AUBURN NATIONAL BANCORPORATION, INC
10-Ks and 10-Qs
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
☒
For the quarterly period ended
☐
For the transition period __________ to __________
Commission File Number:
(Exact Name of Registrant as Specified in Its Charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification 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
☒
☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required
to submit such files).
Yes
☒
☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting
company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated filer
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Accelerated filer
☐
☒
Smaller reporting company
☒
Emerging growth company
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for
complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
☐
☒
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
Outstanding at August 3, 2022
Common Stock, $0.01 par value per share
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
INDEX
PAGE
Item 1
3
4
5
6
7
8
Item 2
27
49
50
51
52
53
54
55
Item 3
56
Item 4
56
Item 1
56
Item 1A
56
Item 2
57
Item 3
57
Item 4
57
Item 5
57
Item 6
58
3
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
June 30,
December 31,
(Dollars in thousands, except share data)
2022
2021
Assets:
Cash and due from banks
$
$
Federal funds sold
Interest-bearing bank deposits
Cash and cash equivalents
Securities available-for-sale
Loans held for sale
Loans, net of unearned income
440,872
458,364
Allowance for loan losses
(4,716 )
(4,939 )
Loans, net
Premises and equipment, net
Bank-owned life insurance
Other assets
Total assets
$
$
Liabilities:
Deposits:
Noninterest-bearing
$
$
Interest-bearing
Total deposits
Federal funds purchased and securities sold under agreements to repurchase
Accrued expenses and other liabilities
Total liabilities
Stockholders' equity:
Preferred stock of $
no shares issued
Common stock of $
issued
Additional paid-in capital
Retained earnings
Accumulated other comprehensive (loss) income, net
(28,419 )
Less treasury stock, at cost -
and December 31, 2021, respectively
(11,303 )
(10,972 )
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
$
See accompanying notes to consolidated financial statements
4
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
(Unaudited)
Quarter ended June 30,
Six months ended June 30,
(Dollars in thousands, except share and per share data)
2022
2021
2022
2021
Interest income:
Loans, including fees
$
$
$
$
Securities:
Taxable
Tax-exempt
Federal funds sold and interest-bearing bank deposits
Total interest income
Interest expense:
Deposits
Short-term borrowings
Total interest expense
Net interest income
Provision for loan losses
(600 )
(250 )
(600 )
Net interest income after provision for loan losses
Noninterest income:
Service charges on deposit accounts
Mortgage lending
Bank-owned life insurance
Other
Total noninterest income
Noninterest expense:
Salaries and benefits
Net occupancy and equipment
Professional fees
Other
Total noninterest expense
Earnings before income taxes
Income tax expense
Net earnings
$
$
$
$
Net earnings per share:
Basic and diluted
$
$
$
$
Weighted average shares outstanding:
Basic and diluted
See accompanying notes to consolidated financial statements
5
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Unaudited)
Quarter ended June 30,
Six months ended June 30,
(Dollars in thousands)
2022
2021
2022
2021
Net earnings
$
$
$
$
Other comprehensive (loss) income, net of tax:
Unrealized net (loss) gain on securities
(10,964 )
(29,310 )
(3,344 )
Other comprehensive (loss) income
(10,964)
1,788
(29,310 )
(3,344 )
Comprehensive (loss) income
$
(9,163 )
$
$
(25,428 )
$
See accompanying notes to consolidated financial statements
6
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(Unaudited)
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
Quarter ended June 30, 2022
Balance, March 31, 2022
$
$
$
$
(17,455 )
$
(11,091 )
$
Net earnings
—
Other comprehensive loss
—
(10,964 )
(10,964 )
Cash dividends paid ($
—
(930 )
(930 )
Stock repurchases
(7,081 )
(212 )
(212 )
Sale of treasury stock
Balance, June 30, 2022
$
$
$
$
(28,419 )
$
(11,303 )
$
Quarter ended June 30, 2021
Balance, March 31, 2021
$
$
$
$
$
(9,354 )
$
Net earnings
—
Other comprehensive income
—
Cash dividends paid ($
—
(922 )
(922 )
Stock repurchases
(20,511 )
(750 )
(750 )
Sale of treasury stock
Balance, June 30, 2021
$
$
$
$
$
(10,103 )
$
Six months ended June 30, 2022
Balance, December 31, 2021
$
$
$
$
$
(10,972 )
$
Net earnings
—
3,882
Other comprehensive loss
—
(29,310 )
(29,310 )
Cash dividends paid ($
—
(1,862 )
(1,862 )
Stock repurchases
(10,640 )
(331 )
(331 )
Sale of treasury stock
Balance, June 30, 2022
$
$
$
$
(28,419 )
$
(11,303 )
$
Six months ended June 30, 2021
Balance, December 31, 2020
$
$
$
$
$
(9,354 )
$
Net earnings
—
4,292
Other comprehensive loss
—
(3,344 )
(3,344 )
Cash dividends paid ($
—
(1,849 )
(1,849 )
Stock repurchases
(20,511 )
(750 )
(750 )
Sale of treasury stock
Balance, June 30, 2021
$
$
$
$
$
(10,103 )
$
See accompanying notes to consolidated financial statements
7
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Six months ended June 30,
(Dollars in thousands)
2022
2021
Cash flows from operating activities:
Net earnings
$
$
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Provision for loan losses
(250 )
(600 )
Depreciation and amortization
Premium amortization and discount accretion, net
Net gain on sale of loans held for sale
(349 )
(935 )
Net gain on other real estate owned
(162 )
Loans originated for sale
(8,027 )
(32,608 )
Proceeds from sale of loans
Increase in cash surrender value of bank-owned life insurance
(196 )
(202 )
Net (increase) decrease in other assets
(9,152 )
Net increase (decrease) in accrued expenses and other liabilities
(2,404 )
Net cash provided by operating activities
Cash flows from investing activities:
Proceeds from prepayments and maturities of securities available-for-sale
Purchase of securities available-for-sale
(77,776 )
(94,297 )
Increase in loans, net
Net purchases of premises and equipment
(4,059 )
(7,926 )
(Increase) decrease in FHLB stock
(74 )
Proceeds from sale of other real estate owned
Net cash used in investing activities
(34,284 )
(58,947 )
Cash flows from financing activities:
Net (decrease) increase in noninterest-bearing deposits
(4,924 )
Net increase in interest-bearing deposits
Net increase in federal funds purchased and securities sold
under agreements to repurchase
Stock repurchases
(331 )
(750 )
Dividends paid
(1,862 )
(1,849 )
Net cash provided by financing activities
Net change in cash and cash equivalents
(23,145 )
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
$
$
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest
$
$
Income taxes
See accompanying notes to consolidated financial statements
8
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
Auburn National Bancorporation, Inc. (the “Company”) provides a full range of banking services to individuals and
commercial customers in Lee County, Alabama and surrounding counties through its wholly owned subsidiary,
AuburnBank (the “Bank”). The Company does not have any segments other than banking that are considered material.
Basis of Presentation and Use of Estimates
The unaudited consolidated financial statements in this report have been prepared in accordance with U.S. generally
accepted accounting principles (“GAAP”) for interim financial information. Accordingly, these financial statements do not
include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited
consolidated financial statements include, in the opinion of management, all adjustments necessary to present a fair
statement of the financial position and the results of operations for all periods presented. All such adjustments are of a
normal recurring nature. The results of operations in the interim statements are not necessarily indicative of the results of
operations that the Company and its subsidiaries may achieve for future interim periods or the entire year. For further
information, refer to the consolidated financial statements and footnotes included in the Company's Annual Report on Form
10-K for the year ended December 31, 2021.
The unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.
Significant intercompany transactions and accounts are eliminated in consolidation.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of
the balance sheet date and the reported amounts of revenues and expenses 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 other-than-temporary impairment on investment securities, the determination of the allowance for loan losses, fair
value of financial instruments, and the valuation of deferred tax assets and other real estate owned (“OREO”).
Revenue Recognition
On January 1, 2018, the Company implemented Accounting Standards Update (“ASU” or “updates”) 2014-09,
from Contracts with Customers
, codified at
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 securities 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 OREO
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 ratio, 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 we believe may affect collectability.
9
Subsequent Events
The Company has evaluated the effects of events and transactions through the date of this filing that have occurred
subsequent to June 30, 2022. The Company does not believe there were any material subsequent events during this period
that would have required further recognition or disclosure in the unaudited consolidated financial statements included in
this report.
Reclassifications
Certain amounts reported in prior periods have been reclassified to conform to the current -period presentation. These
reclassifications had no effect on the Company’s previously reported net earnings or total stockholders’ equity.
Accounting Developments
In the first six months of 2022, the Company did not adopt any new accounting guidance.
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 respective period. 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. At June 30, 2022 and 2021,
respectively, the Company had no such securities or 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 periods are presented below
Quarter ended June 30,
Six months ended June 30,
(Dollars in thousands, except share and per share data)
2022
2021
2022
2021
Basic and diluted:
Net earnings
$
$
$
$
Weighted average common shares outstanding
Net earnings per share
$
$
$
$
NOTE 3: VARIABLE INTEREST ENTITIES
Generally, a variable interest entity (“VIE”) is a corporation, partnership, trust or other legal structure that does not have
equity investors with substantive or proportional voting rights or has equity investors that do not provide sufficient financial
resources for the entity to support its activities.
At June 30, 2022, the Company did not have any consolidated VIEs to disclose but did have one nonconsolidated VIE,
discussed below.
10
New Markets Tax Credit Investment
The New Markets Tax Credit (“NMTC”) program provides federal tax incentives to investors to make investments in
distressed communities and promotes economic improvement through the development of successful businesses in these
communities. The NMTC is available to investors over seven years and is subject to recapture if certain events occur
during such period. At June 30, 2022 and December 31, 2021, respectively, the Company had one such investment in the
amounts of $2.1 million and $2.2 million, respectively, which was included in other assets in the consolidated balance
sheets. The Company’s equity investment meets the definition of a VIE. While the Company’s investment exceeds 50% of
the outstanding equity interests, the Company does not consolidate the VIE because it does not meet the characteristics of a
primary beneficiary since the Company lacks the power to direct the activities of the VIE.
(Dollars in thousands)
Maximum
Loss Exposure
Asset Recognized
Classification
Type:
New Markets Tax Credit investment
$
$
Other assets
NOTE 4: SECURITIES
At June 30, 2022 and December 31, 2021, 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 June 30, 2022 and December 31, 2021, 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
June 30, 2022
Agency obligations (a)
$
$
Agency MBS (a)
State and political subdivisions
Total available-for-sale
$
$
December 31, 2021
Agency obligations (a)
$
$
Agency MBS (a)
State and political subdivisions
Total available-for-sale
$
$
(a) Includes securities issued by U.S. government agencies or government-sponsored entities.
Securities with aggregate fair values of $
respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, Federal Home Loan
Bank of Atlanta (“FHLB of Atlanta”) advances, and for other purposes required or permitted by law.
Included in other assets on the accompanying consolidated balance sheets are non-marketable equity investments. The
carrying amounts of non-marketable equity investments were $
respectively. Non-marketable equity investments include FHLB of Atlanta Stock, Federal Reserve Bank of Atlanta
(“FRB”) stock, and stock in a privately held financial institution.
11
Gross Unrealized Losses and Fair Value
The fair values and gross unrealized losses on securities at June 30, 2022 and December 31, 2021, respectively, segregated
by those securities that have been in an unrealized loss position for less than 12 months and 12 months or longer, 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
June 30, 2022:
Agency obligations
$
$
Agency MBS
State and political subdivisions
Total
$
$
December 31, 2021:
Agency obligations
$
$
Agency MBS
State and political subdivisions
Total
$
$
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 securities 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 security’s fair value;
●
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 increases in market 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.
12
Agency mortgage-backed securities (“MBS”)
The unrealized losses associated with agency MBS were primarily driven by increases in market interest rates and not due
to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored
entities and did not have any credit losses given the explicit government guarantee or other government support.
Securities of U.S. states and political subdivisions
The unrealized losses associated with securities of U.S. states and political subdivisions were primarily driven by increases
in market 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 such guarantees 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 market interest rates continue to
increase. If the financial condition of an issuer (other than the U.S. government or its agencies) deteriorates and the
Company determines it is probable that it will not recover the entire amortized cost basis for the security, there is a risk that
other-than-temporary impairment charges may occur in the future.
temporary or not.
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 June 30,
2022 and December 31, 2021, 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 quarters and six months ended June 30,
2022 and 2021, respectively.
Realized Gains and Losses
The Company had no realized gains and losses on sale of securities during the quarters and six months ended June 30, 2022
and 2021, respectively.
NOTE 5: LOANS AND ALLOWANCE FOR LOAN LOSSES
June 30,
December 31,
(Dollars in thousands)
2022
2021
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
34,365
Multi-family
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total loans
Less: unearned income
(511 )
(759 )
Loans, net of unearned income
$
$
13
Loans secured by real estate were approximately
82.5%
2022, the Company’s geographic loan distribution was concentrated primarily in Lee County, Alabama, and surrounding
areas.
In accordance with ASC 310, 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 included 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 describes the risk characteristics relevant to each of the portfolio segments and classes.
Commercial and industrial (“CI”) —
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. As of June 30, 2022, the Company had
million included in this category, compared to
December 31, 2021.
Construction and land development (“CD”) —
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 credit
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 four classes: (1) owner occupied, (2) hotel/motel,
(3) multifamily and (4) other.
●
Owner occupied
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.
●
Multi-family
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
multi-family properties, and which are not owner occupied. Loans in this class include loans for neighborhood
retail centers, medical and professional offices, single retail stores, industrial buildings, and warehouses leased to
local businesses. 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
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.
14
●
Investment property
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 and property value, as
well as the financial health of the borrower.
Consumer installment —
includes loans to individuals both secured by personal property and unsecured. Loans include
personal lines of credit, automobile loans, and other retail loans. These loans are underwritten in accordance with the
Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s
financial condition, satisfactory credit history, and, if applicable, property value.
The following is a summary of current, accruing past due, and nonaccrual loans by portfolio segment and class as of June
30, 2022 and December 31, 2021.
Accruing
Accruing
Total
30-89 Days
Greater than
Accruing
Non-
Total
(Dollars in thousands)
Current
Past Due
90 days
Loans
Accrual
Loans
June 30, 2022:
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
Multi-family
29,722
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total
$
$
December 31, 2021:
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
Multi-family
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total
$
$
15
Allowance for Loan Losses
The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of
the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality
trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including
the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic
conditions, industry and peer bank loan loss rates, and other pertinent factors, including regulatory recommendations. This
evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or
in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off
after a “confirming event” has occurred, which serves to validate that full repayment pursuant to the terms of the loan is
unlikely.
The Company deems loans impaired when, based on current information and events, it is probable that the Company will
be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due
according to the contractual terms means that both the interest and principal payments of a loan will be collected as
scheduled in the loan agreement.
An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The
impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected
future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, the 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 and independent
loan review processes. 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 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 evaluates the loan portfolio’s five segments:
commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer
installment. 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 each
loan segment. 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 June 30, 2022 and December 31, 2021, and for the periods 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 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.
16
The Company regularly re-evaluates its practices in determining the allowance for loan losses. The Company’s look-back
period each quarter incorporates the effects of at least one economic downturn in its loss history. The Company believes
this look-back period is appropriate due to the risks inherent in the loan portfolio. Absent this look-back period, 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 quarter ended June 30, 2022, the Company increased its
look-back period to 53 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 the second quarter of 2021, the Company adjusted certain qualitative and economic
factors, previously downgraded as a result of the COVID-19 pandemic, to reflect improvements in economic conditions in
our primary market area. Further adjustments may be made from time to time in the future as a result of the COVID-19
pandemic and other changes in economic conditions.
The following table details the changes in the allowance for loan losses by portfolio segment for the respective periods.
June 30, 2022
(Dollars in thousands)
Commercial and
industrial
Construction
and land
development
Commercial
real estate
Residential
real estate
Consumer
installment
Total
Quarter ended:
Beginning balance
$
$
Charge-offs
(4 )
(16 )
(20 )
Recoveries
Net (charge-offs) recoveries
(2 )
Provision for loan losses
(11 )
(35 )
(31 )
Ending balance
$
$
Six months ended:
Beginning balance
$
$
Charge-offs
(4 )
(64 )
(68 )
Recoveries
Net recoveries (charge-offs)
(9 )
Provision for loan losses
(96 )
(238 )
(250 )
Ending balance
$
$
June 30, 2021
(Dollars in thousands)
Commercial and
industrial
Construction
and land
development
Commercial
real estate
Residential
real estate
Consumer
installment
Total
Quarter ended:
Beginning balance
$
$
Charge-offs
(1 )
(1 )
Recoveries
Net recoveries
Provision for loan losses
(1 )
(598 )
(82 )
(7 )
(600 )
Ending balance
$
$
Six months ended:
Beginning balance
$
$
Charge-offs
(1 )
(5 )
(6 )
Recoveries
Net recoveries
Provision for loan losses
(32 )
(465 )
(131 )
(17 )
(600 )
Ending balance
$
$
17
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 June 30, 2022 and 2021.
Collectively evaluated (1)
Individually evaluated (2)
Total
Allowance
Recorded
Allowance
Recorded
Allowance
Recorded
for loan
investment
for loan
investment
for loan
investment
(Dollars in thousands)
losses
in loans
losses
in loans
losses
in loans
June 30, 2022:
Commercial and industrial (3)
$
Construction and land development
Commercial real estate
Residential real estate
Consumer installment
Total
$
4,716
June 30, 2021:
Commercial and industrial (4)
$
Construction and land development
Commercial real estate
Residential real estate
Consumer installment
Total
$
(1)
Represents loans collectively evaluated for impairment in accordance with ASC 450-20,
Loss Contingencies
, and
pursuant to amendments by ASU 2010-20 regarding allowance for non-impaired loans.
(2)
Represents loans individually evaluated for impairment in accordance with ASC 310-30,
Receivables
, and
pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.
(3)
Includes $0.6 million of PPP loans for which no allowance for loan losses was allocated due to 100% SBA guarantee.
(4)
Includes $22.1 million of PPP loans for which no allowance for loan losses was allocated due to 100% SBA guarantee.
See “Impaired Loans” and “Troubled Debt Restructurings” below for additional information about such 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 not
expected.
18
(Dollars in thousands)
Mention
Substandard
Accruing
Nonaccrual
Total loans
June 30, 2022:
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
Multi-family
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total
$
$
December 31, 2021:
Commercial and industrial
$
$
Construction and land development
Commercial real estate:
Owner occupied
Hotel/motel
Multi-family
Other
Total commercial real estate
Residential real estate:
Consumer mortgage
Investment property
Total residential real estate
Consumer installment
Total
$
$
Impaired loans
The following tables present details related to the Company’s impaired loans. Loans that have been fully charged-off are
not included in the following tables. The related allowance generally represents the following components that 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 loans).
●
Individually evaluated impaired loans equal to or greater than $250 thousand not secured by real estate
(nonaccrual commercial and industrial and consumer installment loans).
19
The following tables set forth certain information regarding the Company’s impaired loans that were individually evaluated
for impairment at June 30, 2022 and December 31, 2021.
June 30, 2022
(Dollars 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
$
(23 )
$
Total commercial real estate
(23 )
Total impaired loans
$
(23 )
$
(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been
applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before
December 31, 2021
(Dollars in thousands)
Unpaid principal
balance (1)
Charge-offs and
payments applied
(2)
Recorded
investment (3)
Related allowance
With no allowance recorded:
Commercial real estate:
Other
$
(18 )
$
Total commercial real estate
(18 )
Residential real estate:
Investment property
(6 )
Total residential real estate
(6 )
Total impaired loans
$
(24 )
$
(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been
applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before
20
The following table provides the average recorded investment in impaired loans, if any, by portfolio segment, and the
amount of interest income recognized on impaired loans after impairment by portfolio segment and class during the
respective periods.
Quarter ended June 30, 2022
Six months ended June 30, 2022
Average
Total interest
Average
Total interest
recorded
income
recorded
income
(Dollars in thousands)
investment
recognized
investment
recognized
Impaired loans:
Commercial real estate:
Other
$
Total commercial real estate
Residential real estate:
Investment property
Total residential real estate
Total
$
Quarter ended June 30, 2021
Six months ended June 30, 2021
Average
Total interest
Average
Total interest
recorded
income
recorded
income
(Dollars in thousands)
investment
recognized
investment
recognized
Impaired loans:
Commercial real estate:
Other
$
Total commercial real estate
Residential real estate:
Investment property
Total residential real estate
Total
$
Troubled Debt Restructurings
Impaired loans also include troubled debt restructurings (“TDRs”). Section 4013 of the CARES Act, “Temporary Relief
From Troubled Debt Restructurings,” provided 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, encouraged 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 was eligible, a bank could elect to account for the loan under
section 4013 of the CARES Act. If a loan modification was not eligible under section 4013, or if the bank elected not to
account for the loan modification under section 4013, the Revised Statement include d 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 and related regulatory guidance 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 risk characteristics similar to 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.
21
Similar to other impaired loans, TDRs are measured for impairment based on the present value of expected payments using
the loan’s original effective interest rate as the discount rate, or the fair value of the collateral, less selling costs if the loan is
collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, impairment is recognized by
establishing a valuation allowance as part of the allowance for loan losses or a charge -off to the allowance for loan losses.
In periods subsequent to the modification, all TDRs are evaluated individually, including those that have payment defaults,
for possible impairment.
The following is a summary of accruing and nonaccrual TDRs, which are included in the impaired loan totals, and the
related allowance for loan losses, by portfolio segment and class as of June 30, 2022 and December 31, 2021, respectively.
TDRs
Related
(Dollars in thousands)
Accruing
Nonaccrual
Total
Allowance
June 30, 2022
Commercial real estate:
Other
$
$
—
Total commercial real estate
—
Total
$
$
—
TDRs
Related
(In thousands)
Accruing
Nonaccrual
Total
Allowance
December 31, 2021
Commercial real estate:
Other
$
$
—
Total commercial real estate
—
Investment property
—
Total residential real estate
—
Total
$
$
—
At June 30, 2022 there were no significant outstanding commitments to advance additional funds to customers whose loans
had been restructured.
There were no loans modified in a TDR during the quarters and six months ended June 30, 2022 and 2021,
respectively. For the same periods, the Company had no loans modified in a TDR within the previous 12 months for which
there was a payment default.
NOTE 6: MORTGAGE SERVICING RIGHTS, NET
Mortgage servicing rights (“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 fair value 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 rates, default rates, costs 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 Company has recorded MSRs related to loans sold without recourse to Fannie Mae. The Company generally sells
conforming, fixed-rate, closed-end, residential mortgages to Fannie Mae. MSRs are included in other assets on the
accompanying consolidated balance sheets.
The Company evaluates MSRs for impairment on a quarterly basis. Impairment is determined by stratifying MSRs into
groupings based on predominant risk characteristics, such as interest rate and loan type. If, by individual stratum, the
carrying amount of the MSRs exceeds fair value, a valuation allowance is established. The valuation allowance is adjusted
as the fair value changes. Changes in the valuation allowance are recognized in earnings as a component of mortgage
lending income.
22
The following table details the changes in amortized MSRs and the related valuation allowance for the respective periods.
Quarter ended June 30,
Six months ended June 30,
(Dollars in thousands)
2022
2021
2022
2021
MSRs, net:
Beginning balance
$
$
$
$
Additions, net
Amortization expense
(69 )
(134 )
(147 )
(285 )
Ending balance
$
$
$
$
Valuation allowance included in MSRs, net:
Beginning of period
$
$
$
$
End of period
Fair value of amortized MSRs:
Beginning of period
$
$
$
$
End of period
NOTE 7: FAIR VALUE
Fair Value Hierarchy
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 each 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 six months ended June 30, 2022, there were no
transfers between levels and no changes in valuation techniques for the Company’s financial assets and liabilities.
23
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, benchmark yields, reported trades for similar securities, market
consensus prepayment speeds, credit information, and the securities’ terms and conditions. On a quarterly basis,
management reviews the pricing received from the third party pricing services for reasonableness given current market
conditions. As part of its review, management may obtain non-binding third party broker quotes to validate the fair value
measurements. In addition, management will periodically submit pricing provided by the third party pricing services to
another independent valuation firm on a sample basis. This independent valuation firm will compare the price provided by
the third party pricing service with its own price and will review the significant assumptions and valuation methodologies
used with management.
The following table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of June
30, 2022 and December 31, 2021, 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)
June 30, 2022:
Securities available-for-sale:
Agency obligations
$
Agency RMBS
State and political subdivisions
Total securities available-for-sale
Total assets at fair value
$
December 31, 2021:
Securities available-for-sale:
Agency obligations
$
Agency RMBS
State and political subdivisions
Total securities available-for-sale
Total assets at fair value
$
Assets and liabilities measured at fair value on a nonrecurring basis
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.
24
The fair value of impaired loans was primarily measured based on the value of the collateral securing these loans. Impaired
loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including
equipment, inventory, and/or accounts receivable. The Company determines the value of the collateral based on
independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach
or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for
costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions
from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the
customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for
determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment
and adjusted accordingly, based on the same factors discussed above.
Other real estate owned
Other real estate owned, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially
recorded at the lower of the loan’s carrying amount or the fair value less costs to sell upon transfer of the loans to other real
estate. Subsequently, other real estate is carried at the lower of carrying value or fair value less costs to sell. Fair values are
generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The
appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market
conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and
the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases
where the carrying amount exceeds the fair value, less costs to sell, a loss is recognized in noninterest expense.
Mortgage servicing rights, net
MSRs, 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 rates, 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.
25
The following table presents the balances of the assets and liabilities measured at fair value on a nonrecurring basis as of
June 30, 2022 and December 31, 2021, respectively, by caption, on the accompanying consolidated balance sheets and by
FASB ASC 820 valuation hierarchy (as described above):
Quoted Prices in
Active Markets
Other
Significant
for
Observable
Unobservable
Carrying
Identical Assets
Inputs
Inputs
(Dollars in thousands)
Amount
(Level 1)
(Level 2)
(Level 3)
June 30, 2022:
Loans held for sale
$
Loans, net
(1)
Other assets
(2)
Total assets at fair value
$
December 31, 2021:
Loans held for sale
$
Loans, net
(1)
Other assets
(2)
Total assets at fair value
$
(1)
Loans considered impaired under ASC 310-10-35 Receivables. This amount reflects the recorded investment in impaired loans, net
of any related allowance for loan losses.
(2)
Represents other real estate owned and MSRs, net, carried at lower of cost or estimated fair value.
Quantitative Disclosures for Level 3 Fair Value Measurements
At June 30, 2022 and December 31, 2021, 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 at June 30, 2022 and December 31, 2021, 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
June 30, 2022:
Impaired loans
$
Appraisal
Appraisal discounts
-
%
%
Mortgage servicing rights, net
Discounted cash flow
Prepayment speed or CPR
-
Discount rate
-
December 31, 2021:
Impaired loans
$
Appraisal
Appraisal discounts
-
%
%
Other real estate owned
Appraisal
Appraisal discounts
-
Mortgage servicing rights, net
Discounted cash flow
Prepayment speed or CPR
-
Discount rate
-
Fair Value of Financial Instruments
ASC 825,
Financial Instruments
, requires disclosure of fair value information about financial instruments, whether or not
recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the
estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are
not available, fair values are based on estimates using discounted cash flow analyses. Discounted cash flows can be
significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The
following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered
representative of the liquidation value of the Company’s financial instruments, but rather are 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.
26
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 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.
The carrying value, related estimated fair value, and placement in the fair value hierarchy of the Company’s financial
instruments at June 30, 2022 and December 31, 2021 are presented below. This table excludes financial instruments for
which the carrying amount approximates fair value. Financial assets for which fair value approximates carrying value
included cash and cash equivalents. Financial liabilities for which fair value approximates carrying value included
noninterest-bearing demand deposits, interest-bearing demand deposits, and savings deposits. Fair value approximates
carrying value in these financial liabilities due to these products having no stated maturity. Additionally, financial
liabilities for which fair value approximates carrying value included overnight borrowings such as federal funds purchased
and securities sold under agreements to repurchase.
Fair Value Hierarchy
Carrying
Estimated
Level 1
Level 2
Level 3
(Dollars in thousands)
amount
fair value
inputs
inputs
Inputs
June 30, 2022:
Financial Assets:
Loans, net (1)
$
$
$
$
$
Loans held for sale
Financial Liabilities:
Time Deposits
$
$
$
$
$
December 31, 2021:
Financial Assets:
Loans, net (1)
$
$
$
$
$
Loans held for sale
Financial Liabilities:
Time Deposits
$
$
$
$
$
(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.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
General
The following discussion and analysis is designed to provide a better understanding of various factors related to the results
of operations and financial condition of the Company and the Bank. This discussion is intended to supplement and
highlight information contained in the accompanying unaudited condensed consolidated financial statements and related
notes for the quarters and six months ended June 30, 2022 and 2021, as well as the information contained in our Annual
Report on Form 10-K for the year ended December 31, 2021 and our Quarterly Reports on Form 10-Q.
Special Notice 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, as
amended (the “Securities Act”) 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 inflation, seasonality, natural disasters or climate change, such as rising sea and water levels, hurricanes
and tornados, COVID-19 or other epidemics or pandemics including supply chain disruptions, inventory volatility,
and changes in consumer behaviors;
●
the effects of war or other conflicts, acts of terrorism, or other events that may affect general economic conditions;
●
governmental monetary and fiscal policies, including the continuing effects of COVID-19 fiscal and monetary
stimulus, and changes in monetary policies in response to inflations including increases in the Federal Reserve’s
target federal funds rate and reductions in the Federal Reserve’s holdings of securities;
●
legislative and regulatory changes, including changes in banking, securities and tax laws, regulations and rules and
their application by our regulators, including capital and liquidity requirements, and changes in the scope and cost
of FDIC insurance;
●
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 mortgage
loan originations, and the values and liquidity of loan collateral, securities, and interest-sensitive assets and
liabilities, and the risks and uncertainty of the amounts realizable on collateral;
●
changes in borrower liquidity and credit risks, and savings, deposit and payment behaviors;
●
changes in the availability and cost of credit and capital in the financial markets, and the types of instruments that
may be included as capital for regulatory purposes;
28
●
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, the timing and amount of rental income from third parties following
the June 2022 opening of this building, and the timing and amount of the sale of approximately 0.85 acres of land
next to the Company’s headquarters for development by a third party as a hotel;
●
the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of
implementing such transactions, integrating operations as part of these transactions and possible failures to achieve
expected gains, revenue growth and/or expense savings from such transactions;
●
changes in technology or products that may be more difficult, costly, or less effective than anticipated;
●
cyber-attacks and data breaches that may compromise our systems, our vendor systems or customers’
information;
●
the risks that our deferred tax assets (“DTAs”), if any, could be reduced if estimates of future taxable income from
our operations and tax planning strategies are less than currently estimated, and sales of our capital stock could
trigger a reduction in the amount of net operating loss carry-forwards that we may be able to utilize for income tax
purposes;
●
the timing and amount of any credit approved by the Internal Revenue Service (“IRS”) resulting from our planned
filing, seeking an Employee Retention Credit, which we believe we are eligible for under the CARES Act and the
2020 Consolidated Appropriations Act; and
●
other factors and information in this report and other filings that we make with the SEC under the Exchange Act,
including our Annual Report on Form 10-K for the year ended December 31, 2021 and subsequent quarterly and
current reports. See Part II, Item 1A. “RISK FACTORS”.
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.
29
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.
Certain of the statements made in this discussion and analysis and elsewhere, including information incorporated herein by
reference to other documents, are “forward-looking statements” within the meaning of, and subject to, the protections of
Section 27A of the Securities Act.
Summary of Results of Operations
Quarter ended June 30,
Six months ended June 30,
(Dollars in thousands, except per share amounts)
2022
2021
2022
2021
Net interest income (a)
$
6,484
$
6,093
$
12,674
$
12,150
Less: tax-equivalent adjustment
110
118
222
238
Net interest income (GAAP)
6,374
5,975
12,452
11,912
Noninterest income
848
1,131
1,756
2,313
Total revenue
7,222
7,106
14,208
14,225
Provision for loan losses
—
(600)
(250)
(600)
Noninterest expense
5,058
4,916
9,959
9,606
Income tax expense
363
504
617
927
Net earnings
$
1,801
$
2,286
$
3,882
$
4,292
Basic and diluted earnings per share
$
0.51
$
0.65
$
1.10
$
1.21
(a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures."
Financial Summary
The Company’s net earnings were $3.9 million for the first six months of 2022, compared to $4.3 million for the first six
months of 2021. Basic and diluted earnings per share were $1.10 per share for the first six months of 2022, compared to
$1.21 per share for the first six months of 2021.
Net interest income (tax-equivalent) was $12.7 million for the first six months of 2022, a 4% increase compared to $12.2
million for the first six months of 2021. This increase was primarily due to balance sheet growth, partially offset by a
decrease in the Company’s net interest margin (tax-equivalent). Net interest margin (tax-equivalent) declined to 2.51% in
the first six months of 2022, compared to 2.63% for the first six months of 2021 due to the continued lower interest rate
environment through most of the first quarter followed by increases in the Federal Reserve’s target federal funds rates
beginning March 16, 2022, and changes in our asset mix resulting from the continuing elevated levels of customer deposits.
Net interest income (tax-equivalent) included $0.3 million in PPP loan fees, net of related costs for the first six months of
2022, compared to $0.4 million for the first six months of 2021.
At June 30, 2022, the Company’s allowance for loan losses was $4.7 million, or 1.07% of total loans, compared to $4.9
million, or 1.08% of total loans, at December 31, 2021, and $5.7 million, or 1.12% of total loans, at June 30, 2021.
The Company recorded a negative provision for loan losses of $0.3 million and $0.6 million during the first six months of
2022 and 2021, respectively. The negative provision for loan losses during 2022 was primarily related to a decrease in total
loans, excluding PPP, during the first six months of 2022. The negative provision for loan losses during 2021 was
primarily related to improvements in economic conditions in our primary market area, and related improvements in our
asset quality. The provision for loan losses is based upon various estimates and judgments, including the absolute level of
loans, economic conditions, credit quality and the amount of net charge -offs.
Noninterest income was $1.8 million for the first six months of 2022 compared to $2.3 million for the first six months of
2021. The decrease in noninterest income was primarily due to a decrease in mortgage lending income of $0.5 million as
refinance activity slowed in our primary market area, as market interest rates on mortgage loans increased.
Noninterest expense was $10.0 million for the first six months of 2022 compared to $9.6 million for the first six months of
2021. The increase in noninterest expense was due to increases in salaries and benefits expense of $0.2 million and net
occupancy and equipment expense of $0.3 million related to the Company’s new headquarters, partially offset by a
decrease in professional fees of $0.1 million.
30
Income tax expense was $0.6 million for the first six months of 2022 compared to $0.9 million during the first six months
of 2021. The Company’s effective tax rate for the first six months of 2022 was 13.71%, compared to 17.76% in the first six
months of 2021. The decrease was primarily due to an income tax benefit related to a New Markets Tax Credit investment
funded in the fourth quarter of 2021. The Company’s effective income tax rate is principally impacted by tax-exempt
earnings from the Company’s investments in municipal securities, bank-owned life insurance, and New Markets Tax
Credits.
The Company paid cash dividends of $0.53 per share in the first six months of 2022, an increase of 2% from the same
period of 2021. The Company’s share repurchases of $0. 3 million since December 31, 2021 resulted in 10,640 fewer
outstanding common shares at June 30, 2022. At June 30, 2022, the Bank’s regulatory capital ratios were well above the
minimum amounts required to be “well capitalized” under current regulatory standards with a total risk-based capital ratio
of 17.38%, a tier 1 leverage ratio of 9.16 % and a common equity tier 1 (“CET1”) ratio of 16.59 % at June 30, 2022.
For the second quarter of 2022, net earnings were $1.8 million, or $0.51 per share, compared to $2.3 million, or $0.65 per
share, for the second quarter of 2021. Net interest income (tax-equivalent) was $6.5 million for the second quarter of 2022,
a 6% increase compared to $6.1 million for the second quarter of 2021. This increase was primarily due to balance sheet
growth, and recent increases in market interest rates. The Federal Reserve increased the target federal funds range by 25
basis points on March 27, 2022, 50 basis points on May 5 and 75 basis points on each of June 16 and July 27. Further
increases in the target federal funds rate are possible if inflation remains elevated. The Company’s net interest margin (tax-
equivalent) was 2.60% in the second quarter of 2022 and 2021. Net interest income (tax-equivalent) included $0.1 million
in PPP loan fees, net of related costs for the second quarter of 2022 and $0.2 million in the second quarter of 2021. The
Company had no provision for loan losses during the second quarter of 2022 compared to a negative provision for loan
losses of $0.6 million during the second quarter 2021. Noninterest income was $0.8 million in the second quarter of 2022,
compared to $1.1 million in the second quarter of 2021. The decrease in noninterest income was primarily due to a
decrease in mortgage lending income of $0.2 million as refinance activity slowed in our primary market area, as market
interest rates on mortgage loans increased. Noninterest expense was $5.1 million in the second quarter of 2022, compared
to $4.9 million for the second quarter of 2021. The increase in noninterest expense was primarily due to an increase in net
occupancy and equipment expense of $0.3 million related to the Company’s new headquarters, which opened in June 2022.
Income tax expense was $0.4 million for the second quarter of 2022 compared to $0.5 million for the second quarter of
2021. The Company's effective tax rate for the second quarter of 2022 was 16.77%, compared to 18.06% in the second
quarter of 2021. This decrease was primarily due to an income tax benefit related to a New Markets Tax Credit investment
funded in the fourth quarter of 2021. The Company’s effective income tax rate is principally impacted by tax-exempt
earnings from the Company’s investment in municipal securities, bank-owned life insurance, and New Markets Tax
Credits.
Other Events
We entered into a contract on February 15, 2022 to sell approximately 0.85 acres of land to a third party, where our former
headquarters building was located. The land, which is adjacent to our new headquarters, has been cleared and site
improvements, which are a condition to the buyer’s obligation to close its purchase, are being made. The sale includes all
appurtenances, privileges, development and rights for an aggregate purchase price of $4.26 million, net of estimated
prorations and closing costs. The principal owner of the purchaser and his related interests are Bank customers and are
among the Bank’s largest borrowers. All such loans and deposits are in the ordinary course of the Bank’s business upon
market terms and conditions not more favorable than similarly situated customers. The Bank entered into the agreement on
an arms-length basis in consultation with the Bank’s real estate developer, and the agreement is on market terms and
conditions.
The agreement contains various other terms, representations, warranties, covenants and closing conditions that are
customary for transactions similar to the sale. The purchaser has a 180 day inspection period ending on August 14, 2022
subject to up to 3 possible extensions, to complete all its due diligence, inspections and reviews, and receive its necessary
approvals. The closing is subject to the completion of such matters satisfactory to the purchaser, the satisfaction of the
agreement’s other terms, including customary closing conditions, and the negotiation and execution of various use and
other ancillary agreements and may be extended. The purchaser’s obligations to close are not contingent upon the purchaser
obtaining financing. The sale of the property is expected to close 30 days following the later of (a) the expiration of the
inspection period and (b) the satisfaction of all the closing conditions. Upon closing, the Company currently expects the
sale to be accretive to earnings by approximately $0.70 per share. Currently, the Bank expects the transaction to close later
this year.
31
We also intend to file a request with the IRS for an employee retention credit of $1.6 million, or approximately $1.2 million
net of estimated income tax effects, or approximately $0.33 per share, under the CARES Act and the 2022 Consolidated
Appropriations Act. IRS action on this request, including its timing and the amount of any credit approved by the IRS,
cannot be predicted. See “COVID-19 Impact Assessment.”
COVID-19 Impact Assessment
The COVID-19 pandemic has occurred in waves of different variants since the first quarter of 2020. Vaccines to protect
against and/or reduce the severity of COVID-19 were widely introduced at the beginning of 2021. At times, the pandemic
has severely restricted the level of economic activity in our markets. In response to the COVID-19 pandemic, the State of
Alabama, and most other states, have taken preventative or protective actions to prevent the spread of the virus, including
imposing restrictions on travel and business operations and a statewide mask mandate, advising or requiring individuals to
limit or forego their time outside of their homes, limitations on gathering of people and social distancing, and causing
temporary closures of businesses that have been deemed to be non-essential. Though certain of these measures have been
relaxed or eliminated, especially as vaccination levels increased, such measures could be reestablished in cases of new
waves, especially a wave of a COVID-19 variant that is more resistant to existing vaccines and newly developed
treatments.
COVID-19 has significantly affected local state, national and global health and economic activity and its future effects are
uncertain and will depend on various factors, including, among others, the duration and scope of the pandemic, especially
new variants of the virus, effective vaccines and drug treatments, together with governmental, regulatory and private sector
responses. COVID-19 has had continuing significant effects on the economy, financial markets and our employees,
customers and vendors. Our business, financial condition and results of oper ations generally rely upon the ability of our
borrowers to make deposits and repay their loans, the value of collateral underlying our secured loans, market value,
stability and liquidity and demand for loans and other products and services we offer, all of which are affected by the
pandemic.
We have implemented a number of procedures in response to the pandemic to support the safety and well-being of our
employees, customers and shareholders.
●
We believe our business continuity plan has worked to provide essential banking services to our communities and
customers, while protecting our employees’ health. As part of our efforts to exercise social distancing in
accordance with the guidelines of the Centers for Disease Control and the Governor of the State of Alabama,
starting March 23, 2020, we limited branch lobby service to appointment only while continuing to operate our
branch drive-thru facilities and ATMs. As permitted by state public health guidelines, on June 1, 2020, we re-
opened some of our branch lobbies. In 2021, we opened our remaining branch lobbies. We continue to provide
services through our online and other electronic channels. In addition, we maintain remote work access to help
employees stay at home while providing continuity of service during outbreaks of COVID-19 variants.
●
We serviced the financial needs of our commercial and consumer clients with extensions and deferrals to loan
customers effected by COVID-19, provided such customers were not more than 30 days past due at the time of the
request; and
●
We were an active PPP lender. PPP loans were forgiva ble, in whole or in part, if the proceeds are used for payroll
and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of
1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5,
2020), if not forgiven, in whole or in part. Payments are deferred until either the date on which the Small Business
Administration (“SBA”) remits the amount of forgiveness proceeds to the lender or the date that is 10 months after
the last day of the covered period if the borrower does not apply for forgiveness within that 10-month period. We
believe these loans and our participation in the program helped our customers and the communities we serve.
32
COVID-19 has also had various economic effects, generally. These include supply chain disruptions and manufacturing
delays, shortages of certain goods and services, reduced consumer expenditure on hospitality and travel, and migration from
larger urban centers to less populated areas and remote work. The demand for single family housing has exceeded existing
supplies. When coupled with construction delays attributable to supply chain disruptions and worker shortages, these
factors have caused housing prices and apartment rents to increase, generally. Stimulative monetary and fiscal policies,
along with shortages of certain goods and services, and rising petroleum and food prices, reflecting, among other things, the
war in the Ukraine, have led to the highest inflation in decades. Although fiscal stimulus remains under consideration by
the President and Congress, the Federal Reserve has begun increasing its target interest rates and is considering reducing its
holdings of securities to counteract inflation.
A summary of PPP loans extended during 2020 follows:
(Dollars in thousands)
# of SBA
Approved
Mix
$ of SBA
Approved
Mix
SBA Tier:
$2 million to $10 million
—
—
%
$
—
—
%
$350,000 to less than $2 million
23
5
14,691
40
Up to $350,000
400
95
21,784
60
Total
423
100
%
$
36,475
100
%
We collected approximately $1.5 million in fees from the SBA related to our PPP loans during 2020. Throug h December
31, 2021, we have recognized all of these fees, net of related costs. As of December 31, 2021, we had received payments
and forgiveness on all PPP loans extended during 2020.
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid
Act”) was signed into law. The Economic Aid Act provides a second $900 billion stimulus package, including $325 billion
in additional PPP loans. The Economic Aid Act also permits the collection of a higher amount of PPP loan fees by
participating banks.
A summary of PPP loans extended during 2021 under the Economic Aid Act follows:
(Dollars in thousands)
# of SBA
Approved
Mix
$ of SBA
Approved
Mix
SBA Tier:
$2 million to $10 million
—
—
%
$
—
—
%
$350,000 to less than $2 million
12
5
6,494
32
Up to $350,000
242
95
13,757
68
Total
254
100
%
$
20,251
100
%
We collected approximately $1.0 million in fees from the SBA related to PPP loans under the Economic Aid Act. Through
June 30, 2022, we have recognized $0.9 million of these fees, net of related costs. As of June 30, 2022, we have received
payments and forgiveness on 240 PPP loans under the Economic Aid Act, totaling $19.6 million. The outstanding balance
for the remaining 14 PPP loans under the Economic Aid Act was approximately $0.6 million at June 30, 2022.
We continue to closely monitor this pandemic, and are working to continue our services and to address developments as
those occur. Our results of operations for the six months ended June 30, 2022, and our financial condition at that date
reflect only the ongoing effects of the pandemic, and may not be indicative of future results or financial conditions,
including possible changes in monetary or fiscal stimulus, and the possible effects of the expiration or extension of
temporary accounting and bank regulatory relief measures in response to the COVID -19 pandemic.
As of June 30, 2022, all of our capital ratios were in excess of all regulatory requirements to be well capitalized. The
continuing effects of the COVID-19 pandemic could result in adverse changes to credit quality and our regulatory capital
ratios, and inflation will affect our costs, interest rates and the values of our assets and liabilities, customer behaviors and
economic activity. Continuing supply chain and supply disruptions also adversely affect the levels and costs of economic
activities. We continue to closely monitor this pandemic, and are working to continue our services during the pandemic
and to address developments as those occur.
33
The CARES Act and the 2020 Consolidated Appropriations Act provide eligible employers an employee retention credit
related to COVID-19. After consultation with our tax advisors, we believe we are eligible, subject to the finalization and
filing of our request with the IRS, and approval of such request by the IRS, of an estimated employee retention credit of
$1.6 million, or approximately $1.2 million, net of estimated income tax effects, or approximately $0.33 per share. IRS
action on this request, including its timing and the amount of any credit approved by the IRS, cannot be predicted.
CRITICAL ACCOUNTING POLICIES
The accounting and financial reporting policies of the Company conform with U.S. generally accepted accounting
principles and with general practices within the banking industry. In connection with the application of those principles, we
have made judgments and estimates which, in the case of the determination of our allowance for loan losses, our
assessment of other-than-temporary impairment, recurring and non-recurring fair value measurements, the valuation of
other real estate owned, and the valuation of deferred tax assets, were critical to the determination of our financial position
and results of operations. Other policies also require subjective judgment and assumptions and may accordingly impact our
financial position and results of operations.
Allowance for Loan Losses
The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of
the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality
trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including
the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic
conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory recommendations. This
evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or
in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off
after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan is
unlikely.
The Company deems loans impaired when, based on current information and events, it is probable that the Company will
be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due
according to the contractual terms means that both the interest and principal payments of a loan will be collected as
scheduled in the loan agreement.
An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The
impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected
future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment
measurement is based on the fair value of the collateral, less estimated disposal costs.
The level of allowance maintained is believed by management, based on its processes and estimates, to be adequate to
absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged
to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off and by releases from the
allowance when determined to be appropriate to the levels of loans and probable loan losses in such loans.
In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal, independent
loan review process. The Company’s loan review process assists in determining whether there are loans in the portfolio
whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The
Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and
reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company
incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all
amounts due according to the contractual terms of a loan.
As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments:
commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer
installment loans. The Company analyzes each segment and estimates an allowance allocation for each loan segment.
34
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 June 30, 2022 and December 31, 2021, and for the periods 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. The Company’s look-back
period each quarter incorporates the effects of at least one economic downturn in its loss history. The Company believes
this look-back period is appropriate due to the risks inherent in the loan portfolio. Absent this look-back period, 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 quarter ended June 30, 2022, the Company increased its
look-back period to 53 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 the quarter ended June 30, 2021, the Company adjusted certain qualitative and
economic factors, previously downgraded as a result of the COVID-19 pandemic, to reflect improvements in economic
conditions in our primary market area. Further adjustments may be made from time to time in the future as a result of the
COVID-19 pandemic and other economic changes.
Assessment for Other-Than-Temporary Impairment of Securities
On a quarterly basis, management makes an assessment to determine whether there have been events or economic
circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired.
For debt securities with an unrealized loss, an other-than-temporary impairment write-down is triggered when (1) the
Company has the intent to sell a debt security, (2) it is more likely than not that the Company will be required to sell the
debt security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized
cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more likely than not that it will
be required to sell the debt security before recovery, the other-than-temporary write-down is equal to the entire difference
between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not
more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-
down is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The
credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the
present value of its expected future cash flows. The remaining difference between the security’s fair value and the present
value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive
income, net of applicable taxes.
The Company is required to own certain stock as a condition of membership, such as Federal Home Loan Bank (“FHLB”)
and Federal Reserve Bank (“FRB”). These non-marketable equity securities are accounted for at cost which equals par or
redemption value. These securities do not have a readily determinable fair value as their ownership is restricted and there is
no market for these securities. The Company records these non-marketable equity securities as a component of other
assets, which are periodically evaluated for impairment. Management considers these non-marketable equity securities to
be long-term investments. Accordingly, when evaluating these securities for impairment, management considers the
ultimate recoverability of the par value rather than by recognizing temporary declines in value.
35
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 7, Fair Value, of the consolidated financial statements that accompany this report.
Fair values are based on active market prices of identical assets or liabilities when available. Comparable assets or
liabilities or a composite of comparable assets in active markets are used when identical assets or liabilities do not have
readily available active market pricing. However, some of the Company’s assets or liabilities lack an available or
comparable trading market characterized by frequent transactions between willing buyers and sellers. In these cases, fair
value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and
their underlying assumptions are based upon management’s best estimates for appropriate discount rates, default rates,
prepayments, market volatility and other factors, taking into account current observable market data and experience.
These assumptions may have a significant effect on the reported fair values of assets and liabilities and the related income
and expense. As such, the use of different models and assumptions, as well as changes in market conditions, could result in
materially different net earnings and retained earnings results.
Other Real Estate Owned
Other real estate owned (“OREO”), consists of properties obtained through foreclosure or in satisfaction of loans and is
reported at the lower of cost or fair value, less estimated costs to sell at the date acquired with any loss recognized as a
charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are
determined on a specific property basis and are included as a component of other noninterest expense along with holding
costs. Any gains or losses on disposal of OREO are also reflected in noninterest expense. Significant judgments and
complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates
can be considered current is significantly shortened during periods of market volatility. As a result, the net proceeds
realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to
determine the fair value of OREO.
Deferred Tax Asset Valuation
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-
than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets
is dependent upon the generation of future taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax
planning strategies in making this assessment. At June 30, 2022 we had total deferred tax assets of $10.3 million included
as “other assets”, including $9.5 million resulting from unrealized losses in our securities portfolio. Based upon the level of
taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax
assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible
differences at June 30, 2022. The amount of the deferred tax assets considered realizable, however, could be reduced if
estimates of future taxable income are reduced.
36
RESULTS OF OPERATIONS
Average Balance Sheet and Interest Rates
Six months ended June 30,
2022
2021
Average
Yield/
Average
Yield/
(Dollars in thousands)
Balance
Rate
Balance
Rate
Loans and loans held for sale
$
434,863
4.42%
$
464,332
4.47%
Securities - taxable
371,012
1.57%
299,011
1.32%
Securities - tax-exempt
60,228
3.54%
62,844
3.64%
Total securities
431,240
1.84%
361,855
1.72%
Federal funds sold
63,021
0.36%
34,700
0.13%
Interest bearing bank deposits
88,008
0.52%
71,252
0.09%
Total interest-earning assets
1,017,132
2.74%
932,139
2.91%
Deposits:
NOW
204,912
0.12%
173,102
0.13%
Savings and money market
338,283
0.20%
284,174
0.23%
Time Deposits
157,877
0.88%
159,406
1.07%
Total interest-bearing deposits
701,072
0.33%
616,682
0.42%
Short-term borrowings
4,075
0.50%
3,266
0.50%
Total interest-bearing liabilities
705,147
0.33%
619,948
0.42%
Net interest income and margin (tax-equivalent)
$
12,674
2.51%
$
12,150
2.63%
Net Interest Income and Margin
Net interest income (tax-equivalent) was $12.7 million for the first six months of 2022, a 4% increase compared to $12.2
million for the first six months of 2021. This increase was primarily due to balance sheet growth, partially offset by a
decrease in the Company’s net interest margin (tax-equivalent). Net interest margin (tax-equivalent) declined to 2.51% in
the first six months of 2022, compared to 2.63% for the first six months of 2021 due to the continued lower interest rate
environment and changes in our asset mix resulting from the continuing elevated levels of customer deposits. The Federal
Reserve increased the target federal funds range by 25 basis points on March 27, 2022, 50 basis points on May 5 and 75
basis points on each of June 16 and July 27. Further increases in the target federal funds rate are possible if inflation
remains elevated. Net interest income (tax-equivalent) included $0.3 million in PPP loan fees, net of related costs for the
first six months of 2022, compared to $0.4 million for the first six months of 2021.
The tax-equivalent yield on total interest-earning assets decreased by 17 basis points to 2.74% in the first six months of
2022 compared to 2.91% in the first six months of 2021. This decrease was primarily due to changes in our asset mix
resulting from the significant increase in customer deposits.
The cost of total interest-bearing liabilities decreased by 9 basis points to 0.33% in the first six months of 2022 compared to
0.42% in the first six months of 2021, even as interest bearing deposits increased. The net decrease in our funding costs
was primarily due to lower prevailing market interest rates through most of the first quarter of 2022. Our funding costs
declined less than the rates earned on our interest earning assets. Our deposit costs may increase as the Federal Reserve
increases its target federal funds rate and market interest rates increase.
The Company continues to deploy various asset liability management strategies to manage its risk to interest rate
fluctuations. Pricing remains competitive in our markets. We believe this challenging competitive environment will
continue throughout the remainder of 2022. Our ability to hold our deposit rates low until our interest-earning assets
reprice will be important in our ability to maintain or potentially increase our net interest margin during the beginning of
the monetary tightening cycle that we believe we will continue to experience in 2022.
37
Provision for Loan Losses
The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that
management believes, based on its processes and estimates, should be adequate to provide for the probable losses on
outstanding loans. The Company recorded a negative provision for loan losses of $0.3 million for the first six months of
2022, compared to a negative provision for loan losses of $0.6 million for the first six months of 2021. The negative
provision for loan losses for the first six months of 2022 was primarily related to a decrease in total loans, excluding PPP,
during the first six months of 2022. The negative provision for loan losses for the first six months of 2021 was primarily
related to improvements in economic conditions in our primary market area. The provision for loan losses is based upon
various factors, including the absolute level of loans, economic conditions, credit quality, and the amount of net charge-
offs.
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 1.07% at June 30, 2022, compared to 1.08% at December 31, 2021. While
the policies and procedures used to estimate the allowance for loan losses, as well as the resulting provision for loan losses
charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they
are based on estimates and judgments and are therefore approximate and imprecise. Factors beyond our control (such as
conditions in the local and national economy, 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
Quarter ended June 30,
Six months ended June 30,
(Dollars in thousands)
2022
2021
2022
2021
Service charges on deposit accounts
$
146
$
138
$
288
$
270
Mortgage lending income
187
424
440
973
Bank-owned life insurance
97
99
196
202
Other
418
470
832
868
Total noninterest income
$
848
$
1,131
$
1,756
$
2,313
The Company’s income from mortgage lending was primarily attributable to the (1) origination and sale of 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 associated MSRs when the loan is sold.
MSRs are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold.
Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Servicing
fee income is reported net of any related amortization expense.
The Company evaluates MSRs for impairment on a quarterly basis. Impairment is determined by grouping MSRs by
common predominant characteristics, such as interest rate and loan type. If the aggregate carrying amount of a particular
group of MSRs exceeds the group’s aggregate fair value, a valuation allowance for that group is established. The valuation
allowance is adjusted as the fair value changes. An increase in mortgage interest rates typically results in an increase in the
fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease in the fair value of MSRs.
The following table presents a breakdown of the Company’s mortgage lending income.
Quarter ended June 30,
Six months ended June 30,
(Dollars in thousands)
2022
2021
2022
2021
Origination income
$
120
$
398
$
349
$
935
Servicing fees, net
67
26
91
38
Total mortgage lending income
$
187
$
424
$
440
$
973
38
The Company’s income from mortgage lending typically fluctuates as mortgage interest rates change and is primarily
attributable to the origination and sale of mortgage loans. Origination income decreased due to a decrease in refinance
activity in our primary market area, as market interest rates on mortgage loans increased. The decrease in origination
income was partially offset by an increase in servicing fees, net of related amortization expense as prepayment speeds
slowed, resulting in decreased amortization expense.
Noninterest Expense
Quarter ended June 30,
Six months ended June 30,
(Dollars in thousands)
2022
2021
2022
2021
Salaries and benefits
$
2,976
$
2,897
$
5,926
$
5,748
Net occupancy and equipment
727
439
1,161
877
Professional fees
239
326
469
582
Other
1,116
1,254
2,403
2,399
Total noninterest expense
$
5,058
$
4,916
$
9,959
$
9,606
The increase in salaries and benefits was primarily due to a decrease in deferred costs related to the PPP loan program, and
routine annual wage and benefit increases.
The increase in net occupancy and equipment expense was primarily due to increased expenses related to the
redevelopment of the Company’s headquarters in downtown Auburn. This amount includes depreciation expense and one-
time costs associated with the opening of the Company’s new headquarters. The Company relocated its main office branch
and bank operations into its newly constructed headquarters during June of 2022.
The decrease in professional fees expense was primarily due to a decrease in legal fees.
Income Tax Expense
Income tax expense was $0.6 million for the first six months of 2022 compared to $0.9 million for the first six months of
2021. The Company’s effective income tax rate for the first six months of 2022 was 13.71%, compared to 17.76% in the
first six months of 2021. The decrease was primarily due to an income tax benefit related to a New Markets Tax Credit
investment funded in the fourth quarter of 2021. The Company’s effective income tax rate is principally impacted by tax-
exempt earnings from the Company’s investments in municipal securities, bank-owned life insurance, and New Markets
Tax Credits.
BALANCE SHEET ANALYSIS
Securities
Securities available-for-sale were $429.2 million at June 30, 2022 compared to $421.9 million at December 31, 2021. This
increase reflects an increase in the amortized cost basis of securities available-for-sale of $46.5 million, and a decrease of
$39.2 million in the fair value of securities available-for-sale. The increase in the amortized cost basis of securities
available-for-sale was primarily attributable to management allocating more funding to the investment portfolio following
the significant increase in customer deposits. The decrease in the fair value of securities was primarily due to an increase in
long-term market interest rates, which resulted in $9.5 million of deferred tax assets included in our other assets. The
average annualized tax-equivalent yields earned on total securities were 1.84 % in the first six months of 2022 and 1.72% in
the first six months of 2021.
39
Loans
2022
2021
Second
First
Fourth
Third
Second
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Commercial and industrial
$
70,087
73,297
83,977
79,202
87,933
Construction and land development
38,654
33,058
32,432
34,890
37,477
Commercial real estate
240,296
235,062
258,371
252,798
242,845
Residential real estate
85,224
79,102
77,661
80,205
82,164
Consumer installment
7,122
8,412
6,682
7,060
7,762
Total loans
441,383
428,931
459,123
454,155
458,181
Less: unearned income
(511)
(514)
(759)
(923)
(1,197)
Loans, net of unearned income
$
440,872
428,417
458,364
453,232
456,984
Total loans, net of unearned income, were $440.9 million at June 30, 2022, and $458.4 million at December 31, 2021.
Excluding PPP loans, total loans, net of unearned income, were $440.2 million, a decrease of $10.0 million, or 2% from
December 31, 2021. Four loan categories represented the majority of the loan portfolio at June 30, 2022: commercial real
estate (55%), residential real estate (19%), commercial and industrial (16%) and construction and land development (9%).
Approximately 24% of the Company’s commercial real estate loans were classified as owner-occupied at June 30, 2022.
Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $6.9 million,
or 2%, and $7.2 million, or 2%, of total loans, net of unearned income at June 30, 2022 and December 31, 2021,
respectively. For residential real estate mortgage loans with a consumer purpose, the Company had no loans that required
interest only payments at June 30, 2022 and December 31, 2021. 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 4.42% in the first six months of 2022 and 4.47% in the first
six months of 2021.
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 continuing effects from the COVID-19 pandemic, as well as high inflation rates
and the Federal Reserve’s shift from stimulative monetary policy to increases in the target Federal Funds rate and
reductions in its securities holdings, on our borrowers’ cash flows, real estate market sales volumes, valuations, availability
and cost of financing properties, real estate industry concentrations, competitive pressures from a wide range of other
lenders, deterioration in certain credits, interest rate fluctuations and increases, reduced collateral values or non-existent
collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of applicable
laws and regulations.
The Company attempts to reduce these economic and credit risks through its loan-to-value guidelines for collateralized
loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we have
established and periodically review, lending policies and procedures. Banking regulations limit a bank’s credit exposure by
prohibiting unsecured loan relationships that exceed 10% of its capital; or 20% of capital, if loans in excess of 10% of
capital are fully secured. Under these regulations, we are prohibited from having secured loan relationships in excess of
approximately $21.4 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus
unfunded commitments) to a single borrower of $19.3 million. Our loan policy requires that the Loan Committee of the
Board of Directors approve any loan relationships that exceed this internal limit. At June 30, 2022, the Bank had no
relationships exceeding these limits.
40
We periodically analyze our commercial and industrial and commercial real estate loan portfolios 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 June 30, 2022 and December 31, 2021.
June 30,
December 31,
(Dollars in thousands)
2022
2021
Lessors of 1-4 family residential properties
$
52,329
$
47,880
Hotel/motel
34,365
43,856
Multi-family residential properties
29,722
42,587
Shopping centers
27,309
29,574
In light of disruptions in economic conditions caused by COVID-19, the financial regulators have issued guidance
encouraging banks to work constructively with borrowers affected by the virus in our community. This guidance, including
the Interagency Statement on COVID-19 Loan Modifications and the Interagency Examiner Guidance for Assessing Safety
and Soundness Considering the Effect of the COVID-19 Pandemic on Institutions, provides that the agencies will not
criticize financial institutions that mitigate credit risk through prudent actions consistent with safe and sound practices.
Specifically, examiners will not criticize institutions for working with borrowers as part of a risk mitigation strategy
intended to improve existing loans, even if the restructured loans have or develop weaknesses that ultimately result in
adverse credit classification. Upon demonstrating the need for payment relief, the bank will work with qualified borrowers
that were otherwise current before the pandemic to determine the most appropriate deferral option. For residential
mortgage and consumer loans the borrower may elect to defer payments for up to three months. Interest continues to
accrue and the amount due at maturity increases. Commercial real estate, commercial, and small business borrowers may
elect to defer payments for up to three months or pay scheduled interest payments for a six-month period. The bank
recognizes that a combination of the payment relief options may be prudent dependent on a borrower’s business type. As
of June 30, 2022, we had no COVID-19 loan deferrals, compared to one COVID-19 loan deferral totaling $0.1 million at
December 31, 2021.
Section 4013 of the CARES Act provides that a qualified loan modification is exempt by law from classification as a TDR
pursuant to GAAP. In addition, the Interagency Statement on COVID-19 Loan Modifications provides circumstances in
which a loan modification is not subject to classification as a TDR if such loan is not eligible for modification under
Section 4013.
Allowance for Loan Losses
The Company maintains the allowance for loan losses at a level that management believes appropriate to adequately cover
the Company’s estimate of probable losses inherent in the loan portfolio. The allowance for loan losses was $4.7 million at
June 30, 2022 compared to $4.9 million at December 31, 2021, which management believed to be adequate at each of the
respective dates. The judgments and estimates associated with the determination of the allowance for loan losses are
described under “Critical Accounting Policies.”
41
A summary of the changes in the allowance for loan losses and certain asset quality ratios for the second quarter of 2022
and the previous four quarters is presented below.
2022
2021
Second
First
Fourth
Third
Second
(Dollars in thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Balance at beginning of period
$
4,658
4,939
5,119
5,107
5,682
Charge-offs:
Commercial and industrial
(4)
—
—
—
—
Commercial real estate
—
—
(254)
—
—
Residential real estate
—
—
(2)
—
(1)
Consumer installment
(16)
(48)
(32)
—
—
Total charge -offs
(20)
(48)
(288)
—
(1)
Recoveries
78
17
108
12
26
Net recoveries (charge-offs)
58
(31)
(180)
12
25
Provision for loan losses
—
(250)
—
—
(600)
Ending balance
$
4,716
4,658
4,939
5,119
5,107
as a % of loans
1.07
%
1.09
1.08
1.13
1.12
as a % of nonperforming loans
1,314
%
1,256
1,112
1,053
813
Net (recoveries) charge-offs as % of average loans (a)
(0.05)
%
0.03
0.16
(0.01)
(0.02)
(a) Net (recoveries) charge-offs are annualized.
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 1.07% at June 30, 2022, compared to 1.08% at December 31, 2021.
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 and increasing market
interest rates as the Federal Reserve shifts from stimulus to fighting inflation, 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 June 30, 2022 the Company had $0.4 million in nonperforming assets compared to $0.8 million at December 31, 2021.
42
The table below provides information concerning total nonperforming assets and certain asset quality ratios for the second
quarter of 2022 and the previous four quarters.
2022
2021
Second
First
Fourth
Third
Second
(Dollars in thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Nonperforming assets:
Nonaccrual loans
$
359
371
444
486
628
Other real estate owned
—
374
374
—
—
Total nonperforming assets
$
359
745
818
486
628
as a % of loans and other real estate owned
0.08
%
0.17
0.18
0.11
0.14
as a % of total assets
0.03
%
0.07
0.07
0.05
0.06
Nonperforming loans as a % of total loans
0.08
%
0.09
0.10
0.11
0.14
Accruing loans 90 days or more past due
$
—
—
—
69
—
The table below provides information concerning the composition of nonaccrual loans for the second quarter of 2022 and
the previous four quarters.
2022
2021
Second
First
Fourth
Third
Second
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Nonaccrual loans:
Commercial real estate
$
176
182
187
193
199
Residential real estate
183
189
257
293
429
Total nonaccrual loans
$
359
371
444
486
628
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
90 days or more past due, unless the loan is both well-secured and in the process of collection . The Company had $0.4
million in loans on nonaccrual status at June 30, 2022 and December 31, 2021, respectively.
The Company had no loans 90 days or more past due and still accruing at June 30, 2022 and December 31, 2021,
respectively.
The table below provides information concerning the composition of OREO for the second quarter of 2022 and the
previous four quarters.
2022
2021
Second
First
Fourth
Third
Second
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Other real estate owned:
Commercial real estate
$
—
374
374
—
—
Total other real estate owned
$
—
374
374
—
—
Potential Problem Loans
Potential problem loans represent those loans with a well-defined weakness and where information about possible credit
problems of a borrower has caused management to have serious doubts about the borrower’s ability to comply with present
repayment terms. This definition is believed to be substantially consistent with the standards established by the Federal
Reserve, the Company’s primary regulator, for loans classified as substandard, excluding nonaccrual loans. Potential
problem loans, which are not included in nonperforming assets, amounted to $1.3 million, or 0.3% of total loans at June 30,
2022, and $2.4 million, or 0.5% of total loans at December 31, 2021.
43
The table below provides information concerning the composition of potential problem loans for the second quarter of 2022
and the previous four quarters.
2022
2021
Second
First
Fourth
Third
Second
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Potential problem loans:
Commercial and industrial
$
225
215
226
274
291
Construction and land development
—
13
218
231
239
Commercial real estate
146
150
156
172
178
Residential real estate
915
1,592
1,748
1,848
2,096
Consumer installment
24
8
12
19
7
Total potential problem loans
$
1,310
1,978
2,360
2,544
2,811
At June 30, 2022, approximately $0.1 million or 11 % of total potential problem loans were past due at least 30 days, 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, for the second quarter of 2022 and the previous four quarters.
2022
2021
Second
First
Fourth
Third
Second
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Performing loans past due 30 to 89 days:
Commercial and industrial
$
34
7
3
68
1
Construction and land development
—
1
204
—
204
Commercial real estate
28
—
—
—
205
Residential real estate
130
496
516
409
68
Consumer installment
7
15
25
25
7
Total
$
199
519
748
502
485
Deposits
Total deposits were $1.0 billion at June 30, 2022 and December 31, 2021. Noninterest-bearing deposits were $311.2
million, or 31% of total deposits, at June 30, 2022, compared to $316.1 million, or 32% of total deposits at December 31,
2021.
Estimated uninsured deposits totaled $411.3 million and $420.8 million at June 30, 2022 and December 31, 2021,
respectively. Uninsured amounts are estimated based on the portion of account balances in excess of FDIC insurance
limits.
The average rate paid on total interest-bearing deposits was 0.33% in the first six months of 2022 compared to 0.42% in the
first six months of 2021.
Other Borrowings
Other borrowings 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 funds lines totaling $61.0 million and $41.0 million with none outstanding at June 30, 2022, and
December 31, 2021, respectively. Securities sold under agreements to repurchase totaled $4.1 million and $3.4 million at
June 30, 2022 and December 31, 2021, respectively.
The average rate paid on short-term borrowings was 0.50% in the first six months of 2022 and 2021, respectively.
The Company had no long-term debt at June 30, 2022 and December 31, 2021.
44
CAPITAL ADEQUACY
The Company’s consolidated stockholders’ equity was $76.1 million and $103.7 million as of June 30, 2022 and December
31, 2021, respectively. The decrease from December 31, 2021 was primarily driven by an other comprehensive loss due to
the change in unrealized gains/losses on securities available-for-sale, net of tax of $29.3 million. The increase in the
unrealized loss on securities was primarily due to increases in market interest rates. These unrealized losses do not affect
the Bank’s capital for regulatory capital purposes.
The Company paid cash dividends of $0.53 per share in the first six months of 2022, an increase of 2% from the same
period in 2021. The Company’s share repurchases of $0.3 million since December 31, 2021 resulted in 10,640 fewer
outstanding common shares at June 30, 2022.
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 June 30, 2022, the Bank’s ratio was sufficient to meet the fully phased-in conservation buffer.
Effective March 20, 2020, the Federal Reserve and the other federal banking regulators adopted an interim final rule that
amended the capital conservation buffer. The interim final rule was adopted as a final rule on August 26, 2020. The new
rule revises the definition of “eligible retained income” for purposes of the maximum payout ratio to allow banking
organizations to more freely use their capital buffers to promote lending and other financial intermediation activities, by
making the limitations on capital distributions more gradual. The eligible retained income is now the greater of (i) net
income for the four preceding quarters, net of distributions and associated tax effects not reflected in net income; and (ii)
the average of all net income over the preceding four quarters. The interim final rule only affects the capital buffers, and
banking organizations were encouraged to make prudent capital distribution decisions.
The Federal Reserve has treated us as a “small bank holding company’ under the Federal Reserve’s policy. Accordingly,
our capital adequacy is evaluated at the Bank level, and not for the Company and its consolidated subsidiaries. The Bank’s
tier 1 leverage ratio was 9.16%, CET1 risk-based capital ratio was 16.59%, tier 1 risk-based capital ratio was 16.59%, and
total risk-based capital ratio was 17.38% at June 30, 2022. These ratios exceed the minimum regulatory capital percentages
of 5.0% for tier 1 leverage ratio, 6.5% for CET1 risk-based capital ratio, 8.0% for tier 1 risk-based capital ratio, and 10.0%
for total risk-based capital ratio to be considered “well capitalized.” The Bank’s capital conservation buffe r was 9.38% at
June 30, 2022. Our unrealized losses on securities due to increases in market interest rates do not directly affect our capital
for regulatory purposes, and the resulting deferred tax assets, including $9.5 million resulting from such unrealized
securities losses, was below the 25% threshold requiring deduction of such assets from CET1 capital.
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. ALCO
measures and evaluates interest rate risk so that the Bank can meet customer demands for various types of loans and
deposits. Measurements used to help manage interest rate sensitivity include an earnings simulation model and an economic
value of equity (“EVE”) model.
45
Earnings simulation
. Management believes that interest rate risk is best estimated by our earnings simulation modeling.
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
At June 30, 2022, our earnings simulation model indicated that we were in compliance with the policy guidelines noted
above.
Economic Value of Equity
. EVE measures the extent that the 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
At June 30, 2022, our EVE model indicated that we were in compliance with our policy guidelines.
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. Prepayments 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 a tool to manage interest rate sensitivity while continuing to meet the credit and deposit
needs of our customers. From time to time, the Company also may enter into back-to-back interest rate swaps to facilitate
customer transactions and meet their financing needs. These interest rate swaps qualify as derivatives, but are not
designated as hedging instruments. At June 30, 2022 and December 31, 2021, the Company had no derivative contracts
designated as part of a hedging relationship to assist in managing its interest rate sensitivity.
46
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 could lead
to lower earnings due to the cost of foregoing alternative higher-yield market 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 regulatory
restrictions on such dividends.
The primary source of funding and liquidity for the Company has been dividends received from the Bank. If needed, the
Company could also borrow money, or issue common stock or other securities. Primary uses of funds by the Company
include dividends paid to stockholders, Company stock repurchases, and payment of Company expenses.
Primary sources of funding for the Bank include customer deposits, other borrowings, repayment and maturity of securities,
sales of securities, and the 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 may participate in the
FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and may be
taken out with varying maturities. At June 30, 2022, the Bank had a remaining available line of credit with the FHLB of
$332.7 million. At June 30, 2022, the Bank also had $51.0 million of available federal funds lines with no borrowings
outstanding. Primary uses of funds include repayment of maturing obligations and growing the loan portfolio.
Management believes that the Company and the Bank have adequate sources of liquidity to meet all their respective known
contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and
creditor requirements over the next twelve months.
Off-Balance Sheet Arrangements, Commitments, Contingencies and Contractual Obligations
At June 30, 2022, the Bank had outstanding standby letters of credit of $1.2 million and unfunded loan commitments
outstanding of $60.4 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 could liquidate federal funds sold or a portion of our securities available-
for-sale, or draw on its available credit facilities.
Mortgage lending activities
We primarily sell 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 June 30, 2022, the unpaid principal balance of residential mortgage loans, which we have originated and sold, but
retained the servicing rights, was $247.1 million. Although these loans are generally sold on a non-recourse basis, we may
be obligated to repurchase residential mortgage loans or reimburse investors for losses incurred (make whole requests) if a
loan review reveals a potential breach of seller representations and warranties. Upon receipt of a repurchase or make whole
request, we work with investors to arrive at a mutually agreeable resolution. Repurchase and make whole requests 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 or make whole event has occurred. We seek to reduce and manage the risks of potential
repurchases, make whole requests, or other claims by mortgage loan investors through our underwriting and quality
assurance practices and by servicing mortgage loans to meet investor and secondary market standards.
47
The Company was not required to repurchase any loans during the first six months of 2022 as a result of representation and
warranty provisions contained in the Company’s sale agreements with Fannie Mae, and had no pending repurchase or
make-whole requests at June 30, 2022.
We service all residential mortgage loans originated and sold by us to Fannie Mae. As servicer, our primary duties are to:
(1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain
and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any
required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on
defaulted mortgage loans or take other actions to mitigate the potential losses to investors consistent with the agreements
governing our rights and duties as servicer.
The agreement under which we act as servicer generally specifies standards of responsibility for actions taken by us in such
capacity and provides protection against expenses and liabilities incurred by us when acting in compliance with the
respective servicing agreements. However, if we commit a material breach of our obligations as servicer, we may be
subject to termination if the breach is not cured within a specified period following notice. The standards governing
servicing and the possible remedies for violations of such standards are determined by servicing guides issued by Fannie
Mae as well as the contract provisions established between Fannie Mae and the Bank. Remedies could include repurchase
of an affected loan.
Although repurchase and make whole requests related to representation and warranty provisions and servicing activities
have been limited to date, it is possible that requests to repurchase mortgage loans or reimburse investors for losses incurred
(make whole requests) may increase in frequency if investors more aggressively pursue all means of recovering losses on
their purchased loans. As of June 30, 2022, we do not believe that this exposure is material due to the historical level of
repurchase requests and loss trends, in addition to the fact that 99% of our residential mortgage loans serviced for Fannie
Mae were current as of such date. We maintain ongoing communications with our investors and will continue to evaluate
this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in our investor
portfolios.
Section 4021 of the CARES Act allows borrowers under 1-to-4 family residential mortgage loans sold to Fannie Mae to
request forbearance to the servicer after affirming that such borrower is experiencing financial hardships during the
COVID-19 emergency. Except for vacant or abandoned properties, Fannie Mae servicers may not initiate foreclosures on
similar procedures or related evictions or sales until December 31, 2020. The forbearance period was extended, generally,
to March 31, 2021. The Bank sells mortgage loans to Fannie Mae and services these on an actual/actual basis. As a result,
the Bank is not obligated to make any advances to Fannie Mae on principal and interest on such mortgage loans where the
borrower is entitled to forbearance.
Effects of Inflation and Changing Prices
The consolidated financial statements and related consolidated financial data presented herein have been prepared in
accordance with GAAP and practices within the banking industry which require the measurement of financial position and
operating results in terms of historical dollars without considering the changes in the relative purchasing power of money
over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution
are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance
than the effects of general levels of inflation. Inflation, however, could increase our noninterest expenses, and Federal
Reserve monetary policy in response to inflation has increased market interest rates and affected values of certain of our
assets and liabilities, including our securities portfolio and mortgage servicing assets.
CURRENT ACCOUNTING DEVELOPMENTS
The following ASUs have been issued by the FASB but are not yet effective.
●
ASU 2016-13,
Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial
Instruments;
48
Information about these pronouncements is described in more detail below.
ASU 2016-13,
Financial Instruments - Credit Losses (Topic 326): - Measurement of Credit Losses on Financial
Instruments
, amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt
securities. For assets held at amortized cost basis, the new standard eliminates the probable initial recognition threshold in
current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses using a broader
range of information regarding past events, current conditions and forecasts assessing the collectability of cash flows. The
allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to
present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a
manner similar to current GAAP, however the new standard will require that credit losses be presented as an allowance
rather than as a write-down. The new guidance affects entities holding financial assets and net investment in leases that are
not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net
investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial assets not
excluded from the scope that have the contractual right to receive cash. For public business entities, the new guidance was
originally effective for annual and interim periods in fiscal years beginning after December 15, 2019. The Company has
developed an implementation team that is following a general timeline. The team has been working with an advisory
consultant, with whom a third-party software license has been purchased. The Company’s preliminary evaluation indicates
the provisions of ASU No. 2016-13 are expected to impact the Company’s consolidated financial statements, in particular
the level of the reserve for credit losses. The Company is continuing to evaluate the extent of the potential impact and
expects that portfolio composition and economic conditions at the time of adoption will be a factor. On October 16, 2019,
the FASB approved a previously issued proposal granting smaller reporting companies a postponement of the required
implementation date for ASU 2016-13.
The Company is required to implement the new standard in January 2023, with early adoption permitted in any period prior
to that date.
49
Table 1 – Explanation of Non-GAAP Financial Measures
In addition to results presented in accordance with U.S. generally accepted accounting principles (GAAP), this quarterly
report on Form 10-Q includes certain designated net interest income amounts presented on a tax-equivalent basis, a non-
GAAP financial measure, including the presentation and 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 reconciliations of these non-
GAAP financial measures to their most directly comparable GAAP financial measures are presented below.
2022
2021
Second
First
Fourth
Third
Second
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Net interest income (GAAP)
$
6,374
6,078
6,037
6,041
5,975
Tax-equivalent adjustment
110
112
115
117
118
Net interest income (Tax -equivalent)
$
6,484
6,190
6,152
6,158
6,093
Six months ended June 30,
(In thousands)
2022
2021
Net interest income (GAAP)
$
12,452
11,912
Tax-equivalent adjustment
222
238
Net interest income (Tax -equivalent)
$
12,674
12,150
50
Table 2 - Selected Quarterly Financial Data
2022
2021
Second
First
Fourth
Third
Second
(Dollars in thousands, except per share amounts)
Quarter
Quarter
Quarter
Quarter
Quarter
Results of Operations
Net interest income (a)
$
6,484
6,190
6,152
6,158
6,093
Less: tax-equivalent adjustment
110
112
115
117
118
Net interest income (GAAP)
6,374
6,078
6,037
6,041
5,975
Noninterest income
848
908
1,019
956
1,131
Total revenue
7,222
6,986
7,056
6,997
7,106
Provision for loan losses
—
(250)
—
—
(600)
Noninterest expense
5,058
4,901
5,092
4,736
4,916
Income tax expense
363
254
93
386
504
Net earnings
$
1,801
2,081
1,871
1,875
2,286
Per share data:
Basic and diluted net earnings
$
0.51
0.59
0.53
0.53
0.65
Cash dividends declared
0.265
0.265
0.26
0.26
0.26
Weighted average shares outstanding:
Basic and diluted
3,513,353
3,518,657
3,524,311
3,536,320
3,554,871
Shares outstanding
3,509,940
3,516,971
3,520,485
3,529,338
3,545,855
Book value
$
21.68
24.57
29.46
29.73
29.91
Common stock price
High
$
33.57
34.49
34.79
35.36
38.90
Low
27.04
31.75
31.32
33.25
34.50
Period end
27.04
33.21
32.30
33.80
35.46
To earnings ratio
12.52
x
14.44
14.23
14.57
15.22
To book value
125
%
135
110
114
119
Performance ratios:
Return on average equity
8.26
%
7.97
7.07
7.01
8.74
Return on average assets
0.66
%
0.75
0.70
0.72
0.91
Dividend payout ratio
51.96
%
44.92
49.06
49.06
40.00
Asset Quality:
Allowance for loan losses as a % of:
Loans
1.07
%
1.09
1.08
1.13
1.12
Nonperforming loans
1,314
%
1,256
1,112
1,053
813
Nonperforming assets as a % of:
Loans and other real estate owned
0.08
%
0.17
0.18
0.11
0.14
Total assets
0.03
%
0.07
0.07
0.05
0.06
Nonperforming loans as a % of total loans
0.08
%
0.09
0.10
0.11
0.14
Annualized net (recoveries) charge-offs as a % of average loans
(0.05)
%
0.03
0.16
(0.01)
(0.02)
Capital Adequacy: (c)
CET 1 risk-based capital ratio
16.59
%
17.26
16.23
16.82
17.03
Tier 1 risk-based capital ratio
16.59
%
17.26
16.23
16.82
17.03
Total risk-based capital ratio
17.38
%
18.08
17.06
17.72
17.94
Tier 1 leverage ratio
9.16
%
9.09
9.35
9.57
9.81
Other financial data:
Net interest margin (a)
2.60
%
2.43
2.45
2.51
2.60
Effective income tax rate
16.77
%
10.88
4.74
17.07
18.06
Efficiency ratio (b)
68.99
%
69.05
71.01
66.57
68.05
Selected average balances:
Securities
$
427,426
435,097
414,061
395,529
370,582
Loans, net of unearned income
428,612
439,713
455,726
452,668
460,672
Total assets
1,092,759
1,114,407
1,073,564
1,040,985
1,005,041
Total deposits
999,867
1,003,394
961,544
927,368
894,757
Total stockholders’ equity
87,247
104,493
105,925
106,936
104,591
Selected period end balances:
Securities
$
429,220
417,459
421,891
407,474
384,865
Loans, net of unearned income
440,872
428,417
458,364
453,232
456,984
Allowance for loan losses
4,716
4,658
4,939
5,119
5,107
Total assets
1,084,251
1,109,664
1,105,150
1,065,871
1,036,232
Total deposits
1,002,698
1,017,742
994,243
954,971
923,462
Total stockholders’ equity
76,107
86,411
103,726
104,929
106,043
(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.
51
Table 3 - Selected Financial Data
Six months ended June 30,
(Dollars in thousands, except per share amounts)
2022
2021
Results of Operations
Net interest income (a)
$
12,674
12,150
Less: tax-equivalent adjustment
222
238
Net interest income (GAAP)
12,452
11,912
Noninterest income
1,756
2,313
Total revenue
14,208
14,225
Provision for loan losses
(250)
(600)
Noninterest expense
9,959
9,606
Income tax expense
617
927
Net earnings
$
3,882
4,292
Per share data:
Basic and diluted net earnings
$
1.10
1.21
Cash dividends declared
0.53
0.52
Weighted average shares outstanding:
Basic and diluted
3,515,991
3,560,554
Shares outstanding, at period end
3,509,940
3,545,855
Book value
$
21.68
29.91
Common stock price:
High
$
34.49
48.00
Low
27.04
34.50
Period end
27.04
35.46
To earnings ratio
12.52
x
15.22
To book value
125
%
119
Performance ratios:
Return on average equity
8.10
%
8.04
Return on average assets
0.70
%
0.86
Dividend payout ratio
48.18
%
42.98
Asset Quality:
Allowance for loan losses as a % of:
Loans
1.07
%
1.12
Nonperforming loans
1,314
%
813
Nonperforming assets as a % of:
Loans and other real estate owned
0.08
%
0.14
Total assets
0.03
%
0.06
Nonperforming loans as a % of total loans
0.08
%
0.14
Annualized net recoveries as a % of average loans
(0.01)
%
(0.04)
Capital Adequacy: (c)
CET 1 risk-based capital ratio
16.59
%
17.03
Tier 1 risk-based capital ratio
16.59
%
17.03
Total risk-based capital ratio
17.38
%
17.94
Tier 1 leverage ratio
9.16
%
9.81
Other financial data:
Net interest margin (a)
2.51
%
2.63
Effective income tax rate
13.71
%
17.76
Efficiency ratio (b)
69.02
%
66.42
Selected average balances:
Securities
$
431,240
361,855
Loans, net of unearned income
434,131
462,040
Total assets
1,103,523
992,940
Total deposits
1,001,620
879,063
Total stockholders’ equity
95,822
106,729
Selected period end balances:
Securities
$
429,220
384,865
Loans, net of unearned income
440,872
456,984
Allowance for loan losses
4,716
5,107
Total assets
1,084,251
1,036,232
Total deposits
1,002,698
923,462
Total stockholders’ equity
76,107
106,043
(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. See
"Table 1 - Explanation of Non-GAAP Financial Measures."
(c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank.
52
Table 4 - Average Balances and Net Interest Income Analysis
Quarter ended June 30,
2022
2021
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)
$
429,182
$
4,691
4.38%
$
462,319
$
5,112
4.44%
Securities - taxable
367,241
1,547
1.69%
307,941
1,009
1.31%
Securities - tax-exempt (2)
60,185
525
3.50%
62,641
562
3.60%
Total securities
427,426
2,072
1.94%
370,582
1,571
1.70%
Federal funds sold
52,582
82
0.63%
36,570
11
0.12%
Interest bearing bank deposits
92,802
196
0.85%
72,144
17
0.09%
Total interest-earning assets
1,001,992
$
7,041
2.82%
941,615
$
6,711
2.86%
Cash and due from banks
15,485
14,824
Other assets
75,282
48,602
Total assets
$
1,092,759
$
1,005,041
Interest-bearing liabilities:
Deposits:
NOW
$
208,873
$
62
0.12%
$
174,138
$
45
0.10%
Savings and money market
331,097
159
0.19%
286,477
150
0.21%
Time deposits
155,990
331
0.85%
159,347
419
1.05%
Total interest-bearing deposits
695,960
552
0.32%
619,962
614
0.40%
Short-term borrowings
4,205
5
0.50%
3,370
4
0.50%
Total interest-bearing liabilities
700,165
$
557
0.32%
623,332
$
618
0.40%
Noninterest-bearing deposits
303,907
274,795
Other liabilities
1,440
2,323
Stockholders' equity
87,247
104,591
Total liabilities and stockholders' equity
$
1,092,759
$
1,005,041
Net interest income and margin (tax-equivalent)
$
6,484
2.60%
$
6,093
2.60%
(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using a federal income
tax rate of 21%.
53
Table 5 - Average Balances and Net Interest Income Analysis
Six months ended June 30,
2022
2021
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)
$
434,863
$
9,541
4.42%
$
464,332
$
10,290
4.47%
Securities - taxable
371,012
2,883
1.57%
299,011
1,958
1.32%
Securities - tax-exempt (2)
60,228
1,056
3.54%
62,844
1,134
3.64%
Total securities
431,240
3,939
1.84%
361,855
3,092
1.72%
Federal funds sold
63,021
113
0.36%
34,700
23
0.13%
Interest bearing bank deposits
88,008
228
0.52%
71,252
33
0.09%
Total interest-earning assets
1,017,132
$
13,821
2.74%
932,139
$
13,438
2.91%
Cash and due from banks
15,296
14,355
Other assets
71,095
46,446
Total assets
$
1,103,523
$
992,940
Interest-bearing liabilities:
Deposits:
NOW
$
204,912
$
119
0.12%
$
173,102
$
111
0.13%
Savings and money market
338,283
331
0.20%
284,174
321
0.23%
Time deposits
157,877
687
0.88%
159,406
848
1.07%
Total interest-bearing deposits
701,072
1,137
0.33%
616,682
1,280
0.42%
Short-term borrowings
4,075
10
0.50%
3,266
8
0.50%
Total interest-bearing liabilities
705,147
$
1,147
0.33%
619,948
$
1,288
0.42%
Noninterest-bearing deposits
300,548
262,381
Other liabilities
2,006
3,882
Stockholders' equity
95,822
106,729
Total liabilities and stockholders' equity
$
1,103,523
$
992,940
Net interest income and margin (tax-equivalent)
$
12,674
2.51%
$
12,150
2.63%
(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using a federal income
tax rate of 21%.
54
Table 6 - Allocation of Allowance for Loan Losses
2022
2021
Second Quarter
First Quarter
Fourth Quarter
Third Quarter
Second Quarter
(Dollars in thousands)
Amount
%*
Amount
%*
Amount
%*
Amount
%*
Amount
%*
Commercial and industrial
$
761
15.9
$
857
18.3
$
816
17.4
$
829
19.2
$
828
19.1
Construction and land
development
576
8.8
518
7.1
590
7.7
639
8.2
551
6.5
Commercial real estate
2,523
54.4
2,739
56.2
2,823
55.6
2,704
53.0
3,259
55.1
Residential real estate
753
19.3
739
16.9
799
17.7
838
17.9
951
17.9
Consumer installment
103
1.6
86
1.5
91
1.6
97
1.7
93
1.4
Total allowance for loan losses
$
4,716
$
4,939
$
5,119
$
5,107
$
5,682
* Loan balance in each category expressed as a percentage of total loans.
55
Table 7 – Estimated Uninsured Time Deposits by Maturity
(Dollars in thousands)
June 30, 2022
Maturity of:
3 months or less
$
17,778
Over 3 months through 6 months
11,792
Over 6 months through 12 months
4,496
Over 12 months
5,458
Total estimated uninsured time deposits
$
39,524
56
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by ITEM 3 is set forth in ITEM 2 under the caption “MARKET AND LIQUIDITY RISK
MANAGEMENT” and is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
The Company, with the participation of its management, including its Chief Executive Officer and Chief Financial Officer,
carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the
period covered by this report. Based upon that evaluation and as of the end of the period covered by this report, the
Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and
procedures were effective to allow timely decisions regarding disclosure in its reports that the Company files or submits to
the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. There have been no
changes in the Company’s internal control over financial reporting that occurred during the period covered by this report
that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial
reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of its business, the Company and the Bank are, from time to time, involved in legal proceedings. The
Company’s and Bank’s management believe there are no pending or threatened legal, governmental, or regulatory
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. See also, Part I, Item 3 of the Company’s Annual Report on Form 10-K for the
year ended December 31, 2021.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I,
Item 1A. “RISK FACTORS” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021,
which could materially affect our business, financial condition or future results. The risks described in our annual report on
Form 10-K are not the only the risks facing our Company. Increases in inflation and the resulting tightening of Federal
Reserve monetary policy by increased target interest rates, has and is expected to continue to affect mortgage originations
and income and the market values of our securities portfolio. These could also affect our deposit, costs and mixes, and
change consumer savings and payment behaviors. Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating
results in the future.
57
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The Company’s repurchases of its common stock during the second quarter of 2022 were as follows:
Period
Total Number of
Shares Purchased
Average Price
Paid per Share
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
Approximate Dollar
Value of Shares that
May Yet Be
Purchased Under the
Plans or Programs
(1)
April 1 - April 30, 2022
—
$
—
—
$
5,000,000
May 1 - May 31, 2022
7,081
29.97
7,081
4,787,778
June 1 - June 30, 2022
—
—
—
4,787,778
Total
7,081
29.97
7,081
4,787,778
(1)
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
58
ITEM 6. EXHIBITS
Exhibit
Number Description
3.1
3.2
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
104
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
*
**
***
The certifications attached as exhibits 32.1 and 32.2 to this quarterly report on Form 10-Q 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.
SIGNATURES
Pursuant to the requirements 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.
AUBURN NATIONAL BANCORPORATION, INC.
Date: August 4, 2022
By: /s/ Robert W. Dumas
Robert W. Dumas
Chairman, President and CEO
Date: August 4, 2022
By: /s/ David A. Hedges
David A. Hedges
Executive Vice President and Chief Financial Officer
TABLE OF CONTENTS
Part 1. Financial InformationItem 1. Financial StatementsNote 1: Summary Of Significant Accounting PoliciesNote 2: Basic and Diluted Net Earnings Per ShareNote 3: Variable Interest EntitiesNote 4: SecuritiesNote 5: Loans and Allowance For Loan LossesNote 6: Mortgage Servicing Rights, NetNote 7: Fair ValueItem 2. Management's Discussion and Analysis Of Financial Condition and Results OfItem 1. BusinessItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPart II. Other InformationItem 1. Legal ProceedingsItem 1A. Risk FactorsItem 1A. Risk Factors in The Company S Annual Report on Form 10-k For The Year Ended December 31, 2021,Item 2. Unregistered Sales Of Equity Securities and Use Of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. Mine Safety DisclosuresItem 5. Other InformationItem 6. Exhibits