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
☐
Accelerated filer
☐
☒
Smaller reporting company
☒
Emerging growth company
☐
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 November 8, 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
28
50
51
52
53
54
55
56
Item 3
57
Item 4
57
Item 1
57
Item 1A
57
Item 2
58
Item 3
58
Item 4
58
Item 5
58
Item 6
59
3
PART 1.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL
STATEMENTS
AUBURN
NATIONAL BANCORPORATION,
INC. AND
SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
September
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
474,035
458,364
Allowance
for loan losses
(
4,966
)
(
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
(
45,675
)
Less treasury stock,
at cost -
and December 31, 2021,
respectively
(
11,431
)
(
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
September
30,
Nine months
ended September
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
)
Net interest income after
provision for
loan losses
Noninterest income:
Service charges
on deposit accounts
Mortgage lending
Bank-owned life insurance
Other
Securities gains,
net
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
$
$
$
$
Weight
ed 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
September
30,
Nine months
ended September
30,
(Dollars
in thousands)
2022
2021
2022
2021
Net earnings
$
$
$
$
Other comprehensive loss,
net of
tax:
Unrealized
net loss on securities
(
17,223
)
(
1,493
)
(
46,533
)
(
4,837
)
Reclassification adjustment
for net gain
on securities
recognized in
net earnings
(
33
)
(
11
)
(
33
)
(
11
)
Other comprehensive
loss
(17,256)
(1,504)
(
46,566
)
(
4,848
)
Comprehensive (loss)
income
$
(
15,258
)
$
$
(
40,686
)
$
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
September
30, 2022
Balance, June
30, 2022
$
$
$
$
(
28,419
)
$
(
11,303
)
$
Net earnings
—
Other comprehensive
loss
—
(
17,256
)
(
17,256
)
Cash dividends
paid ($
—
(
929
)
(
929
)
Stock repurchases
(
4,640
)
(
128
)
(
128
)
Sale of treasury
stock
Balance, September
30, 2022
$
$
$
$
(
45,675
)
$
(
11,431
)
$
Quarter ended
September
30, 2021
Balance, June
30, 2021
$
$
$
$
$
(
10,103
)
$
Net earnings
—
Other comprehensive
loss
—
(
1,504
)
(
1,504
)
Cash dividends
paid ($
—
(
917
)
(
917
)
Stock repurchases
(
16,582
)
(
570
)
(
570
)
Sale of treasury
stock
Balance, September
30, 2021
$
$
$
$
$
(
10,673
)
$
Nine months
ended September
30, 2022
Balance, December
31, 2021
$
$
$
$
$
(
10,972
)
$
Net earnings
—
5,880
Other comprehensive
loss
—
(
46,566
)
(
46,566
)
Cash dividends
paid ($
—
(
2,791
)
(
2,791
)
Stock repurchases
(
15,280
)
(
460
)
(
460
)
Sale of treasury
stock
Balance, September
30, 2022
$
$
$
$
(
45,675
)
$
(
11,431
)
$
Nine months
ended September
30, 2021
Balance, December
31, 2020
$
$
$
$
$
(
9,354
)
$
Net earnings
—
6,167
Other comprehensive
loss
—
(
4,848
)
(
4,848
)
Cash dividends
paid ($
—
(
2,766
)
(
2,766
)
Stock repurchases
(
37,093
)
(
1,320
)
(
1,320
)
Sale of treasury
stock
Balance, September
30, 2021
$
$
$
$
$
(
10,673
)
$
See accompanying
notes to consolidated
financial statements
7
AUBURN
NATIONAL BANCORPORATION,
INC. AND
SUBSIDIARIES
Consolidated Statements
of Cash
Flows
(Unaudited)
Nine months
ended September
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
(
600
)
Depreciation and
amortization
Premium amortization
and
discount accretion, net
Net gain on securities available-for-sale
(
44
)
(
15
)
Net gain on sale
of loans held
for sale
(
315
)
(
1,168
)
Net gain on other
real estate owned
(
162
)
Loans originated
for sale
(
8,711
)
(
39,632
)
Proceeds from sale of loans
Increase in cash
surrender value
of bank-owned
life insurance
(
294
)
(
302
)
Net increase in
other assets
(
15,570
)
(
216
)
Net increase (decrease) in
accrued expenses
and
other liabilities
(
2,430
)
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
(
93,106
)
(
135,434
)
(Increase) decrease in
loans, net
(
15,644
)
Net purchases
of premises and
equipment
(
5,540
)
(
13,287
)
(Increase) decrease in
FHLB
stock
(
74
)
Proceeds from sale of other
real estate owned
Net cash used in
investing activities
(
74,957
)
(
86,161
)
Cash flows from financing activities:
Net increase in
noninterest-bearing
deposits
Net (decrease) increase in
interest-bearing
deposits
(
21,875
)
Net (decrease) increase in
federal funds
purchased
and securities sold
under agreements to
repurchase
(
835
)
Stock repurchases
(
460
)
(
1,320
)
Dividends paid
(
2,791
)
(
2,766
)
Net cash (used
in) provided
by financing
activities
(
20,391
)
Net change in cash
and cash equivalents
(
86,622
)
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
areas 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, 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 September 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 except as
reported in NOTE
8, SUBSEQUENT
EVENTS.
Reclassifications
Certain amounts
reported in prior periods
have
been reclassified to conform
to the current-period
presentation. These
reclassifications had
no material effect on
the Company’s
previously
reported net earnings
or total stockholders’
equity.
Accounting Developments
In the first nine 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 September
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
September
30,
Nine months
ended September
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 September 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 September 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
in the NMTC
entity 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 September 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 September 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
September 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
September 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
September 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
also 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
MBS, in
the financial
condition of the
underlying
obligors on the
assets securing such
MBS, 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,
in the case of variable
rate securities, the likelihood
of the issuer
being able to
make payments
that may 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’
obligations) 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.
The Company
will evaluate whether
any loss is
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 September
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 nine
months ended
September 30, 2022 and
2021, respectively.
Realized Gains and
Losses
The following
table presents the gross realized
gains
and losses on sales of securities.
Quarter ended
September
30,
Nine months
ended September
30,
(Dollars
in thousands)
2022
2021
2022
2021
Gross realized gains
$
$
Realized
gains, net
$
$
13
NOTE 5:
LOANS AND
ALLOWANCE FOR LOAN
LOSSES
.
September
30,
December 31,
(Dollars
in thousands)
2022
2021
Commercial and
industrial
$
$
Construction and
land development
Commercial real estate:
Owner occupied
Hotel/motel
33,918
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
(
602
)
(
759
)
Loans, net of unearned
income
$
$
Loans secured by
real estate were
approximately
83.5%
September 30, 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 (“C&I”)
—
includes loans
to finance
business operations, equipment
purchases, or
other needs
for small and
medium-sized commercial
customers. Also
included
in this category
are loans
to finance
agricultural
production.
Generally,
the primary
source of repayment
is the cash
flow from business operations
and
activities of the
borrower.
As of September
30, 2022, the Company
had
compared to
Construction and land development
(“C&D”)
—
includes both loans
and credit lines for the
purpose of purchasing,
carrying, and
developing
land into commercial developments
or residential
subdivisions.
Also included
are loans and
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.
14
●
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 respective
borrowers.
●
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.
●
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.
15
The following
is a summary
of current, accruing
past due,
and nonaccrual loans
by portfolio segment and
class as of
September 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
September 30, 2022:
Commercial and
industrial
$
$
Construction and
land development
Commercial real estate:
Owner occupied
Hotel/motel
Multi-family
29,317
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
$
$
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, market
interest rates, inflation
and
related expectations, 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.
16
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 September 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.
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
September 30, 2022, the
Company
increased its look-back period
to 54 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
waning of
COVID-19 as
a pandemic and
other changes
in economic conditions.
17
The following
table details the
changes in the
allowance for loan
losses by portfolio segment for the
respective
periods.
September
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
(
13
)
(
3
)
(
16
)
Recoveries
Net (charge-offs) recoveries
(
11
)
Provision for loan
losses
(
18
)
(
5
)
Ending balance
$
$
Nine months ended:
Beginning balance
$
$
Charge-offs
(
17
)
(
67
)
(
84
)
Recoveries
Net (charge-offs) recoveries
(
11
)
(
6
)
Provision for loan
losses
(
114
)
(
200
)
Ending balance
$
$
September
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
$
$
Recoveries
Net recoveries
Provision for loan
losses
(
14
)
(
49
)
(
46
)
(
10
)
Ending balance
$
$
Nine months ended:
Beginning balance
$
$
Charge-offs
(
1
)
(
5
)
(
6
)
Recoveries
Net recoveries
Provision for loan
losses
(
46
)
(
4
)
(
346
)
(
177
)
(
27
)
(
600
)
Ending balance
$
$
18
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
September 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
September 30, 2022:
Commercial and
industrial
$
Construction and
land development
Commercial real estate
Residential real estate
Consumer installment
Total
$
4,966
September 30, 2021:
Commercial and
industrial (3)
$
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 $13.3
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.
19
(Dollars
in thousands)
Mention
Substandard
Accruing
Nonaccrual
Total
loans
September 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).
20
The following
tables set forth certain
information regarding
the Company’s
impaired
loans that were
individually evaluated
for impairment
at September 30,
2022 and
December 31, 2021.
September
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
$
(
27
)
$
Total commercial real estate
(
27
)
Total impaired loans
$
(
27
)
$
(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
21
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
September
30, 2022
Nine months
ended September
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
September
30, 2021
Nine months
ended September
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
included
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.
22
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 September
30, 2022 and
December 31, 2021,
respectively.
TDRs
Related
(Dollars
in thousands)
Accruing
Nonaccrual
Total
Allowance
September 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 September 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
nine months
ended
September 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.
23
The following
table details the
changes in amortized
MSRs
and the related valuation
allowance
for the respective periods.
Quarter ended
September
30,
Nine months
ended September
30,
(Dollars
in thousands)
2022
2021
2022
2021
MSRs, net:
Beginning balance
$
$
$
$
Additions, net
Amortization
expense
(
64
)
(
127
)
(
211
)
(
411
)
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 nine months
ended September
30, 2022, there
were no transfers between
levels and
no changes
in valuation techniques
for the Company’s
financial assets and
liabilities.
24
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/dealer 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
September 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)
September 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.
25
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
estimated 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 the estimated 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.
26
The following
table presents the balances
of the assets and
liabilities measured at
fair value
on a nonrecurring
basis as of
September 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)
September 30, 2022:
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 September 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 September
30, 2022 and
December 31, 2021,
the significant unobservable
inputs used in
the fair value
measurements and
the range of such
inputs with respect to such
assets are presented below.
Range of
Weighted
Carrying
Significant
Unobservable
Average
(Dollars
in thousands)
Amount
Valuation
Technique
Unobservable
Input
Inputs
of Input
September 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.
27
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
September 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
September 30, 2022:
Financial Assets:
Loans, net (1)
$
$
$
$
$
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.
NOTE 8:
SUBSEQUENT EVENTS
On October 13, 2022, the
Company
closed the sale of
approximately
0.85 acres of land
located next
to the Company’s
headquarters
in Auburn, Alabama
at a purchase
price of $
prorations, closing
costs and
costs of demolishing
the Bank’s former main
office building,
the Company
estimates that the
sale will result in
a pre-tax gain of
$
28
ITEM 2. MANAGEMENT'S
DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION
AND RESULTS OF
OPERATIONS
General
Auburn National
Bancorporation, Inc.
(the “Company”)
is a bank
holding company
registered with
the Board
of Governors
of the Federal Reserve
System (the
“Federal
Reserve”) under
the Bank Holding
Company Act
of 1956, as amended
(the
“BHC Act”).
The Company
was incorporated in
Delaware in
1990, and in
1994 it succeeded its Alabama
predecessor as
the
bank holding company
controlling AuburnBank,
an Alabama
state member bank
with its
principal office in Auburn,
Alabama (the
“Bank”). The
Company and
its predecessor have
controlled the Bank
since 1984.
As
a bank holding
company, the Company
may diversify
into a broader range
of financial
services and
other business activities than
currently
are permitted to the
Bank
under applicable
laws and regulations.
The holding company
structure also provides
greater
financial
and operating flexibility than
is presently permitted to
the Bank.
The Bank
has operated continuously
since 1907 and
currently conducts its business
primarily in
East Alabama,
including
Lee County
and surrounding
areas.
The Bank
has been a member
of the Federal
Reserve System
since April 1995.
The
Bank’s primary regulators
are the
Federal Reserve
and the Alabama
Superintendent of
Banks (the “Alabama
Superintendent”).
The Bank has
been a member
of the Federal Home
Loan Bank
of Atlanta (the “FHLB
of Atlanta”)
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” as
more fully described
under
“Special Notice
Regarding Forward-Looking
Statements” below.
The following
discussion and
analysis is intended
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
nine months ended
September 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 interim reports on
Form 10-Q
for the quarters
ended March 31,
2022 and
June 30, 2022.
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,”
“appears,” “should,”
“indicate,”
“would,” “believe,”
“contemplate,” “expect,”
“estimate,”
“continue,” “plan,”
“point to,”
“project,”
“could,” “intend,”
“target,” “view,” 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;
29
●
legislative and
regulatory changes,
including changes
in banking, securities and
tax laws,
regulations and rules
and
their application
by our regulators, including
capital and liquidity
requirements, and
changes in the scope and
cost
of FDIC insurance;
●
changes in accounting
pronouncements and
interpretations, including
the required
implementation of Financial
Accounting Standards
Board’s (“FASB”) Accounting
Standards Update
(ASU) 2016-13, “Financial
Instruments –
Credit Losses (Topic 326): Measurement
of Credit Losses
on Financial
Instruments,” as
well as the
updates issued
since June 2016 (collectively,
FASB ASC Topic 326) on Current
Expected Credit
Losses (“CECL”),
and ASU
2022-02, Troubled Debt
Restructurings and
Vintage Disclosures, which
eliminates troubled debt
restructurings
(“TDRs”) and
related guidance;
●
the failure of assumptions
and
estimates, as well
as differences in, and
changes to,
economic, market and
credit
conditions, including
changes in borrowers’
credit risks and
payment behaviors
from those used
in our loan
portfolio reviews;
●
the risks of changes
in 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;
●
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 timing and
amount of rental income
from third parties
following
the June 2022 opening
of our new
headquarters;
●
the risks of mergers, acquisitions
and
divestitures, including,
without limitation,
the related time
and
costs of
implementing
such transactions,
integrating
operations as part
of these transactions and
possible failures to achieve
expected gains,
revenue growth
and/or expense
savings from such
transactions;
●
changes in technology
or products that
may be more difficult, costly,
or less effective than
anticipated;
●
cyber-attacks and
data breaches that
may compromise our
systems, our
vendor
systems
or customers’
information;
●
the risks that
our deferred tax
assets (“DTAs”) included
in “other assets” on
our consolidated balance
sheets, if
any, could be reduced
if estimates of future taxable
income from our operations
and
tax planning
strategies are less
than currently estimated,
and
sales of our capital
stock could trigger
a reduction in
the amount of
net operating
loss
carry-forwards that
we may be able to
utilize for income tax
purposes;
●
the timing and
amount of any credit approved
by the Internal
Revenue Service
(“IRS”) resulting
from our 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”.
30
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.
Summary of Results of
Operations
Quarter ended
September
30,
Nine months
ended September
30,
(Dollars
in thousands, except
per share
amounts)
2022
2021
2022
2021
Net interest income (a)
$
7,360
$
6,158
$
20,034
$
18,308
Less: tax-equivalent
adjustment
117
117
339
355
Net interest income (GAAP)
7,243
6,041
19,695
17,953
Noninterest income
852
975
2,608
3,288
Total revenue
8,095
7,016
22,303
21,241
Provision for loan
losses
250
—
—
(600)
Noninterest expense
5,415
4,755
15,374
14,361
Income tax expense
432
386
1,049
1,313
Net earnings
$
1,998
$
1,875
$
5,880
$
6,167
Basic and
diluted earnings
per share
$
0.57
$
0.53
$
1.67
$
1.74
(a) Tax-equivalent.
See "Table 1 - Explanation
of Non-GAAP Financial
Measures."
Financial Summary
The Company’s net earnings
were $5.9 million for the first
nine months
of 2022, down
5% compared to $6.2 million
for the
first nine months
of 2021.
Basic and
diluted earnings
per share were $1.67 per
share for the
first nine months
of 2022,
down 4% from the
$1.74 per share
for the first nine
months of
2021.
Net interest
income (tax-equivalent)
was $20.0 million for the
first nine
months of
2022, a 9%
increase compared to $18.3
million for the first nine
months of
2021.
This
increase was due
to balance sheet growth,
and an increase in
the Company’s
net interest margin (tax-equivalent).
Net interest margin
(tax-equivalent)
increased to 2.67%
in the
first nine months
of
2022, compared to 2.59%
for the
first nine months
of 2021 due to increases
in the
Federal Reserve’s target
federal funds
rates, and changes
in our asset
mix resulting from the
continuing
elevated levels
of customer deposits.
Beginning
in March
2022 through September
30, 2022, the
Federal Reserve
increased the
target federal funds
range
from 0 – 0.25% to 3.00 –
3.25%.
On November
3, the Federal
Reserve increased its
target federal funds
rate by
a further 0.75%.
The
Federal
Reserve has
indicated that additional
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 nine
months of
2022, compared to $0.8 million
for the first nine
months of 2021.
At September 30,
2022, the Company’s
allowance for loan
losses was $5.0 million,
or 1.05
%
of total
loans, compared
to
$4.9 million, or 1.08%
of total loans,
at December 31,
2021, and
$5.1 million, or 1.13%
of total loans,
at September
30,
2021.
The Company
recorded no net
provision for loan
losses during
the first nine
months of 2022 compared
to a negative
provision for loan
losses of $0.6 million during
the first nine
months of 2021.
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
$2.6 million for the
first nine months
of 2022,
21% less than
the $3.3 million earned
in the first
nine months
of 2021.
The
decrease in noninterest income
was
primarily due
to a decrease in mortgage
lending income of
$0.7 million as
market interest rates on
mortgage loans
increased.
31
Noninterest expense was
$15.4 million for the
first nine months
of 2022,
up
7% compared
to $14.4 million for the
first nine
months of
2021.
The
increase in noninterest expense
was
due to increases in
salaries and
benefits expense of $0.3
million,
net occupancy
and equipment expense
of $0.6
million related
to the Company’s
new headquarters,
and other noninterest
expense of $0.2
million.
Inflation
may also
have affected our costs adversely.
These increases were partially
offset by
a
decrease in professional fees
of $0.1 million.
Income tax expense
was $1.0 million for the
first nine
months of
2022 compared to
$1.3 million during
the first nine
months of 2021.
The
Company’s effective tax
rate for the first nine
months of
2022 was 15.14%, compared
to 17.55% in
the first nine 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 $0.765 per share in
the first nine
months of
2022, an increase of 2%
from the same
period of 2021.
The
Company has
repurchased 15,280 shares
for $0.5 million
since December 31,
2021.
At
September 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 16.16%, a
tier 1 leverage ratio
of 9.29% and
a common
equity tier 1 (“CET1”)
ratio of 15.39% at
September 30, 2022.
At
September 30, 2022, the
Company’s
equity
to total
assets ratio was
5.74%, compared
to 9.39% at
December 31, 2021,
and
9.84% at
September 30, 2021.
For the third
quarter of 2022, net earnings
were $2.0 million, or
$0.57 per share, compared
to $1.9 million,
or $0.53 per
share, for the third
quarter of 2021.
Net interest income
(tax-equivalent)
was
$7.4 million for the third
quarter of
2022, a
20%
increase compared to
$6.2
million for the
third quarter
of 2021.
This increase was
primarily due
to recent increases in
market interest rates.
Since March
2022, the Federal
Reserve has
increased the target
federal funds
range by 300 basis
points.
Further increases in
the target federal
funds rate
are possible if inflation remains
elevated.
The
Company’s net
interest margin (tax-equivalent)
was 3.00%
in the third
quarter of
2022 compared to 2.51% in
the third
quarter of 2021.
Net
interest income (tax-equivalent)
included
$26 thousand
in PPP loan fees, net
of related costs for the
third quarter
of 2022
and $0.3
million in
the third quarter
of 2021.
The
Company recorded a
provision for loan
losses during the
third quarter
of
2022 of $0.3 million, compared
to no
provision for loan
losses during the
third quarter
2021.
The
provision for loan
losses
was primarily
related to loan growth
during the third
quarter of
2022.
Noninterest income
was
$0.9 million in the
third
quarter of
2022, compared to $1.0 million
in the
third quarter
of 2021.
The decrease in
noninterest income was
primarily
due to a decrease in
mortgage lending
income of $0.1
million as
market interest rates on
mortgage loans
increased.
Noninterest expense was
$5.4
million in
the third quarter
of 2022,
compared to
$4.8 million
for the third
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, and
other noninterest expenses of
$0.2
million.
Income tax
expense was
$0.4
million for the third
quarter of 2022 and
2021, respectively.
The
Company's
effective tax rate
for the third quarter
of 2022 was 17.79%, compared
to 17.07%
in the
third 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.
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.
32
COVID-19 has significantly
affected local state, national
and
global health and
economic activity and
its future effects are
uncertain and
will depend on various
factors, including,
among others, the
duration
and scope of the pandemic,
especially
new variants of
the virus, effective vaccines
and
drug treatments, together with
governmental,
regulatory and
private sector
responses. COVID-19
has had
continuing
significant effects on the
economy, financial markets
and our
employees,
customers and
vendors. Our
business, financial
condition and results of operations
generally rely
upon
the ability
of our
borrowers to make
deposits and
repay their loans,
the value of collateral underlying
our secured loans,
market value,
stability and
liquidity and demand
for loans and
other products and
services we offer, all of which
are affected by
the
pandemic.
We have implemented a number
of procedures in
response to the pandemic
to support
the safety
and well-being
of our
employees, customers and
shareholders.
●
We believe our business continuity
plan has
worked to provide
essential banking
services to our communities and
customers, while protecting
our employees’
health.
As part of our
efforts
to exercise social
distancing
in
accordance with
the guidelines
of the Centers for Disease
Control and
the Governor of
the State of
Alabama,
starting March
23, 2020, we
limited branch lobby
service to appointment
only while continuing
to operate our
branch drive-thru
facilities and ATMs. As permitted by
state public health
guidelines, on
June 1, 2020, we
re-
opened some of
our branch lobbies.
In 2021, we
opened our remaining
branch lobbies. We continue
to provide
services through
our online and
other electronic channels.
In addition,
we maintain
remote work access to
help
employees stay at
home while
providing continuity
of service 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 forgivable,
in whole or
in part, if the
proceeds are used
for payroll
and other permitted purposes
in accordance
with
the requirements of the PPP. These
loans carry
a fixed rate
of
1.00% and
a term of two years
(loans made
before June 5,
2020) or five years
(loans made
on or after June
5,
2020), if not forgiven,
in whole or
in part. Payments
are deferred until either the
date on
which the Small
Business
Administration
(“SBA”) remits the amount
of forgiveness proceeds to the
lender or the
date that
is 10 months after
the last day
of the covered period
if the borrower
does not apply
for forgiveness within
that 10-month period.
We
believe these loans
and our participation
in the program
helped our customers and
the communities we
serve.
COVID-19 has also
had various
economic effects, generally. These
include supply
chain disruptions
and
manufacturing
delays, shortages of
certain goods and
services, reduced consumer expenditure
on hospitality
and
travel, and
migration from
larger urban centers to less populated
areas and
remote work.
The demand
for single family
housing has exceeded existing
supplies. When
coupled with construction
delays
attributable to
supply chain
disruptions and
worker shortages, these
factors have
caused housing prices and
apartment
rents to increase, generally. Stimulative
monetary and fiscal policies,
along with shortages
of certain goods
and
services, and
rising petroleum and
food prices,
reflecting, among
other things, the
war in the Ukraine,
have led to
the highest inflation
in decades.
The Federal
Reserve has
begun rapidly
increasing its target
federal funds rate
from 0 – 0.25%
at the beginning
of March 2022 to 3.00 – 3.25%
at September
30, 2022 and
3.75 – 4.00%
as of November
30.
The Federal
Reserve also has
been 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. Through
December
31, 2021, we
had
recognized all of these fees, net
of related costs.
As
of December 31, 2021, we
had received payments
and
forgiveness on all
PPP loans extended
during 2020.
33
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
September 30, 2022, we
have recognized
all of these fees, net
of related costs. As
of September 30, 2022, we
have received
payments and
forgiveness on all but
1 PPP loan,
in the amount
of $0.1 million, under
the Economic Aid
Act.
We believe that the COVID-19
pandemic stimuli
and decreased economic activity
increased customer
liquidity
and
tier
deposits at the
Bank and decreased loan
demand, while
monetary stimulus
reduced interest rates
and
our costs of funds
and
our interest earnings
on loans.
As a result, our
net interest margin
was adversely
affected.
A return
to more normal
interest
rates appears underway,
beginning
in March 2022, and
has accelerated in
recent months as
a result of Federal
Reserve
efforts
to curb
inflation.
This
has resulted in improved
net interest margin,
but at the same
time has reduced the
market
values of our
securities portfolio and
resulted in unrealized
securities losses.
As a
result, we have
had losses in our
other
comprehensive income and
our equity under generally
accepted accounting
principles has
declined.
This has not
adversely
affected our regulatory
capital,
however.
We continue to closely monitor the
pandemic’s
effects
,
and
are working
to continue our
services and
to address
developments
as those occur. Our results of operations
for the
nine months
ended September 30,
2022, and
our financial
condition at
that date,
which
reflect only the continuing
direct and
indirect effects of the pandemic,
may not be
indicative
of
future results or financial
conditions, including
possible changes
in monetary
or fiscal stimulus, and
the possible effects of
the expiration or extension
of temporary
accounting
and
bank regulatory relief measures
in response to
the COVID-19
pandemic.
As of September 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 these
continuing
effects of the pandemic,
and are working
to anticipate and
address developments.
The CARES
Act and the 2020 Consolidated
Appropriations
Act
provide eligible employers
an
employee retention credit
related to COVID-19.
After consultation with
our tax advisors,
we believe
we are eligible, and
have filed amended
payroll
tax returns with
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.
The direct health
issues related to COVID-19
appear to
be waning as a
result of vaccinations,
new medications and
increased resistance to the
virus
as a result of prior infections,
although
new strains continue
to appear.
The economic
effects
of the pandemic
and
government fiscal and
monetary policy responses,
supply
chain disruptions
and inflation
continue, however.
34
CRITICAL
ACCOUNTING
POLICIES
The accounting
and financial reporting
policies of the Company
conform with
U.S. generally
accepted accounting
principles and
with general
practices within
the banking industry.
In connection with
the application
of those principles, we
have made judgments
and estimates which,
in the case of the
determination of our
allowance
for loan losses, our
assessment of other-than-temporary
impairment,
recurring and
non-recurring fair value
measurements, the
valuation
of
other real estate owned,
and the valuation
of deferred tax
assets, were critical to the
determination of
our financial
position
and results of operations.
Other policies also
require subjective
judgment
and assumptions
and may accordingly
impact our
financial
position and results of operations.
Allowance for Loan
Losses
The Company
assesses the adequacy
of its allowance
for loan losses prior to the
end
of each calendar
quarter. The level of
the allowance
is based upon
management’s evaluation
of the loan
portfolio, past loan
loss experience, current asset
quality
trends, known and
inherent risks in
the portfolio, adverse
situations that
may affect a
borrower’s ability to
repay (including
the timing of
future payment),
the estimated value
of any underlying
collateral, composition
of the loan
portfolio, economic
conditions, changes
in, and expectations
regarding,
market interest rates and
inflation, industry and
peer bank
loan loss rates
and other pertinent factors.
This
evaluation is inherently
subjective as it
requires material estimates including
the amounts
and timing of
future cash flows
expected to be
received on impaired
loans that
may be susceptible to significant
change.
Loans are
charged off, in whole
or in part,
when management
believes that
the full collectability
of the loan
is unlikely. A
loan may be partially
charged-off after a
“confirming event”
has occurred which
serves to validate
that full repayment
pursuant to the
terms of the loan
is unlikely.
In addition, our
regulators, as
an integral part
of their examination
process,
will periodically review
the Company’s 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.
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 the
allowance for loan
losses maintained is
believed
by management, based
on its processes and
estimates, to
be adequate
to absorb probable
losses inherent in the
portfolio at the
balance sheet date.
The allowance
is increased by
provisions charged
to expense and decreased by
charge-offs, net of recoveries of amounts
previously
charged-off and
by
releases from the allowance
when determined
to be
appropriate to
the levels of loans
and probable loan
losses in such
loans.
In assessing the
adequacy of
the allowance,
the Company also
considers the results of its
ongoing
internal, independent
loan review
process. The Company’s
loan review
process assists in determining
whether
there are loans
in the portfolio
whose credit quality
has weakened
over time and
evaluating the
risk characteristics of the entire
loan portfolio. The
Company’s loan review
process includes the judgment
of management,
the input from our
independent loan
reviewers, and
reviews that
may have been
conducted by bank
regulatory agencies
as part of
their examination
process. The
Company
incorporates loan
review results in
the determination
of whether
or not it is
probable
that it will be able
to collect all
amounts due according
to the contractual
terms of a
loan.
As part of the
Company’s quarterly assessment of the
allowance,
management
divides the loan
portfolio into five segments:
commercial and
industrial,
construction and
land development,
commercial real estate, residential
real estate,
and
consumer
installment loans.
The Company
analyzes
each segment and
estimates an
allowance allocation for each
loan segment.
35
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 September
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
September 30, 2022, the
Company
increased its look-back period
to 54 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 the FHLB
of Atlanta
and Federal
Reserve Bank
of Atlanta
(“FRB”).
These non-marketable
equity securities are accounted
for at cost which
equals
par or
redemption value.
These securities do not
have a
readily determinable fair
value
as their ownership
is restricted and
there is
no market
for these securities.
The
Company records these
non-marketable equity
securities as
a
component of other
assets, which
are periodically evaluated
for impairment.
Management
considers these non-marketable
equity
securities to
be long-term investments.
Accordingly, when
evaluating
these securities for impairment,
management
considers the
ultimate recoverability of
the par
value rather than by
recognizing temporary
declines in value.
36
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
September 30, 2022 we
had total deferred tax
assets of $16.1 million
included as “other
assets”, including
$15.3 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
September 30, 2022.
The
amount of the
deferred tax
assets considered realizable,
however,
could
be reduced if
estimates of future taxable
income are reduced.
37
RESULTS OF OPERATIONS
Average Balance Sheet and
Interest Rates
Nine months
ended September
30,
2022
2021
Average
Yield/
Average
Yield/
(Dollars
in thousands)
Balance
Rate
Balance
Rate
Loans and loans
held for sale
$
442,613
4.42%
$
460,732
4.47%
Securities - taxable
370,402
1.69%
310,288
1.30%
Securities - tax-exempt
61,227
3.52%
62,915
3.60%
Total securities
431,629
1.95%
373,203
1.68%
Federal funds
sold
54,924
0.76%
36,821
0.14%
Interest bearing
bank deposits
73,630
0.82%
75,170
0.12%
Total interest
-earning
assets
1,002,796
2.89%
945,926
2.86%
Deposits:
NOW
201,792
0.13%
176,242
0.12%
Savings and
money market
335,005
0.20%
289,758
0.23%
Time deposits
155,824
0.84%
159,412
1.05%
Total interest
-bearing
deposits
692,621
0.32%
625,412
0.41%
Short-term borrowings
3,969
0.50%
3,329
0.50%
Total interest
-bearing
liabilities
696,590
0.32%
628,741
0.41%
Net interest income and
margin (tax-equivalent)
$
20,034
2.67%
$
18,308
2.59%
Net Interest Income and
Margin
Net interest income (tax-equivalent)
was
$20.0 million for the first nine
months of
2022,
a
9% increase compared
to $18.3
million for the first nine
months of
2021.
This
increase was due
to balance sheet
growth, and
an increase in
the Company’s
net interest margin (tax-equivalent).
Net interest margin
(tax-equivalent)
increased to 2.67% in
the first nine
months of
2022, compared to 2.59% for
the first nine
months of
2021 due to increases
in the
Federal Reserve’s target
federal funds
rates beginning
March 17, 2022, 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 17, 2022, 50 basis
points on May
5 and 75 basis
points on each of
June 16, July 28,
and September 22.
The
target rate was increased 75
basis
points on November
3, 2022, and further
increases in
the target federal
funds rate
appear likely if
inflation remains
elevated.
Net interest income (tax-equivalent)
included
$0.3 million in
PPP loan fees, net
of related costs for the
first nine
months of
2022, compared to $0.8 million
for the first nine
months of
2021.
The tax-equivalent yield
on total interest-earning
assets increased by
3 basis points
to 2.89% in the
first nine months
of
2022 compared to 2.86% in
the first nine
months of
2021.
This
increase 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 0.32% in the
first nine months
of 2022 compared
to 0.41% in
the first nine months
of 2021, even
as interest bearing
deposits increased.
The
net decrease in
our funding
costs
was primarily
due to a portion of
our time deposits repricing
into lower prevailing
market interest rates through
the first
nine months
of 2022.
Our
deposit costs may
increase as the
Federal Reserve
increases its target federal
funds
rate, market
interest rates increase, and
as customer behaviors
change
as a result of inflation and
higher market
interest rates on deposits
and other alternative
investments.
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.
38
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 no net
provision for loan
losses during the
first nine months
of 2022 compared
to a negative
provision for loan
losses of $0.6 million during
the first nine months
of 2021.
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.
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
1.05%
at September
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
September
30,
Nine months
ended September
30,
(Dollars
in thousands)
2022
2021
2022
2021
Service charges
on deposit accounts
$
158
$
149
$
446
$
419
Mortgage lending
income
126
268
566
1,241
Bank-owned life insurance
97
100
293
302
Securities gains,
net
44
15
44
15
Other
427
443
1,259
1,311
Total noninterest income
$
852
$
975
$
2,608
$
3,288
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
September
30,
Nine months
ended September
30,
(Dollars
in thousands)
2022
2021
2022
2021
Origination income
$
39
$
233
$
315
$
1,168
Servicing fees, net
87
35
251
73
Total mortgage lending income
$
126
$
268
$
566
$
1,241
39
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 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
September
30,
Nine months
ended September
30,
(Dollars
in thousands)
2022
2021
2022
2021
Salaries and
benefits
$
2,975
$
2,893
$
8,901
$
8,641
Net occupancy
and equipment
794
467
1,955
1,340
Professional fees
235
232
704
814
Other
1,411
1,163
3,814
3,566
Total noninterest expense
$
5,415
$
4,755
$
15,374
$
14,361
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 2022.
Income Tax Expense
Income tax expense
was $1.0 million for the
first nine
months of
2022 compared
to $1.3 million
for the first nine
months of
2021.
The
Company’s effective income tax
rate for the
first nine months
of 2022 was 15.14%, compared
to 17.55% in
the
first nine 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 $411.5 million
at September
30, 2022 compared
to $421.9 million
at December 31,
2021.
This decrease reflects
an
increase in the amortized
cost basis of securities
available-for-sale
of $51.8 million,
offset by
a
decrease of $62.2
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 $15.3 million
of deferred tax
assets included
in our other
assets.
The
average annualized
tax-equivalent
yields earned on total
securities were 1.95%
in the
first nine months
of 2022
and 1.68%
in the first
nine months
of 2021.
40
Loans
2022
2021
Third
Second
First
Fourth
Third
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Commercial and
industrial
$
70,685
70,087
73,297
83,977
79,202
Construction and
land development
54,773
38,654
33,058
32,432
34,890
Commercial real estate
250,030
240,296
235,062
258,371
252,798
Residential real estate
91,598
85,224
79,102
77,661
80,205
Consumer installment
7,551
7,122
8,412
6,682
7,060
Total loans
474,637
441,383
428,931
459,123
454,155
Less:
unearned income
(602)
(511)
(514)
(759)
(923)
Loans, net of unearned
income
$
474,035
440,872
428,417
458,364
453,232
Total loans, net of
unearned income, were
$474.0 million at
September 30, 2022,
and
$458.4 million at
December 31, 2021,
an increase of $15.7 million,
or 3%.
Total loans at December
31, 2021 included
$8.0
million in
PPP loans, all
of which
were repaid
during the first nine
months of
2022.
Excluding
PPP loans, total loans,
net of unearned
income, increased
$23.8 million, or 5%
from December 31,
2021.
Four loan
categories represented
the majority
of the loan
portfolio at
September 30, 2022: commercial
real estate (53%),
residential real
estate (19%),
commercial and
industrial (15%) and
construction and
land development
(12%).
Approximately
23% of the
Company’s commercial real estate
loans were
classified as owner-occupied
at September
30, 2022.
Within the residential real estate portfolio
segment, the
Company
had junior lien
mortgages of approximately
$6.8
million,
or 1%, and $7.2 million,
or 2%, of
total loans,
net of unearned
income at September
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 September 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 consumer mortgage
products which
are generally viewed
as high risk.
The average
yield earned
on loans and
loans held for sale was
4.42% in the first nine
months of
2022 and 4.47% in
the first
nine 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
$21.7 million.
Furthermore, we
have an internal
limit for aggregate
credit exposure (loans
outstanding
plus
unfunded commitments)
to a
single borrower of
$19.5 million. Our
loan policy
requires that
the Loan Committee of the
Board of Directors approve
any loan relationships that
exceed this internal
limit.
At September
30, 2022, the Bank
had no
relationships exceeding
these limits.
41
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 September 30,
2022 and
December 31, 2021.
September
30,
December 31,
(Dollars
in thousands)
2022
2021
Lessors of 1-4 family
residential properties
$
51,391
$
47,880
Hotel/motel
33,918
43,856
Multi-family residential properties
29,317
42,587
Shopping centers
27,174
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 September 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 GAA
P.
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.
We had no new
TDRs during the
first nine months
of 2022, and
only $170 thousand
of nonaccruing
TDRs
remained at
September 30, 2022 compared
to $249 thousand
at December 31,
2021.
Allowance for Loan
Losses
The Company
maintains the
allowance for loan
losses at a
level that management
believes appropriate
to adequately cover
the Company’s estimate of probable
losses inherent
in the
loan portfolio. The
allowance
for loan losses was
$5.0 million at
September 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.”
42
A summary
of the changes in
the allowance
for loan losses and
certain asset quality
ratios for the third
quarter of
2022 and
the previous
four quarters is
presented below.
2022
2021
Third
Second
First
Fourth
Third
(Dollars
in thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Balance at beginning
of period
$
4,716
4,658
4,939
5,119
5,107
Charge-offs:
Commercial and
industrial
(13)
(4)
—
—
—
Commercial real estate
—
—
—
(254)
—
Residential real estate
—
—
—
(2)
—
Consumer installment
(3)
(16)
(48)
(32)
—
Total charge-offs
(16)
(20)
(48)
(288)
—
Recoveries
16
78
17
108
12
Net recoveries (charge-offs)
—
58
(31)
(180)
12
Provision for loan
losses
250
—
(250)
—
—
Ending balance
$
4,966
4,716
4,658
4,939
5,119
as a % of loans
1.05
%
1.07
1.09
1.08
1.13
as a % of nonperforming
loans
1,431
%
1,314
1,256
1,112
1,053
Net (recoveries) charge-offs
as %
of average loans
(a)
—
%
(0.05)
0.03
0.16
(0.01)
(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, current asset
quality
trends, 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,
inflation
and
changes in market
interest rates, 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
1.05%
at September
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 and
expectations regarding
inflation and 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 September 30,
2022 the Company
had $0.3 million in
nonperforming assets compared
to $0.8 million
at December 31,
2021.
43
The table below
provides information concerning
total nonperforming
assets and
certain asset quality
ratios for the third
quarter of
2022 and the previous
four quarters.
2022
2021
Third
Second
First
Fourth
Third
(Dollars
in thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Nonperforming assets:
Nonaccrual loans
$
347
359
371
444
486
Other real
estate owned
—
—
374
374
—
Total nonperforming assets
$
347
359
745
818
486
as a % of loans
and other real
estate owned
0.07
%
0.08
0.17
0.18
0.11
as a % of total assets
0.03
%
0.03
0.07
0.07
0.05
Nonperforming loans
as a % of
total loans
0.07
%
0.08
0.09
0.10
0.11
Accruing loans
90 days or more past
due
$
—
—
—
—
69
The table below
provides information concerning
the composition of
nonaccrual
loans for the third
quarter of
2022 and the
previous four quarters.
2022
2021
Third
Second
First
Fourth
Third
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Nonaccrual loans:
Commercial real estate
$
170
176
182
187
193
Residential real estate
177
183
189
257
293
Total nonaccrual loans
$
347
359
371
444
486
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
$0.3
million in
loans on nonaccrual
status at September
30, 2022 and
December 31, 2021,
respectively.
The Company
had no loans
90 days or more past
due and still accruing
at September 30,
2022 and
December 31, 2021,
respectively.
The table below
provides information concerning
the composition of OREO
for the third
quarter of 2022 and
the previous
four quarters.
2022
2021
Third
Second
First
Fourth
Third
(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
September 30, 2022, and
$2.4 million, or 0.5%
of total loans
at December 31,
2021.
44
The table below
provides information concerning
the composition of
potential
problem loans
for the third
quarter of
2022
and the previous
four quarters.
2022
2021
Third
Second
First
Fourth
Third
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Potential problem loans:
Commercial and
industrial
$
194
225
215
226
274
Construction and
land development
—
—
13
218
231
Commercial real estate
191
146
150
156
172
Residential real estate
892
915
1,592
1,748
1,848
Consumer installment
29
24
8
12
19
Total potential problem loans
$
1,306
1,310
1,978
2,360
2,544
At September 30,
2022,
approximately
$46 thousand
or 4% 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 third
quarter of 2022 and
the previous
four quarters.
2022
2021
Third
Second
First
Fourth
Third
(In thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Performing loans past
due 30 to 89 days:
Commercial and
industrial
$
1
34
7
3
68
Construction and
land development
282
—
1
204
—
Commercial real estate
—
28
—
—
—
Residential real estate
86
130
496
516
409
Consumer installment
8
7
15
25
25
Total
$
377
199
519
748
502
Deposits
Total deposits were $978.0 million
at September
30, 2022 compared
to $994.2 million
at December 31,
2021.
The
decrease
in total deposits was
primarily due
to a decrease in rate-sensitive
money market
and savings
accounts of $21.8
million.
Noninterest
-bearing
deposits were $321.7
million, or
32% of total deposits,
at September
30, 2022, compared
to
$316.1 million, or 32%
of total deposits
at December 31,
2021.
We had no brokered
deposits on September
30, 2022 or at
December 31, 2021.
Estimated uninsured
deposits totaled $393.8
million and
$420.8 million at
September 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
0.32% in the first nine
months of
2022 compared to 0.41% in
the first nine 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 September 30,
2022, and
December 31, 2021, respectively.
Securities sold
under
agreements to repurchase totaled
$2.6 million and
$3.4 million at
September 30, 2022 and
December 31, 2021,
respectively.
The average
rate paid on short-term
borrowings
was 0.50% in
the first nine
months of
2022 and 2021,
respectively.
45
The Company
had no long-term debt
at September 30,
2022 and
December 31, 2021.
CAPITAL ADEQUACY
The Company’s consolidated stockholders’
equity
was
$59.8 million and
$103.7 million as
of September 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 $46.6 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’s consolidated stockholders’
equity
was
also
decreased by cash
dividends paid
of $2.8 million, and
repurchases of the
Company’s stock of $0.5 million.
These
decreases in the
Company’s consolidated
stockholders’
equity
were partially
offset by net
earnings of $5.9 million.
The Company
paid cash dividends
of $0.795 per share in
the first nine
months of 2022, an
increase of 2% from the
same
period in 2021. The
Company’s share
repurchases of $0.5
million since December
31, 2021 resulted
in 15,280 fewer
outstanding common
shares at
September 30, 2022.
These
shares were
repurchased at
an average cost per
share of $30.06
and a total cost of $0.5 million.
On January 1,
2015, the Company
and Bank became
subject to the
rules of the
Basel III regulatory
capital framework
and
related Dodd-Frank
Wall Street Reform and
Consumer Protection Act
changes.
The rules included
the implementation of
a
capital conservation buffer
that
is added to
the minimum requirements for
capital adequacy
purposes.
The capital
conservation buffer was
subject to a
three year phase-in
period that began
on January 1,
2016 and was
fully phased-in on
January 1, 2019 at
2.5%.
A banking organization
with a conservation
buffer of less than
the required
amount will
be
subject to limitations on
capital distributions,
including
dividend
payments and
certain discretionary bonus
payments
to
executive officers.
At
September 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.
This rule only affects the capital
buffers, and
banking
organizations were
encouraged to make
prudent capital
distribution decisions.
The Federal
Reserve has
treated us as a
“small bank holding
company’ under
the Federal
Reserve’s Small Bank
Holding
Company Policy.
Accordingly, our
capital adequacy
is evaluated
at the Bank
level, and not
for the Company
and its
consolidated subsidiaries.
The
Bank’s tier 1 leverage
ratio was 9.29%, CET1
risk-based capital ratio
was 15.39%, tier 1
risk-based capital
ratio was 15.39%,
and
total risk-based capital
ratio was 16.16% at
September 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 buffer was
8.16%
at September 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
$15.3 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.
46
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.
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
While a gradual
change in
interest rates was
used in the above
analysis to provide
an estimate of exposure under
these
scenarios, our modeling
under
both a gradual
and instantaneous change
in interest rates indicates
our balance
sheet is asset
sensitive.
At September 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 September 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.
47
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 September
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.
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
September 30, 2022, the
Bank
had a remaining
available line
of credit with
the FHLB
of $325.1 million.
At
September 30, 2022, the
Bank
also had $61.0 million of available
federal funds
lines with no
borrowings outstanding.
Primary uses of
funds include
repayment of maturing
obligations and growing
the loan portfolio.
The Bank
has no brokered deposits on
September 30, 2022
or at
December 31, 2021
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 September 30,
2022, the Bank
had outstanding
standby letters of credit of
$1.0
million and
unfunded loan
commitments
outstanding of
$88.8 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.
48
As of September 30,
2022, the unpaid
principal
balance of residential mortgage
loans, which
we have originated
and sold,
but retained the servicing
rights, was
$238.3 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.
The Company
was not required to
repurchase any
loans during
the first nine
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 September
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 September 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.
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; and
49
●
ASU 2022-02,
Financial Instruments
– Credit Losses (Topic 326):
Troubled Debt Restructurings
and Vintage
Disclosures
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.
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.
Institutions are
to apply the changes
through a cumulative-effect
adjustment
to retained earnings
as of the
beginning of the
first reporting period
in which
the standard
is effective.
The
Company is
currently assessing the
impact of
the new guidance
on its consolidated
financial
statements. An
increase in the
overall allowance
for loan losses is likely
upon
adoption in order to provide
for expected credit losses over
the life of the
loan portfolio.
ASU 2022-02,
Financial Instruments
- Credit Losses (Topic 326): -
Troubled Debt Restructurings
and Vintage
Disclosures,
requirements for certain loan
refinancings and
restructurings by
creditors when
a borrower is experiencing
financial
difficulty.
The new
standard is effective for fiscal
years, and
interim periods within
those fiscal years, beginning
after
December 15, 2022.
The
new standard is
not expected to have
a material
impact on
the Company’s consolidated financial
tatements.
50
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
Third
Second
First
Fourth
Third
(in thousands)
Quarter
Quarter
Quarter
Quarter
Quarter
Net interest income (GAAP)
$
7,243
6,374
6,078
6,037
6,041
Tax-equivalent adjustment
117
110
112
115
117
Net interest income (Tax-equivalent)
$
7,360
6,484
6,190
6,152
6,158
Nine months
ended September
30,
(In thousands)
2022
2021
Net interest income (GAAP)
$
19,695
17,953
Tax-equivalent adjustment
339
355
Net interest income (Tax-equivalent)
$
20,034
18,308
51
Table 2 - Selected Quarterly Financial
Data
2022
2021
Third
Second
First
Fourth
Third
(Dollars
in thousands, except
per share
amounts)
Quarter
Quarter
Quarter
Quarter
Quarter
Results of Operations
Net interest income
(a)
$
7,360
6,484
6,190
6,152
6,158
Less: tax-equivalent
adjustment
117
110
112
115
117
Net interest income
(GAAP)
7,243
6,374
6,078
6,037
6,041
Noninterest
income
852
848
908
1,019
975
Total revenue
8,095
7,222
6,986
7,056
7,016
Provision for loan
losses
250
—
(250)
—
—
Noninterest
expense
5,415
5,058
4,901
5,092
4,755
Income tax expense
432
363
254
93
386
Net earnings
$
1,998
1,801
2,081
1,871
1,875
Per share
data:
Basic and
diluted net earnings
$
0.57
0.51
0.59
0.53
0.53
Cash dividends
declared
0.265
0.265
0.265
0.26
0.26
Weighted
average shares
outstanding:
Basic and
diluted
3,507,318
3,513,353
3,518,657
3,524,311
3,536,320
Shares outstanding,
at period end
3,505,355
3,509,940
3,516,971
3,520,485
3,529,338
Book value
$
17.06
21.68
24.57
29.46
29.73
Common stock price:
High
$
29.02
33.57
34.49
34.79
35.36
Low
23.02
27.04
31.75
31.32
33.25
Period end:
23.02
27.04
33.21
32.30
33.80
To earnings
ratio
10.46
x
12.52
14.44
14.23
14.57
To book
value
135
%
125
135
110
114
Performance ratios:
Return on average
equity
10.35
%
8.26
7.97
7.07
7.01
Return on average
assets
0.75
%
0.66
0.75
0.70
0.72
Dividend payout
ratio
46.49
%
51.96
44.92
49.06
49.06
Asset Quality:
Allowance for
loan losses
as a % of:
Loans
1.05
%
1.07
1.09
1.08
1.13
Nonperforming
loans
1,431
%
1,314
1,256
1,112
1,053
Nonperforming
assets
as a % of:
Loans and foreclosed
properties
0.07
%
0.08
0.17
0.18
0.11
Total assets
0.03
%
0.03
0.07
0.07
0.05
Nonperforming
loans as a %
of total loans
0.07
%
0.08
0.09
0.10
0.11
Annualized
net (recoveries) charge
-offs as % of
average loans
—
%
(0.05)
0.03
0.16
(0.01)
Capital Adequacy:
(c)
CET 1 risk-based
capital ratio
15.39
%
16.59
17.26
16.23
16.82
Tier 1
risk-based capital ratio
15.39
%
16.59
17.26
16.23
16.82
Total risk-based
capital ratio
16.16
%
17.38
18.08
17.06
17.72
Tier 1
leverage ratio
9.29
%
9.16
9.09
9.35
9.57
Other financial
data:
Net interest margin
(a)
3.00
%
2.60
2.43
2.45
2.51
Effective income
tax rate
17.78
%
16.77
10.88
4.74
17.07
Efficiency
ratio (b)
65.94
%
68.99
69.05
71.01
66.66
Selected average
balances:
Securities
$
432,393
427,426
435,097
414,061
395,529
Loans, net of unearned
income
457,722
428,612
439,713
455,726
452,668
Total assets
1,069,973
1,092,759
1,114,407
1,073,564
1,040,985
Total deposits
987,614
999,867
1,003,394
961,544
927,368
Total stockholders’
equity
77,191
87,247
104,493
105,925
106,936
Selected period
end balances:
Securities
$
411,538
429,220
417,459
421,891
407,474
Loans, net of unearned
income
474,035
440,872
428,417
458,364
453,232
Allowance for
loan losses
4,966
4,716
4,658
4,939
5,119
Total assets
1,042,559
1,084,251
1,109,664
1,105,150
1,065,871
Total deposits
977,938
1,002,698
1,017,742
994,243
954,971
Total stockholders’
equity
59,793
76,107
86,411
103,726
104,929
(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 3 - Selected Financial Data
Nine months
ended September
30,
(Dollars
in thousands, except
per share
amounts)
2022
2021
Results of Operations
Net interest income
(a)
$
20,034
18,308
Less: tax-equivalent
adjustment
339
355
Net interest income
(GAAP)
19,695
17,953
Noninterest
income
2,608
3,288
Total revenue
22,303
21,241
Provision for loan
losses
—
(600)
Noninterest
expense
15,374
14,361
Income tax expense
1,049
1,313
Net earnings
$
5,880
6,167
Per share
data:
Basic and
diluted net earnings
$
1.67
1.74
Cash dividends
declared
0.795
0.78
Weighted
average shares
outstanding:
Basic and
diluted
3,513,068
3,552,387
Shares outstanding,
at period end
3,505,355
3,529,338
Book value
$
17.06
29.73
Common stock price:
High
$
34.49
48.00
Low
23.02
33.25
Period end
23.02
33.80
To earnings
ratio
10.46
x
14.57
To book
value
135
%
114
Performance ratios:
Return on average
equity
8.76
%
7.70
Return on average
assets
0.72
%
0.81
Dividend payout
ratio
47.60
%
44.83
Asset Quality:
Allowance for
loan losses
as a % of:
Loans
1.05
%
1.13
Nonperforming
loans
1,431
%
1,053
Nonperforming
assets
as a % of:
Loans and other
real estate
owned
0.07
%
0.11
Total assets
0.03
%
0.05
Nonperforming
loans as a %
of total loans
0.07
%
0.11
Annualized
net recoveries as
a % of average
loans
(0.01)
%
(0.03)
Capital Adequacy:
(c)
CET 1 risk-based
capital ratio
15.39
%
16.82
Tier 1
risk-based capital ratio
15.39
%
16.82
Total risk-based
capital ratio
16.16
%
17.72
Tier 1
leverage ratio
9.29
%
9.57
Other financial
data:
Net interest margin
(a)
2.67
%
2.59
Effective income
tax rate
15.14
%
17.55
Efficiency
ratio (b)
67.90
%
66.50
Selected average
balances:
Securities
$
431,629
373,203
Loans, net of unearned
income
442,081
458,882
Total assets
1,092,216
1,009,131
Total deposits
996,900
895,342
Total stockholders’
equity
89,544
106,798
Selected period
end balances:
Securities
$
411,538
407,474
Loans, net
of unearned income
474,035
453,232
Allowance for
loan losses
4,966
5,119
Total assets
1,042,559
1,065,871
Total deposits
977,938
954,971
Total stockholders’
equity
59,793
104,929
(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.
53
Table 4 - Average Balances and Net
Interest Income Analysis
Quarter ended
September
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)
$
457,861
$
5,097
4.42%
$
453,649
$
5,127
4.48%
Securities - taxable
369,202
1,808
1.94%
332,474
1,048
1.25%
Securities - tax-exempt (2)
63,191
558
3.50%
63,055
558
3.51%
Total securities
432,393
2,366
2.17%
395,529
1,606
1.61%
Federal funds
sold
38,994
200
2.03%
40,995
16
0.15%
Interest bearing
bank deposits
45,343
226
1.98%
82,878
33
0.16%
Total interest
-earning
assets
974,591
$
7,889
3.21%
973,051
$
6,782
2.77%
Cash and due
from banks
14,503
14,326
Other assets
80,879
53,608
Total assets
$
1,069,973
$
1,040,985
Interest-bearing liabilities:
Deposits:
NOW
$
195,655
$
70
0.14%
$
182,417
$
51
0.11%
Savings and
money market
328,555
163
0.20%
300,746
167
0.22%
Time deposits
151,785
291
0.76%
159,423
402
1.00%
Total interest
-bearing
deposits
675,995
524
0.31%
642,586
620
0.38%
Short-term borrowings
3,759
5
0.50%
3,454
4
0.50%
Total interest
-bearing
liabilities
679,754
$
529
0.31%
646,040
$
624
0.38%
Noninterest-bearing deposits
311,619
284,781
Other liabilities
1,409
3,228
Stockholders' equity
77,191
106,936
Total liabilities and stockholders' equity
$
1,069,973
$
1,040,985
Net interest income and
margin (tax-equivalent)
$
7,360
3.00%
$
6,158
2.51%
(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 5 - Average Balances and Net
Interest Income Analysis
Nine months
ended September
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)
$
442,613
$
14,638
4.42%
$
460,732
$
15,417
4.47%
Securities - taxable
370,402
4,691
1.69%
310,288
3,006
1.30%
Securities - tax-exempt (2)
61,227
1,614
3.52%
62,915
1,692
3.60%
Total securities
431,629
6,305
1.95%
373,203
4,698
1.68%
Federal funds
sold
54,924
313
0.76%
36,821
39
0.14%
Interest bearing
bank deposits
73,630
454
0.82%
75,170
66
0.12%
Total interest
-earning
assets
1,002,796
$
21,710
2.89%
945,926
$
20,220
2.86%
Cash and due
from banks
15,029
14,345
Other assets
74,391
48,860
Total assets
$
1,092,216
$
1,009,131
Interest-bearing liabilities:
Deposits:
NOW
$
201,792
$
189
0.13%
$
176,242
$
161
0.12%
Savings and
money market
335,005
494
0.20%
289,758
488
0.23%
Time deposits
155,824
978
0.84%
159,412
1,251
1.05%
Total interest
-bearing
deposits
692,621
1,661
0.32%
625,412
1,900
0.41%
Short-term borrowings
3,969
15
0.50%
3,329
12
0.50%
Total interest
-bearing
liabilities
696,590
$
1,676
0.32%
628,741
$
1,912
0.41%
Noninterest-bearing deposits
304,279
269,930
Other liabilities
1,803
3,662
Stockholders' equity
89,544
106,798
Total liabilities and stockholders' equity
$
1,092,216
$
1,009,131
Net interest income and
margin (tax-equivalent)
$
20,034
2.67%
$
18,308
2.59%
(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%.
55
Table 6 - Allocation of Allowance for
Loan
Losses
2022
2021
Third Quarter
Second Quarter
First Quarter
Fourth Quarter
Third Quarter
(Dollars
in thousands)
Amount
%*
Amount
%*
Amount
%*
Amount
%*
Amount
%*
Commercial and
industrial
$
732
14.9
$
761
15.9
$
774
17.1
$
857
18.3
$
816
17.4
Construction and
land
development
789
11.5
576
8.8
508
7.7
518
7.1
590
7.7
Commercial real estate
2,561
52.7
2,523
54.4
2,536
54.8
2,739
56.2
2,823
55.6
Residential real estate
783
19.3
753
19.3
737
18.4
739
16.9
799
17.7
Consumer installment
101
1.6
103
1.6
103
2.0
86
1.5
91
1.6
Total allowance for
loan losses
$
4,966
$
4,716
$
4,658
$
4,939
$
5,119
* Loan balance
in each category expressed
as a
percentage of total
loans.
56
Table 7 – Estimated Uninsured Time
Deposits by
Maturity
(Dollars
in thousands)
September
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
57
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.
58
ITEM 2.
UNREGISTERED
SALES OF
EQUITY SECURITIES
AND USE OF
PROCEEDS
The Company’s repurchases
of its common stock
during
the third 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)
July 1 - July 31, 2022
658
27.53
658
4,769,664
August 1 - August 31, 2022
3,982
27.72
3,982
4,659,289
September 1 - September 30, 2022
—
—
—
4,659,289
Total
4,640
27.69
4,640
4,659,289
(1)
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4.
MINE SAFETY
DISCLOSURES
Not applicable.
ITEM 5.
OTHER INFORMATION
Not applicable.
59
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.
60
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:
November 9,
2022
By:
/s/ Robert W. Dumas
Robert W. Dumas
Chairman, President and
CEO
Date:
November 9,
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 ValueNote 8: Subsequent EventsItem 2. Management's Discussion and Analysis Of Financial Condition and Results OfItem 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