
obtains pricing from third party pricing services.
 
These third party pricing services consider observable data
 
that may
include broker/dealer quotes, market spreads, cash flows, market consensus
 
prepayment speeds, benchmark yields, reported
trades for similar securities, credit information and the securities’ terms
 
and conditions.
 
On a quarterly basis, management
reviews the pricing received from the third party pricing services
 
for reasonableness given current market conditions.
 
As
part of its review, management
 
may obtain non-binding third party broker quotes to validate the fair value measurements.
 
In addition, management will periodically submit pricing provided
 
by the third party pricing services to another
independent valuation firm on a sample basis.
 
This independent valuation firm will compare the price
 
provided by the
third-party pricing service with its own price and will review the significant
 
assumptions and valuation methodologies used
with management.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
108
The following table presents the balances of the assets and liabilities
 
measured at fair value on a recurring as of December
31, 2020 and 2019, respectively,
 
by caption, on the accompanying consolidated balance sheets by ASC
 
820 valuation
hierarchy (as described above).
 
Quoted Prices in
Significant
Active Markets
Other
Significant
for
Observable
Unobservable
Identical Assets
Inputs
Inputs
(Dollars in thousands)
Amount
(Level 1)
(Level 2)
(Level 3)
December 31, 2020:
Securities available-for-sale:
Agency obligations
 
$
97,448
97,448
Agency MBS
163,470
163,470
State and political subdivisions
74,259
74,259
Total securities available
 
-for-sale
335,177
335,177
Total
 
assets at fair value
$
335,177
335,177
December 31, 2019:
Securities available-for-sale:
Agency obligations
 
$
50,708
50,708
Agency MBS
123,277
123,277
State and political subdivisions
61,917
61,917
Total securities available
 
-for-sale
235,902
235,902
Total
 
assets at fair value
$
235,902
235,902
 
Assets and liabilities measured at fair value
 
on a nonrecurring basis
 
Loans held for sale
 
 
Loans held for sale are carried at the lower of cost or fair value.
 
Fair values of loans held for sale are determined using
quoted market secondary market prices for similar loans.
 
Loans held for sale are classified within Level 2 of the fair value
hierarchy.
 
Impaired Loans
 
Loans considered impaired under ASC 310-10-35,
Receivables
, are loans for which, based on current information
 
and
events, it is probable that the Company will be unable to collect
 
all principal and interest payments due in accordance with
the contractual terms of the loan agreement.
 
Impaired loans can be measured based on the present value
 
of expected
payments using the loan’s original
 
effective rate as the discount rate, the loan’s
 
observable market price, or the fair value of
the collateral less selling costs if the loan is collateral dependent.
 
 
The fair value of impaired loans were primarily measured based on
 
the value of the collateral securing these loans.
 
Impaired loans are classified within Level 3 of the fair value
 
hierarchy. Collateral may be
 
real estate and/or business assets
including equipment, inventory,
 
and/or accounts receivable.
 
The Company determines the value of the collateral based on
independent appraisals performed by qualified licensed appraisers.
 
These appraisals may utilize a single valuation
approach or a combination of approaches including comparable
 
sales and the income approach.
 
Appraised values are
discounted for costs to sell and may be discounted further based on
 
management’s historical knowledge,
 
changes in market
conditions from the date of the most recent appraisal, and/or
 
management’s expertise and knowledge of the
 
customer and
the customer’s business.
 
Such discounts by management are subjective and are typically
 
significant unobservable inputs
for determining fair value.
 
Impaired loans are reviewed and evaluated on at least a quarterly
 
basis for additional
impairment and adjusted accordingly,
 
based on the same factors discussed above.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
109
Mortgage servicing rights, net
 
Mortgage servicing rights, net, included in other assets on the accompanying
 
consolidated balance sheets, are carried at the
lower of cost or estimated fair value.
 
MSRs do not trade in an active market with readily observable
 
prices.
 
To determine
the fair value of MSRs, the Company engages an independent
 
third party.
 
The independent third party’s
 
valuation model
calculates the present value of estimated future net servicing
 
income using assumptions that market participants would use
in estimating future net servicing income, including estimates of prepayment
 
speeds, discount rate, default rates, cost to
service, escrow account earnings, contractual servicing fee income,
 
ancillary income, and late fees.
 
Periodically, the
Company will review broker surveys and other market research
 
to validate significant assumptions used in the model.
 
The
significant unobservable inputs include prepayment speeds or
 
the constant prepayment rate (“CPR”) and the weighted
average discount rate.
 
Because the valuation of MSRs requires the use of significant unobservable
 
inputs, all of the
Company’s MSRs are classified
 
within Level 3 of the valuation hierarchy.
 
The following table presents the balances of the assets and liabilities
 
measured at fair value on a nonrecurring basis as of
December 31, 2020 and
 
2019, respectively, by caption, on the
 
accompanying consolidated balance sheets and by ASC 820
valuation hierarchy (as described above):
 
Quoted Prices in
Active Markets
Other
Significant
for
Observable
Unobservable
Identical Assets
Inputs
Inputs
(Dollars in thousands)
Amount
(Level 1)
(Level 2)
(Level 3)
December 31, 2020:
Loans held for sale
$
3,418
3,418
Loans, net
(1)
319
319
Other assets
(2)
1,330
1,330
Total assets at fair value
$
5,067
3,418
1,649
December 31, 2019:
Loans held for sale
$
2,202
2,202
Loans, net
(1)
99
99
Other assets
(2)
1,299
1,299
Total assets at fair value
$
3,600
2,202
1,398
(1)
Loans considered impaired under ASC 310-10-35 Receivables.
 
This amount reflects the recorded investment in
 
impaired loans, net of any related allowance for loan losses.
(2)
Represents MSRs, net carried at lower of cost or estimated fair value.
 
At December 31, 2020 and 2019 and for the years then ended,
 
the Company had no Level 3 assets measured at fair value on
a recurring basis.
 
For Level 3 assets measured at fair value on a non-recurring basis
 
as of December 31, 2020 and 2019, the
significant unobservable inputs used in the fair value measurements
 
are presented below.
 
Weighted
Carrying
Significant
Average
(Dollars in thousands)
Amount
Valuation Technique
 
Unobservable Input
Range
of Input
December 31, 2020:
Impaired loans
$
319
Appraisal
Appraisal discounts
10.0
-
10.0
%
10.0
%
Mortgage servicing rights, net
1,330
Discounted cash flow
Prepayment speed or CPR
18.2
-
36.4
%
20.7
%
 
Discount rate
10.0
-
12.0
%
10.0
%
December 31, 2019:
Impaired loans
$
99
Appraisal
Appraisal discounts
10.0
-
10.0
%
10.0
%
Mortgage servicing rights, net
1,299
Discounted cash flow
Prepayment speed or CPR
11.2
-
22.4
%
11.6
%
 
Discount rate
10.0
-
12.0
%
10.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
110
Fair Value
 
of Financial Instruments
 
 
ASC 825,
Financial Instruments
, requires disclosure of fair value information about financial
 
instruments,
 
whether or not
recognized on the face of the balance sheet, for which it is practicable
 
to estimate that value. The assumptions used in the
estimation of the fair value of the Company’s
 
financial instruments are explained below.
 
Where quoted market prices are
not available, fair values are based on estimates using discounted
 
cash flow analyses. Discounted cash flows can be
significantly affected by the assumptions used,
 
including the discount rate and estimates of future cash flows. The
following fair value estimates cannot be substantiated by comparison
 
to independent markets and should not be considered
representative of the liquidation value of the Company’s
 
financial instruments, but rather are a good-faith estimate of the
fair value of financial instruments held by the Company.
 
ASC 825 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements.
 
 
The following methods and assumptions were used by the Company in
 
estimating the fair value of its financial instruments:
 
 
Loans, net
 
 
Fair values for loans were calculated using discounted cash flows. The
 
discount rates reflected current rates at which similar
loans would be made for the same remaining maturities. Expected
 
future cash flows were projected based on contractual
cash flows, adjusted for estimated prepayments.
 
The fair value of loans was measured using an exit
 
price notion.
 
Loans held for sale
 
 
Fair values of loans held for sale are determined using quoted
 
market secondary market prices for similar loans.
 
Time Deposits
 
 
Fair values for time deposits were estimated using discounted
 
cash flows. The discount rates were based on rates currently
offered for deposits with similar remaining maturities.
 
 
Fair Value Hierarchy
Carrying
 
Estimated
Level 1
Level 2
Level 3
(Dollars in thousands)
amount
fair value
inputs
inputs
Inputs
December 31, 2020:
Financial Assets:
Loans, net (1)
$
456,082
$
451,816
$
$
$
451,816
Loans held for sale
3,418
3,509
3,509
Financial Liabilities:
Time Deposits
$
160,401
$
162,025
$
$
162,025
$
December 31, 2019:
Financial Assets:
Loans, net (1)
$
456,515
$
453,705
$
$
$
453,705
Loans held for sale
2,202
2,251
2,251
Financial Liabilities:
Time Deposits
$
167,199
$
168,316
$
$
168,316
$
(1) Represents loans, net of unearned income and the allowance
 
for loan losses.
 
The fair value of loans was measured using an exit price notion.
 
 
 
 
 
 
 
 
 
 
 
 
 
111
NOTE 16:
 
RELATED PARTY
 
TRANSACTIONS
 
The Bank has made, and expects in the future to continue to make
 
in the ordinary course of business, loans to directors
 
and
executive officers of the Company,
 
the Bank, and their affiliates. In management’s
 
opinion, these loans were made in the
ordinary course of business at normal credit terms, including
 
interest rate and collateral requirements, and do not represent
more than normal credit risk.
 
An analysis of such outstanding loans is presented below.
 
(Dollars in thousands)
Amount
Loans outstanding at December 31, 2019
$
3,149
New loans/advances
871
Repayments
(2,433)
Changes in directors and executive officers
(351)
Loans outstanding at December 31, 2020
$
1,236
 
During 2020 and 2019, certain executive officers and
 
directors of the Company and the Bank, including companies with
which they are affiliated, were deposit customers of
 
the bank.
 
Total deposits for
 
these persons at December 31, 2020 and
2019 amounted to $
18.7
 
million and $
19.1
 
million, respectively.
 
 
NOTE 17: REGULATORY
 
RESTRICTIONS AND CAPITAL
 
RATIOS
 
As required by the Economic Growth, Regulatory Relief, and Consumer
 
Protection Act in August 2018, the Federal
Reserve Board issued an interim final rule that expanded applicability
 
of the Board’s small bank holding
 
company policy
statement. The interim final rule raised the policy statement’s
 
asset threshold from $1 billion to $3 billion in total
consolidated assets for a bank holding company or savings and
 
loan holding company that: (1) is not engaged in significant
nonbanking activities; (2) does not conduct significant off
 
-balance sheet activities; and (3) does not have a material amount
of debt or equity securities, other than trust-preferred securities,
 
outstanding. The interim final rule provides that, if
warranted for supervisory purposes, the Federal Reserve may exclude
 
a company from the threshold increase. Management
believes the Company meets the conditions of the Federal Reserve’s
 
small bank holding company policy statement and is
therefore excluded from consolidated capital requirements at
 
December 31, 2020.
 
The Bank remains subject to regulatory capital requirements
 
administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory
 
- and possibly additional discretionary - actions by regulators
that, if undertaken, could have a direct material effect
 
on the Company’s financial statements.
 
Under capital adequacy
guidelines and the regulatory framework for prompt corrective action,
 
the Bank must meet specific capital guidelines that
involve quantitative measures of their assets, liabilities and certain
 
off-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are
 
also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
 
As of December 31, 2020, the Bank is “well capitalized” under
 
the regulatory framework for prompt corrective action. To
be categorized as “well capitalized,” the Bank must maintain minimum
 
common equity Tier 1, total risk-based,
 
Tier 1 risk-
based, and Tier 1 leverage ratios as set forth
 
in the table. Management has not received any notification from the
 
Bank's
regulators that changes the Bank’s
 
regulatory capital status.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
112
The actual capital amounts and ratios for the Bank and the aforementioned
 
minimums as of December 31, 2020 and 2019
are presented below.
 
Minimum for capital
Minimum to be
 
Actual
adequacy purposes
well capitalized
(Dollars in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
At December 31, 2020:
Tier 1 Leverage Capital
$
96,096
10.32
%
$
37,263
4.00
%
$
46,579
5.00
%
Common Equity Tier 1 Capital
96,096
17.27
25,042
4.50
36,171
6.50
Tier 1 Risk-Based Capital
96,096
17.27
33,389
6.00
44,519
8.00
Total Risk-Based Capital
101,906
18.31
44,519
8.00
55,648
10.00
At December 31, 2019:
Tier 1 Leverage Capital
$
92,778
11.23
%
$
33,043
4.00
%
$
41,303
5.00
%
Common Equity Tier 1 Capital
92,778
17.28
24,162
4.50
34,901
6.50
Tier 1 Risk-Based Capital
92,778
17.28
32,216
6.00
42,955
8.00
Total Risk-Based Capital
97,291
18.12
42,955
8.00
53,693
10.00
 
Dividends paid by the Bank are a principal source of funds available
 
to the Company for payment of dividends to its
stockholders and for other needs. Applicable federal and state
 
statutes and regulations impose restrictions on the amounts
 
of
dividends that may be declared by the subsidiary bank. State
 
law and Federal Reserve policy restrict the Bank from
declaring dividends in excess of the sum of the current year’s
 
earnings plus the retained net earnings from the preceding
two years without prior approval. In addition to the formal statutes
 
and regulations, regulatory authorities also consider the
adequacy of the Bank’s total capital
 
in relation to its assets, deposits, and other such items. Capital adequacy
 
considerations
could further limit the availability of dividends from the Bank. At
 
December 31,
 
2020, the Bank could have declared
additional dividends of approximately $
6.8
 
million without prior approval of regulatory authorities. As a result of this
limitation, approximately $
96.9
 
million of the Company’s investment
 
in the Bank was restricted from transfer in the form
of dividends.
 
NOTE 18: AUBURN NATIONAL
 
BANCORPORATION
 
(PARENT COMPANY)
 
The Parent Company’s condensed
 
balance sheets and related condensed statements of earnings
 
and cash flows are as
follows.
 
CONDENSED BALANCE SHEETS
December 31
(Dollars in thousands)
2020
2019
Assets:
Cash and due from banks
$
4,049
4,119
Investment in bank subsidiary
103,695
94,837
Other assets
631
625
Total assets
$
108,375
99,581
Liabilities:
Accrued expenses and other liabilities
$
685
1,253
Total liabilities
685
1,253
Stockholders' equity
107,690
98,328
Total liabilities and
 
stockholders' equity
$
108,375
99,581
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
113
CONDENSED STATEMENTS
 
OF EARNINGS
Year ended December 31
(Dollars in thousands)
2020
2019
Income:
Dividends from bank subsidiary
$
3,638
8,574
Noninterest income
862
346
Total income
4,500
8,920
Expense:
Noninterest expense
255
212
Total expense
255
212
Earnings before income tax expense and equity
in undistributed earnings of bank subsidiary
4,245
8,708
Income tax expense
110
26
Earnings before equity in undistributed earnings
of bank subsidiary
4,135
8,682
Equity in undistributed earnings of bank subsidiary
3,319
1,059
Net earnings
$
7,454
9,741
 
CONDENSED STATEMENTS
 
OF CASH FLOWS
Year ended December 31
(Dollars in thousands)
2020
2019
Cash flows from operating activities:
Net earnings
$
7,454
9,741
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Net (increase) decrease in other assets
(6)
7
Net decrease in other liabilities
(561)
(215)
Equity in undistributed earnings of bank subsidiary
(3,319)
(1,059)
Net cash provided by operating activities
3,568
8,474
Cash flows from financing activities:
Dividends paid
(3,638)
(3,575)
Stock repurchases
(2,721)
Net cash used in financing activities
(3,638)
(6,296)
Net change in cash and cash equivalents
(70)
2,178
Cash and cash equivalents at beginning of period
4,119
1,941
Cash and cash equivalents at end of period
$
4,049
4,119
 
 
114
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
 
ACCOUNTANTS ON ACCOUNTING
 
AND
FINANCIAL DISCLOSURE
 
Not applicable.
 
ITEM 9A. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
As required by Rule 13a-15(b) under the Securities Exchange
 
Act of 1934 (the “Exchange Act”), the Company’s
management, under the supervision and with the participation of its
 
principal executive and principal financial officer,
conducted an evaluation as of the end of the period covered
 
by this report, of the effectiveness of the Company’s
 
disclosure
controls and procedures as defined in Rule 13a-15(e) under the
 
Exchange Act. Based on that evaluation, and the results of
the audit process described below,
 
the Chief Executive Officer and Chief Financial Officer
 
concluded that the Company’s
disclosure controls and procedures were effective to
 
ensure that information required to be disclosed in the Company’s
reports under the Exchange Act is recorded, processed
 
,
 
summarized and reported within the time periods specified in the
SEC’s rules and regulations, and
 
that such information is accumulated and communicated to
 
the Company’s management,
including the Chief Executive Officer and the Chief Financial
 
Officer, as appropriate,
 
to allow timely decisions regarding
disclosure.
 
Management’s Report on Internal
 
Control Over Financial Reporting
 
The Company’s management is
 
responsible for establishing and maintaining adequate internal
 
control over financial
reporting. The Company’s internal
 
control system was designed to provide reasonable assurance
 
to the Company’s
management and board of directors regarding the preparation and fair
 
presentation of published financial statements. All
internal control systems, no matter how well designed, have inherent
 
limitations. Therefore, even those systems determined
to be effective can provide only reasonable assurance
 
with respect to financial statement preparation and presentation.
 
Under the direction of the Company’s
 
Chief Executive Officer and Chief Financial Officer,
 
management has assessed the
effectiveness of the Company’s
 
internal control over financial reporting as of December 31,
 
2020 in accordance with the
criteria set forth by the Committee of Sponsoring Organizations
 
of the Treadway Commission (“COSO”) i
 
n
 
Internal
Control – Integrated Framework (2013). Based on this assessment, management
 
has concluded that such internal control
over financial reporting was effective as of December
 
31, 2020.
 
This annual report does not include an attestation report of
 
the Company’s independent registered
 
public accounting firm
regarding internal control over financial reporting. Management’s
 
report was not subject to attestation by the Company’s
registered public accounting firm pursuant to the final rules of
 
the Securities and Exchange Commission that permit the
Company to provide only a management’s
 
report in this annual report.
 
Changes in Internal Control Over Financial
 
Reporting
 
During the period covered by this report, there has not been any change
 
in the Company’s internal controls
 
over financial
reporting that has materially affected, or is reasonably
 
likely to materially affect, the Company’s
 
internal controls over
financial reporting.
 
 
ITEM 9B.
 
OTHER INFORMATION
 
None.
 
 
 
115
PART
 
III
 
ITEM 10.
 
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
Information required by this item is set forth under the headings “Proposal
 
One: Election of Directors - Information about
Nominees for Directors,” and “Executive Officers,”
 
“Additional Information Concerning the Company’s
 
Board of
Directors and Committees,” “Executive Compensation,” “Audit
 
Committee Report” and “Compliance with Section 16(a) of
the Securities Exchange Act of 1934” in the Proxy Statement, and
 
is incorporated herein by reference.
 
The Board of Directors has adopted a Code of Conduct and
 
Ethics applicable to the Company’s
 
directors,
 
officers and
employees, including the Company’s
 
principal executive officer,
 
principal financial and principal accounting officer,
controller and other senior financial officers. The Code
 
of Conduct and Ethics, as well as the charters for the Audit
Committee, Compensation Committee, and the Nominating and
 
Corporate Governance Committee, can be found by
hovering over the heading “About Us” on the Company’s
 
website,
www.auburnbank.com
, and then clicking on “Investor
Relations”, and then clicking on “Governance Documents”.
 
In addition, this information is available in print to any
shareholder who requests it. Written requests
 
for a copy of the Company’s Code
 
of Conduct and Ethics or the Audit
Committee, Compensation Committee, or Nominating and
 
Corporate Governance Committee Charters may be sent to
Auburn National Bancorporation, Inc., 132 N. Gay Street, Auburn,
 
Alabama 36830, Attention: Marla Kickliter,
 
Senior Vice
President of Compliance and Internal Audit. Requests may also
 
be made via telephone by contacting Marla Kickliter,
Senior Vice President of Compliance
 
and Internal Audit, or Laura Carrington, Vice
 
President of Human Resources, at
(334) 821-9200.
 
ITEM 11.
 
EXECUTIVE COMPENSATION
 
Information required by this item is set forth under the headings “Additional
 
Information Concerning the Company’s
 
Board
of Directors and Committees – Board Compensation,” and “Executive
 
Officers” in the Proxy Statement, and is incorporated
herein by reference.
 
ITEM 12.
 
SECURITY OWNERSHIP OF CERTAIN
 
BENEFICIAL OWNERS AND MANAGEMENT
 
AND
RELATED STOCKHOLDER
 
MATTERS
 
Information required by this item is set forth under the headings “Proposal
 
One: Election of Directors - Information about
Nominees for Directors and Executive Officers” and
 
“Stock Ownership by Certain Persons” in the Proxy Statement, and
 
is
incorporated herein by reference.
 
ITEM 13. CERTAIN
 
RELATIONSHIPS
 
AND RELATED
 
TRANSACTIONS AND DIRECTOR INDEPENDENCE
 
Information required by this item is set forth under the headings “Additional
 
Information Concerning the Company’s
 
Board
of Directors and Committees – Committees of the Board
 
of Directors – Independent Directors Committee” and “Certain
Transactions and Business Relationships” in
 
the Proxy Statement, and is incorporated herein by reference.
 
ITEM 14.
 
PRINCIPAL ACCOUNTING FEES
 
AND SERVICES
 
 
Information required by this item is set forth under the heading “Independent
 
Public Accountants” in the Proxy Statement,
and is incorporated herein by reference.
 
 
 
 
 
 
 
116
PART
 
IV
 
 
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT
 
SCHEDULES
 
(a)
List of all Financial Statements
 
The following consolidated financial statements and report
 
of independent registered public accounting firm of the
Company are included in this Annual Report on Form 10-K:
 
Report of Independent Registered Public Accounting Firm
 
Consolidated Balance Sheets as of December 31,
 
2020 and 2019
 
Consolidated Statements of Earnings for the years ended December
 
31, 2020 and 2019
 
Consolidated Statements of Comprehensive Income for the years
 
ended December 31, 2020 and 2019
 
Consolidated Statements of Stockholders’ Equity for the years
 
ended December 31, 2020 and 2019
Consolidated Statements of Cash Flows for the years ended
 
December 31, 2020 and
 
2019
Notes to the Consolidated Financial Statements
 
 
(b)
Exhibits
 
 
 
3.1.
 
 
3.2.
 
 
 
4.1.
 
 
 
21.1
 
 
 
31.1
 
 
 
31.2
 
 
 
32.1
 
 
32.2
 
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension
 
Schema Document
101.CAL
 
XBRL Taxonomy Extension
 
Calculation Linkbase Document
101.LAB
 
XBRL Taxonomy Extension
 
Label Linkbase Document
101.PRE
 
XBRL Taxonomy Extension
 
Presentation Linkbase Document
101.DEF
 
XBRL Taxonomy Extension
 
Definition Linkbase Document
 
*
The certifications attached as exhibits 32.1 and 32.2 to
 
this annual report on Form 10-K are “furnished” to the
Securities and Exchange Commission pursuant to Section 906
 
of the Sarbanes-Oxley Act of 2002 and shall not be
deemed “filed” by the Company for purposes of Section 18
 
of the Securities Exchange Act of 1934, as amended.
 
 
 
 
 
117
 
(c)
Financial Statement Schedules
 
All financial statement schedules required pursuant to this item were
 
either included in the financial information set
forth in (a) above or are inapplicable and therefore have been
 
omitted.
 
 
ITEM 16.
FORM 10-K SUMMARY
 
None.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
 
Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto
 
duly authorized, in the City of Auburn, State of
Alabama, on March 9, 2021.
 
 
AUBURN NATIONAL
 
BANCORPORATION,
 
INC.
(Registrant)
By:
 
/S/ ROBERT W.
 
DUMAS
Robert W.
 
Dumas
Chairman, President and CEO
 
Pursuant to the requirements of the Securities Exchange Act of 1934,
 
this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on
 
the dates indicated.
 
 
Signature
 
Title
Date
 
/S/ ROBERT W.
 
DUMAS
Robert W.
 
Dumas
 
Chairman of the Board, President and Chief Executive
Officer
(Principal Executive Officer)
March 9, 2021
 
/S/ DAVID
 
A. HEDGES
David A. Hedges
 
EVP,
 
Chief Financial Officer
(Principal Financial Officer)
March 9, 2021
 
/S/ C. WAYNE
 
ALDERMAN
C. Wayne Alderman
 
Director
March 9, 2021
 
/S/ TERRY W.
 
ANDRUS
Terry W.
 
Andrus
 
Director
March 9, 2021
 
/S/ J. TUTT BARRETT
J. Tutt Barrett
 
Director
March 9, 2021
 
/S/ LAURA J. COOPER
Laura Cooper
 
Director
March 9, 2021
 
/S/ WILLIAM F. HAM,
 
JR.
William F.
 
Ham, Jr.
 
Director
March 9, 2021
 
/S/ DAVID
 
E. HOUSEL
David E. Housel
 
Director
March 9, 2021
 
/S/ ANNE M. MAY
Anne M. May
 
Director
March 9, 2021
 
/S/ EDWARD
 
LEE SPENCER, III
Edward Lee Spencer, III
 
Director
March 9, 2021