AUBURN NATIONAL BANCORPORATION, INC. OF FINANCIAL CONDITION AND RESULTS
OF
OPERATIONS
The following discussion and analysis is designed to provide a better understanding of
various factors related to the results of operations and financial condition of the Company and the Bank.
This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated
financial statements and related
notes for the quarters ended
in our Annual Report on Form 10-K for the year endedDecember 31, 2022 .
Special Cautionary 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" "Description of Property" and elsewhere, are "forward-looking statements" within the meaning and protections of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
as amended (the "Exchange Act"). Forward-looking statements include statements with respect to our beliefs, plans, objectives,
goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve
known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause the actual results, performance, achievements or financial condition of the Company to be materially different from future results, performance, achievements or financial condition expressed or implied by such forward-looking
statements. You should not expect us to update any forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. You can
identify these forward-looking statements through our use of words such as "may,"
"will," "anticipate," "assume," "should," "indicate," "would," "believe," "contemplate," "expect,"
"estimate," "continue," "designed", "plan," "point to," "project," "could," "intend," "seeks," "model," "simulations," "target" and
other similar words and expressions of the future.
These forward-looking statements may not be realized due to a variety of factors,
including, without limitation: ? the effects of future economic, business and market conditions and changes, foreign, domestic and local, 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, trade restrictions, sanctions or other events that may affect general economic conditions; ? governmental monetary and fiscal policies, including the continuing effects
of fiscal and monetary stimuli in response to the COVID-19 crisis, followed by changes in monetary policies beginning
inMarch 2022 in response to inflation, including increases in theFederal Reserve's target federal funds rate and reductions in theFederal Reserve's holdings of securities; ? legislative and regulatory changes, including changes in banking, securities and tax laws,
regulations and rules and their application by our regulators, including capital and liquidity requirements, and changes
in the scope and cost
of
failures inCalifornia andNew York inMarch 2023 ; ? 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 inflation, changes in market interest rates and the shape of the yield curve on the levels, composition and costs of deposits and borrowings, the values of our securities and loans, 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; Table of Contents 28 ? the risks of further increases in market interest rates creating unrealized losses on our
securities available for sale, which adversely affect our stockholders' equity (including tangible stockholders'
equity) for financial reporting purposes; ? changes in borrower liquidity and credit risks, and savings, deposit and payment behaviors; ? changes in the availability and cost of credit and capital in the financial markets, and the types of instruments that may be included as capital for regulatory purposes; ? changes in the prices, values and sales volumes of residential and commercial real estate; ? the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, including the disruptive effects of
financial technology and other competitors who are not subject to the same regulations as the Company and the Bank and credit unions,
which are not subject to federal income taxation; ? the failure of assumptions and estimates underlying the establishment of allowances for credit losses, including asset impairments, losses valuations of assets and liabilities and other
estimates;
?
the timing and amount of rental income from third parties following the
opening of our new headquarters; ? the risks of mergers, acquisitions and divestitures, including,
without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and
possible failures to achieve
expected gains, revenue growth and/or expense savings from such transactions;
?
changes in technology or products that may be more difficult, costly,
or less effective than anticipated;
?
cyber-attacks and data breaches that may compromise our systems, our
vendors' systems or customers'
information;
?
the risks that our deferred tax assets ("DTAs")
included in "other assets" on our consolidated balance sheets, if any, could be reduced if estimates of future
taxable income from our operations and tax planning strategies are less than currently estimated, and sales of our capital stock could trigger a reduction in the amount of
net operating loss carry-forwards that we may be able to utilize for income tax purposes; and ? other factors and risks described under "Risk Factors" herein and in any of our subsequent reports that we make with theSecurities and Exchange Commission (the "Commission" or "SEC") under the Exchange Act. All written or oral forward-looking statements that are we make or are
attributable to us are expressly qualified in their entirety by this cautionary notice.
We have no obligation and
do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such
statements otherwise are made. Table of Contents 29 Summary of Results of Operations Quarter endedMarch 31 , (Dollars in thousands, except per share data) 2023 2022 Net interest income (a)$ 7,217 $ 6,190 Less: tax-equivalent adjustment 108 112 Net interest income (GAAP) 7,109 6,078 Noninterest income 792 908 Total revenue 7,901 6,986 Provision for credit losses 66 (250) Noninterest expense 5,604 4,901 Income tax expense 267 254 Net earnings$ 1,964 $ 2,081 Basic and diluted earnings per share$ 0.56 $ 0.59 (a) Tax-equivalent.
See "Table 1 - Explanation of Non-GAAP
Financial Measures." Financial Summary The Company's net earnings were$2.0
million for the first quarter of 2023, compared to
Basic and diluted earnings per share were
compared to$0.59 per share for the first quarter of 2022.
Net interest income (tax-equivalent) was
a 17% increase compared to$6.2 million for the first quarter of 2022.
This increase was primarily due to improvements in the Company's
net interest margin.
The
Company's net interest margin
(tax-equivalent) was 3.17% in the first quarter of 2023 compared to 2.43%
in the first quarter of 2022.
This increase was primarily due to a more favorable asset mix and higher yields on interest
earning assets.
These higher yields on interest earning assets were partially offset by increased
cost of funds. The cost of funds increased to 71 basis points, compared to 34 basis points in the first quarter of 2022,
which also reflected higher market interest rates.
Average loans for the first quarter
of 2023 were
for credit losses was
million, or 1.09% of total loans, at
The
implementation of CECL required pursuant to Accounting Standards ("ASC")
326, was effective
transition adjustment.
At
recorded investment in loans individually evaluated was
for credit losses) of
valuation allowance atMarch 31, 2022 . The Company recorded a provision for credit losses during the first quarter of 2023 of$0.1 million , compared to a negative provision for credit losses of$0.3 million during the first quarter of 2022. The provision for credit losses under CECL is reflective of the Company's credit risk profile
and the future economic outlook and forecasts.
Our CECL model is largely influenced by economic factors including, most notably,
the anticipated unemployment rate.
The negative provision for credit losses during the first quarter of 2022 was primarily related to a decrease in total loans, excluding PPP,
during the first quarter of 2022. Noninterest income was$0.8 million in the first quarter of 2023,
compared to
The
decrease in noninterest income was primarily due to a decrease in mortgage lending income
of$0.2 million as a result of higher mortgage market interest rates. Noninterest expense was$5.6 million in the first quarter of 2023,
compared
to
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
Table of Contents 30 Income tax expense was$0.3 million for the first quarter of 2023 and 2022,
respectively.
The Company's effective tax rate for the first quarter of 2023 was 11.97%,
compared to 10.88% in the first quarter of 2022.
The Company's effective income tax rate is principally affected by tax-exempt earnings from the Company's
investment in municipal securities,
bank-owned life insurance ("BOLI"), and New Markets Tax
Credits ("NMTCs").
The Company paid cash dividends of
from the same period of 2022. The Company repurchased 2,648 shares for$0.1
million during the first quarter of 2023.
AtMarch 31, 2023 , the Bank's regulatory capital ratios
were well above the minimum amounts required to be "well capitalized" under current regulatory standards with a total risk-based capital ratio of 16.48%,
a tier 1 leverage ratio of 10.07% and a common equity
tier 1 ("CET1") ratio of 15.45% at
At
2023, the Company's equity to total assets ratio
was
7.24%, compared to 6.65% at
2022.
CRITICAL ACCOUNTING POLICIES
The accounting and financial reporting policies of the Company conform with
accounting
principles and with general practices within the banking industry.
In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance
for credit losses for loans, our determination of credit losses for investment securities,
recurring and non-recurring fair value measurements, the valuation of other real estate owned, and the valuation of deferred tax assets, were critical to the determination
of our financial position and results of operations. Other policies also require subjective judgment and
assumptions and may accordingly impact our financial position and results of operations. Accounting Standards Adopted in 2023 OnJanuary 1, 2023 , the Company adopted ASC 326 as described more fully in our unaudited financial statements in Part I of this Quarterly report,
especially Note 1, Accounting Standards Adopted in 2023 and Note 5, Loans and Allowance
for Credit Losses.
This standard replaced the incurred loss methodology with an expected loss
methodology that is referred to
as the current expected credit loss ("CECL") methodology.
CECL requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions,
and reasonable and supportable forecasts and generally applies to financial assets measured at amortized cost, including loan
receivables and held-to-maturity debt securities, and some off-balance sheet credit exposures such as unfunded
commitments to extend credit. Financial assets measured at amortized cost will be presented at the net amount expected to be collected
by using an allowance for credit losses.
In addition, CECL made changes to the accounting for available for sale
debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available for sale debt
securities if management does not intend to sell and does not believe that it is more likely than not, they will be required
to sell. The Company adopted ASC 326 and all related subsequent amendments thereto effectiveJanuary 1, 2023 using the modified retrospective approach for all financial assets measured
at amortized cost and off-balance sheet credit exposures.
The transition adjustment upon the adoption of CECL on
in the allowance for credit
losses on loans of
and an increase in the allowance
for credit losses on unfunded loan commitments of
within other liabilities. The Company
recorded a net decrease to retained earnings of
for the cumulative effect of adopting CECL, which reflects the transition adjustments noted above, net of the applicable deferred
tax assets recorded. Results for reporting periods beginning afterJanuary 1, 2023 are presented under CECL
while prior period amounts continue to be reported in accordance with previously applicable accounting standards. The Company adopted ASC 326 using the prospective transition approach
for debt securities for which other-than- temporary impairment had been recognized prior toJanuary 1, 2023 . As ofDecember 31, 2022 , the Company did not have any other-than-temporarily impaired investment securities. Therefore,
upon adoption of ASC 326, the Company determined that an allowance for credit losses on available for sale securities was not deemed
material.
The Company elected not to measure an allowance for credit losses for accrued interest receivable
and instead elected to reverse interest income on loans or securities that are placed on nonaccrual status,
which is generally when the instrument is 90 days past due, or earlier if the Company believes the collection of interest is doubtful.
The Company has concluded that this policy results in the timely reversal of uncollectible interest. Table of Contents 31 The Company also adopted ASU 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures"
on
requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing
financial difficulty.
Specifically, rather than applying the recognition and measurement guidance for TDRs, an entity
must apply the loan refinancing and restructuring guidance to determine whether a modification results in a new loan or a continuation of an
existing loan. Additionally,
ASU
2022-02 requires an entity to disclose current-period gross write-offs
by year of origination for financing receivables within the scope of Subtopic 326-20, Financial Instruments-Credit Losses-Measured at
Amortized Cost. ASU 2022-02 did not have a material impact on the Company's consolidated financial statements. Loans Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or payoff are reported at amortized cost. Amortized cost is the principal balance outstanding, net of purchase premiums
and discounts and deferred fees and costs. Accrued interest receivable related to loans is recorded
in other assets on the consolidated balance sheets. Interest income is accrued on the unpaid principal balance. Loan origination
fees, net of certain direct origination costs, are deferred and recognized in interest income using methods that approximate a
level yield without anticipating prepayments. The accrual of interest is generally discontinued when a loan becomes 90 days past due and
is not well collateralized and in the process of collection, or when management believes, after considering economic and
business conditions and collection efforts, that the principal or interest will not be collectible in the normal course
of business. Past due status is based on contractual terms of the loan. A loan is considered to be past due when a scheduled payment has
not been received 30 days after the contractual due date. All accrued interest is reversed against interest income when a loan is placed on nonaccrual
status. Interest received on such loans is accounted for using the cost-recovery method, until qualifying for return to accrual.
Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero.
Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, there
is a sustained period of repayment performance, and future payments are reasonably assured. Allowance for Credit Losses - Loans The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged
off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate
of amounts previously charged-off and expected to be charged-off .
Accrued interest receivable is excluded from the estimate of credit losses. The allowance for credit losses represents management's
estimate of lifetime credit losses inherent in loans as of the balance sheet date. The allowance for credit losses is estimated by management using relevant
available information, from both internal and external sources, relating to past events, current conditions, and reasonable
and supportable forecasts.
The Company's loan loss estimation process includes
procedures to appropriately consider the unique characteristics of
its
loan segments (commercial and industrial, construction and land development, commercial
real estate, multifamily, residential real estate, and consumer loans).
These segments are further disaggregated into loan classes, the level at which credit quality is monitored.
See Note 5, Loans and Allowance for Credit Losses for additional information
about our loan
portfolio.
Credit loss assumptions are estimated using a discounted cash flow ("DCF") model
for each loan segment, except consumer
loans.
The weighted average remaining life method is used to estimate credit loss assumptions
for consumer loans. Table of Contents 32 The DCF model calculates an expected life-of-loan loss percentage by considering the forecasted probability that a borrower will default (the "PD"), adjusted for relevant forecasted macroeconomic factors, and LGD, which is the estimate of the amount of net loss in the event of default.
This model utilizes historical correlations between default experience and certain macroeconomic factors as determined through a statistical regression analysis.
The forecasted
and land development, commercial real estate, multifamily,
and residential real estate loans.
In addition, forecasted changes in the
real estate loans; forecasted changes in the national commercial real estate ("CRE") price index is considered in the
model for commercial real estate and multifamily loans; and forecasted changes in theAlabama gross state product is considered in the model for multifamily loans.
Projections of these macroeconomic factors, obtained from an independent
third party, are utilized to predict quarterly rates of default
based on the statistical PD models.
Expected credit losses are estimated over the contractual term of the loan, adjusted for
expected prepayments and principal
payments ("curtailments") when appropriate. Management's determination of the
contract term excludes expected
extensions, renewals, and modifications unless the extension or
renewal option is included in the contract at the reporting date and is not unconditionally cancellable by the Company.
To the extent the lives of the
loans in the portfolio extend beyond the period for which a reasonable and supportable forecast can be
made (which is 4 quarters for the Company), the Company reverts, on a straight-line basis back to the historical rates over an 8 quarter
reversion period. The weighted average remaining life method was deemed most appropriate for the consumer loan segment because consumer loans contain many different payment structures,
payment streams and collateral.
The weighted average remaining life method uses an annual charge-off rate over several vintages
to estimate credit losses.
The average annual charge-off rate is applied to the contractual term adjusted for prepayments. Additionally, the allowance
for credit losses calculation includes subjective adjustments for qualitative risk
factors that are believed likely to cause estimated credit losses to differ from historical experience.
These qualitative adjustments may increase or reduce reserve levels and include adjustments for lending management experience
and risk tolerance, loan review and audit results, asset quality and portfolio trends, loan portfolio growth, industry concentrations,
trends in underlying collateral, external factors and economic conditions not already captured. Loans that do not share risk characteristics are evaluated on an individual basis. When management determines that foreclosure is probable and the borrower is experiencing financial difficulty,
the expected credit losses are based on the estimated fair value of collateral held at the reporting date, adjusted for selling costs as appropriate.
Allowance for Credit Losses - Unfunded Commitments Financial instruments include off-balance sheet credit instruments,
such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company's
exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet
loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded. The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to provision
for credit losses in the Company's consolidated statements of earnings. The allowance for credit losses on off-balance sheet credit
exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same
methodologies as portfolio loans, taking into consideration the likelihood that funding will occur as well as any third-party
guarantees. The allowance for unfunded commitments is included in other liabilities on the Company's
consolidated balance sheets.
On
thousand for the adoption of
ASC 326. For the three months ended
for credit losses for unfunded
commitments of
-balance-sheet credit exposures included in other liabilities was$0.3 million . Table of Contents 33 Assessment for Allowance for Credit Losses - Available -for-Sale Securities For any securities classified as available-for-sale that are in an unrealized loss position at the balance sheet date, the Company assesses whether or not it intends to sell the security,
or more likely than not will be required to sell the security, before recovery of its amortized cost basis.
If either criteria is met, the security's amortized cost basis is written down to fair value through net income.
If neither criteria is met, the Company evaluates whether any portion of the decline in
fair
value is the result of credit deterioration.
Such evaluations consider the extent to which the amortized cost of the security exceeds its fair value, changes in credit ratings and any other known adverse conditions related
to the specific security.
If
the evaluation indicates that a credit loss exists, an allowance for credit losses is recorded
for the amount by which the amortized cost basis of the security exceeds the present value of cash flows expected
to be collected, limited by the amount by which the amortized cost exceeds fair value.
Any impairment not recognized in the allowance for credit losses is recognized in other comprehensive income. The Company is required to own certain stock as a condition of membership, such as the
FHLB ofAtlanta andFederal Reserve Bank of Atlanta ("FRB").
These non-marketable equity securities are accounted for at cost which equals par
or redemption value.
These securities do not have a readily determinable fair value as their ownership is restricted and
there is no market for these securities.
The Company records these non-marketable equity securities as a component
of other assets, which are periodically evaluated for impairment. Management considers these non-marketable equity securities to be long-term investments. Accordingly,
when evaluating these securities for impairment, management considers
the
ultimate recoverability of the par value rather than by recognizing temporary declines in value. Fair Value
Determination
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 withU.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 unaudited consolidated financial statements that accompany this report. Fair values are based on active market prices of identical assets or liabilities when available.
Comparable assets or liabilities or a composite of comparable assets in active markets are used when identical assets
or liabilities do not have readily available active market pricing.
However, some of the Company's
assets or liabilities lack an available or comparable trading market characterized by frequent transactions between willing buyers and sellers. In these cases, fair value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and their underlying assumptions are based upon management's
best estimates for appropriate discount rates, default rates, prepayments,
market volatility and other factors, taking into account current observable market data and
experience.
These assumptions may have a significant effect on the reported
fair values of assets and liabilities and the related income and expense. As such, the use of different models and assumptions, as
well as changes in market conditions, could result in materially different net earnings and retained earnings results.
Other Real Estate Owned Other real estate owned or OREO, consists of properties obtained through foreclosure or otherwise
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 credit 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. Table of Contents 34 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
we had total deferred tax assets of
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 atMarch 31, 2023 . The amount of the deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced. RESULTS OF OPERATIONS Average Balance Sheet and Interest Rates Quarter endedMarch 31, 2023 2022 Average Yield/ Average Yield/ (Dollars in thousands) Balance Rate Balance Rate Loans and loans held for sale$ 502,158 4.65%$ 440,608 4.46% Securities - taxable 344,884 2.19% 374,825 1.45% Securities - tax-exempt 57,800 3.59% 60,272 3.57% Total securities 402,684 2.39% 435,097 1.74% Federal funds sold 7,314 4.71% 73,575 0.17% Interest bearing bank deposits 11,607 4.47% 83,161 0.16% Total interest-earning assets 923,763 3.66% 1,032,441 2.66% Deposits: NOW 187,566 0.54% 200,907 0.12% Savings and money market 300,657 0.39% 345,549 0.20% Time Deposits 155,676 1.51% 159,785 0.90% Total interest-bearing deposits 643,899 0.70% 706,241 0.34% Short-term borrowings 3,046 1.11% 3,943 0.50% Total interest-bearing liabilities 646,945 0.71% 710,184 0.34% Net interest income and margin (tax-equivalent)$ 7,217 3.17%$ 6,190 2.43% Net Interest Income and Margin Net interest income (tax-equivalent) was$7.2 million for the first quarter of 2023, a 17% increase compared to$6.2 million for the first quarter of 2022.
This increase was primarily due to improvements in the Company's
net interest margin (tax- equivalent). The Company's net interest
margin (tax-equivalent) was 3.17% in the first quarter of 2023
compared to 2.43% in the first quarter of 2022.
This increase was primarily due to a more favorable asset mix and higher yields on interest earning assets.
Since March of 2022, the
federal funds range from 0 - 0.25% to 4.75 - 5.00%.
The target rate was increased another 25 basis points on
and further increases in the target federal funds rate appear likely if inflation remains elevated. The tax-equivalent yield on total interest-earning assets increased by 100
basis points to 3.66%
in the first quarter of 2023 compared to 2.66% in the first quarter of 2022.
This increase was primarily due to changes in our asset mix and higher market interest rates on interest earning assets.
The cost of total interest-bearing liabilities increased by 37 basis points to
0.71% in the first quarter of 2023 compared to 0.34% in the first quarter of 2022.
Our deposit costs may continue to increase as the
as a result of inflation and higher market interest rates on deposits and other alternative investments. Table of Contents 35 The Company continues to deploy various asset liability management strategies to manage its risks from interest rate fluctuations. Deposit and loan pricing remain competitive in our markets. We believe this challenging rate environment will continue throughout 2023.
Our ability to compete and manage our deposit costs until our interest-earning assets reprice will be important to maintaining or potentially increasing our net interest
margin during the monetary tightening cycle that we believe will continue throughout 2023. Provision for Credit Losses OnJanuary 1, 2023 , we adopted ASC 326, which introduces the current expected credit
losses (CECL) methodology and requires us to estimate all expected credit losses over the remaining life of our loans.
Accordingly, the provision for credit losses represents a charge to earnings necessary to establish an allowance
for credit losses that, in management's evaluation, is adequate to provide coverage for all expected credit losses. The Company recorded
a provision for credit losses during
the first quarter of 2023 of
losses of$0.3 million during the first quarter of 2022.
Provision expense is affected by organic loan growth in our loan
portfolio, our internal assessment of the credit quality of the loan portfolio, our expectations about future economic conditions and
net charge-offs. Our CECL model is largely influenced by economic factors including,
most notably, the anticipated
unemployment rate, which may be affected by monetary policy.
The negative provision for credit losses during the first quarter of 2022
was primarily related to a decrease in total loans, excluding federally-guaranteed PPP loans, during the first quarter of 2022. Our allowance for credit losses reflects an amount we believe appropriate, based on our allowance assessment methodology, to adequately cover
all expected future losses as of the date the allowance is determined. At
2023,
the Company's allowance for credit
losses was
The implementation of CECL, as ofJanuary 1, 2023 , increased our allowance for credit losses by$1.0 million , or 0.20% of total loans, as a day one transition adjustment to ASC 326.
At
recorded investment in
loans individually evaluated was
(included in the allowance for
credit losses) of
evaluated of$0.2 million with no corresponding valuation allowance atMarch 31, 2022 .
One of the downgraded loans, with a recorded investment of
2023, was paid in full subsequent toMarch 31, 2023 . Noninterest Income Quarter endedMarch 31 , (Dollars in thousands) 2023 2022 Service charges on deposit accounts$ 154 $ 142 Mortgage lending income 93 253 Bank-owned life insurance 156 99 Other 389 414 Total noninterest income$ 792 $ 908 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. Table of Contents 36 The following table presents a breakdown of the Company's mortgage lending income. Quarter endedMarch 31 , (Dollars in thousands) 2023 2022 Origination income, net$ 4 $ 229 Servicing fees, net 89 24 Total mortgage lending income$ 93 $ 253 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 endedMarch 31 , (Dollars in thousands) 2023 2022 Salaries and benefits$ 2,927 $ 2,950 Net occupancy and equipment 799 434 Professional fees 338 230 Other 1,540 1,287 Total noninterest expense$ 5,604 $ 4,901 The increase in net occupancy and equipment expense was primarily due to increased expenses related to the Company's new headquarters in downtownAuburn .
This amount includes depreciation expense and other costs associated
with
operating the new headquarters.
The Company relocated its main office branch and bank operations into its
newly
constructed headquarters during
including increased information technology and systems expenses, losses on New Markets Tax
Credits investments and other miscellaneous operating expenses. Income Tax
Expense
Income tax expense was
and 2022, respectively.
The Company's effective income tax rate for the first quarter of 2023 was 11.97%, compared
to 10.88% in the first quarter of 2022.
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
million at
This increase reflects a
-for-sale, offset by a decrease in the amortized cost basis of securities available-for-sale of$6.9 million .
The average annualized tax-equivalent yields earned on total securities were 2.39%
in the first quarter of 2023 and 1.74% in the first quarter of 2022.
Table of Contents 37 Loans 2023 2022 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Commercial and industrial$ 59,602 66,212 70,715 70,117 73,327 Construction and land development 66,500 66,479 54,773 38,654 33,058 Commercial real estate 267,962 264,576 249,527 239,873 234,637 Residential real estate 101,975 97,648 91,469 85,106 78,983 Consumer installment 9,002 9,546 7,551 7,122 8,412 Total loans$ 505,041 504,461 474,035 440,872 428,417 Total loans
were
31, 2022.
Four loan categories represented the majority of the loan portfolio atMarch 31, 2023 :
commercial real estate (53%), residential real estate (20%), commercial and industrial (12%) and construction and land development
(13%). Approximately 25% of the Company's commercial real estate loans
were classified as owner-occupied at
Company had junior lien mortgages of approximately
million,
or 2%, and
For residential real estate mortgage loans with a consumer purpose, the Company had no loans that required
interest only payments atMarch 31, 2023 andDecember 31, 2022 . The Company's
residential real estate mortgage portfolio does not include any option
or
hybrid 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 4.65% in the first quarter of
2023 and 4.46% in the first quarter of 2022.
The specific economic and credit risks associated with our loan portfolio include, but are
not limited to, the effects of current economic conditions, including inflation and the continuing increases in market interest rates, remaining COVID-19 pandemic effects including supply chain disruptions, commercial
office occupancy levels, housing supply shortages and inflation, on our borrowers' cash flows, real estate market sales volumes and liquidity,
valuations used in making loans and evaluating collateral, availability and cost of financing properties, real
estate industry concentrations, competitive pressures from a wide range of other lenders, deterioration in certain credits, interest rate fluctuations,
reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deteriora
tion of borrowers, fraud, and any violation of applicable laws and regulations. Various
projects financed earlier that were based on lower interest rate assumptions
than
currently in effect may not be as profitable or successful at higher interest rate
currently in effect and currently expected in the future. The Company attempts to reduce these economic and credit risks through its loan-to-value
guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers' financial
position. Also, we have established and periodically review,
lending policies and procedures. Banking regulations limit a bank's
credit exposure by prohibiting unsecured loan relationships that exceed 10% of its capital; or 20%
of capital, if loans in excess of 10% of capital are fully secured. Under these regulations, we are prohibited from having secured
loan relationships in excess of approximately$22.8 million .
Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding
plus
unfunded commitments) to a single borrower of
the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit.
AtMarch 31, 2023 , the Bank had no relationships exceeding these limits. Table of Contents 38 We periodically analyze
our commercial and industrial and commercial real estate loan portfolios to
determine if a concentration of credit risk exists in any one or more industries. We
use classification systems broadly accepted by the financial services industry in order to categorize our commercial borrowers.
Loan concentrations to borrowers in the following classes exceeded 25% of the Bank's total risk
-based capital at
March 31 ,December 31 , (Dollars in thousands) 2023 2022 Lessors of 1-4 family residential properties$ 53,467 $ 52,278 Multi-family residential properties 40,974 41,084 Hotel/motel 32,959 33,378 Allowance for Credit Losses
The Company maintains the allowance for credit losses at a level that management believes
appropriate to adequately cover the Company's estimate of expected
losses in the loan portfolio. The allowance for credit losses was
which management believed to be adequate at each of the respective dates. The judgments and estimates associated with the determination of the
allowance for credit losses are described under "Critical Accounting Policies." OnJanuary 1, 2023 , we adopted ASC 326,
which introduces the current expected credit losses (CECL) methodology and requires us to estimate all expected credit losses over the remaining life of our loan portfolio.
Accordingly, beginning in 2023, the allowance for credit losses represents an amount that, in management's evaluation,
is adequate to provide
coverage for all expected future credit losses on outstanding loans. As of
2023 andDecember 31, 2022 , our allowance for credit losses was approximately$6.8 million and$5.8
million, respectively, which our
management believes to be adequate at each of the respective dates. Our allowance for credit losses as a percentage of total
loans was 1.35% atMarch 31, 2023 , up from 1.14%
at
of ASC
326 on
$1.0 million . Our CECL models rely largely on projections of macroeconomic conditions to estimate
future credit losses. Macroeconomic factors used in the
model include the
national commercial real estate price index and theAlabama gross state product. Projections of these
macroeconomic factors, obtained from an independent third party, are utilized to predict
quarterly rates of default.
Under the CECL methodology the allowance for credit losses is measured
on a collective basis for pools of loans with similar risk characteristics, and for loans that do not share similar risk characteristics
with the collectively evaluated pools, evaluations are performed on an individual basis. Losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period
losses are reverted to long term historical averages.
At
followed by a 24 month straight line reversion period to long term averages. Table of Contents 39 A summary of the changes in the allowance for credit losses and certain asset quality ratios for the first quarter of 2023 and the previous four quarters is presented below. 2023 2022 First Fourth Third Second First (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Balance at beginning of period$ 5,765 4,966 4,716 4,658 4,939 Impact of adopting ASC 326 1,019 Charge-offs: Commercial and industrial - (205) (13) (4) - Consumer installment (11) (3) (3) (16) (48) Total charge -offs (11) (208) (16) (20) (48) Recoveries 8 7 16 78 17 Net (charge-offs) recoveries (3) (201) - 58 (31) Provision for credit losses 40 1,000 250 - (250) Ending balance$ 6,821 5,765 4,966 4,716 4,658 as a % of loans 1.35 % 1.14 1.05 1.07 1.09 as a % of nonperforming loans 255 % 211 1,431 1,314 1,256 Net charge-offs (recoveries) as % of average loans (a) - % 0.04 - (0.05) 0.03 (a) Net charge-offs (recoveries) are annualized. Nonperforming Assets AtMarch 31, 2023 andDecember 31, 2022 the Company had$2.7 million in nonperforming assets,
respectively.
The table below provides information concerning total nonperforming assets
and certain asset quality ratios for the first quarter of 2023 and the previous four quarters. 2023 2022 First Fourth Third Second First (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Nonperforming assets: Nonaccrual loans$ 2,680 2,731 347 359 371 Other real estate owned - - - - 374 Total nonperforming assets$ 2,680 2,731 347 359 745 as a % of loans and other real estate owned 0.53 % 0.54 0.07 0.08 0.17 as a % of total assets 0.26 % 0.27 0.03 0.03 0.07 Nonperforming loans as a % of total loans 0.53 % 0.54 0.07 0.08 0.09 The table below provides information concerning the composition of nonaccrual loans for the first quarter of 2023 and the previous four quarters. 2023 2022 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Nonaccrual loans: Commercial and industrial$ 432 443 - - - Commercial real estate 2,103 2,116 170 176 182 Residential real estate 136 172 177 183 189 Consumer installment 10 - - - - Total nonaccrual loans$ 2,681 2,731 347 359 371 Table of Contents 40 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$2.7 million in loans on nonaccrual status atMarch 31, 2023 andDecember 31 ,
2022, respectively.
The Company had no loans 90 days or more past due and still accruing at
2023 andDecember 31, 2022 , respectively. The table below provides information concerning the composition of OREO for the third quarter of 2023 and the previous four quarters. 2023 2022 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Other real estate owned: Commercial real estate $ - - - - 374 Total other real estate owned $ - - - - 374 Deposits Total deposits decreased
3, compared to
alternatives in a rising interest rate environment and a decline in balances in existing accounts due to increased customer
spending.
Noninterest-bearing
deposits were
compared to$311.4 million , or 33% of total deposits atDecember 31, 2022 . We had no brokered deposits onMarch 31, 2023 or atDecember 31, 2022 .
Estimated uninsured deposits totaled
2023 andDecember 31, 2022 , 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 0.70% in the first
quarter of 2023 compared to 0.34% in the first quarter of 2022. 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 with none outstanding atMarch 31, 2023 , andDecember 31, 2022 , respectively. Securities sold
under agreements to repurchase totaled
2023 andDecember 31, 2022 , respectively.
At
new Bank Term Facility Program
("BTFP"), which opened March 12, 2023 .
The average rate paid on short-term borrowings was 1.11
%
in the first quarter of 2023 and 2022,
respectively.
The Company had no long-term debt at
Table of Contents 41 CAPITAL ADEQUACY The Company's consolidated
stockholders' equity was
2023 andDecember 31, 2022 , respectively.
The increase from
net of tax of$5.5 million .
These
unrealized losses do not affect the Bank's
capital for regulatory capital purposes.
The Company's consolidated stockholders' equity was also increased by net earnings of$2.0 million . These increases in the Company's consolidated stockholders' equity were partially offset by cash dividends
paid of
stock of
million.
The Company paid cash dividends of
from the same period in 2022. The Company's share repurchases of$0 . 1
million since
These shares were repurchased at an average cost per share of
.
On
capital framework and relatedDodd-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
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
was sufficient to meet the fully phased-in conservation buffer.
Effective
banking regulators adopted an interim final rule that amended the capital conservation buffer.
The interim final rule was adopted as a final rule on
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
Reserve'sSmall 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 10.07%, CET1 risk-based capital ratio was 15.45%, tier 1 risk-based capital ratio was 15.45%, and total risk-based capital ratio was 16.48% at
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 8.48% at
MARKET AND LIQUIDITY RISK MANAGEMENT Management's objective is to manage assets and
liabilities to provide a satisfactory,
consistent level of profitability within the framework of established liquidity,
loan, investment, borrowing, and capital policies. The Bank's
Asset Liability
Management Committee ("ALCO") is charged with the responsibility
of monitoring these policies, which are designed to ensure an acceptable asset/liability composition. Two
critical areas of focus for ALCO are interest rate risk and liquidity risk management.
Interest Rate Risk Management In the normal course of business, the Company is exposed to market risk arising from fluctuations
in interest rates. ALCO measures and evaluates interest rate risk so that the Bank can meet customer demands for
various types of loans and deposits. Measurements used to help manage interest rate sensitivity include an earnings simulation
model and an economic
value of equity ("EVE") model.
Table of Contents
42
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. AtMarch 31, 2023 , 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 AtMarch 31, 2023 , our EVE model indicated that we were in compliance
with our policy guidelines. Each of the above analyses may not, on its own, be an accurate indicator of how our net interest
income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated
with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition,
the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain
assets and liabilities may have similar maturities or periods of repricing, they may react in different
degrees to changes in market interest rates, and other economic and market factors, including market perceptions.
Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types of assets
and liabilities may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate
mortgage loans, have features (generally referred to as "interest rate caps and floors") which limit changes in interest rates.
Prepayments
and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments.
The ability of many borrowers to service their debts also may decrease during periods of rising interest rates or economic
stress, which may differ across industries and economic sectors. ALCO reviews each of the
above interest rate sensitivity analyses along with several different interest rate scenarios in seeking satisfactory,
consistent levels of profitability within the framework of the Company's established liquidity,
loan, investment, borrowing, and capital policies.
The Company may also use derivative financial instruments to improve the balance betw
een 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. AtMarch 31, 2023 andDecember 31 ,
2022, the Company had no derivative contracts designated as part of a hedging relationship to assist in managing its interest rate sensitivity.
Table of Contents 43 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.
The Company seeks to manage its liquidity to manage or reduce its costs of funds by maintaining liquidity believed adequate
to meet its anticipated funding needs, while balancing against excessive liquidity that likely would reduce earnings due to the
cost of foregoing alternative higher- yielding assets.
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,
interest payments on earning assets, repayment and maturity of securities and loans, sales of securities, and the
sale of loans,
particularly residential mortgage loans. The Bank has access to federal funds lines from various banks and borrowings
from theFederal Reserve discount window and theFederal Reserve's recent
BTFP borrowing facility.
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
line of credit with the FHLB of$307.0 million . AtMarch 31, 2023 , 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 onMarch 31, 2023 or atDecember 31, 2022 .
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 reasonably
rexpected borrower, depositor, and creditor requirements over the next twelve
months.
Off-Balance Sheet Arrangements, Commitments, Contingencies and Contractual
Obligations
At
unfunded loan commitments outstanding of$91.1 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 or raise deposits.
Mortgage lending activities We generally 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. Table of Contents 44 As ofMarch 31, 2023 , the unpaid principal balance of residential mortgage loans, which we have originated and sold, but retained the servicing rights, was$226.7 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 quarter of 2023
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
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 standard s
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
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 can affect our noninterest expenses. It also can affect
the interest rates we have to pay on our deposits and other borrowings, and the interest rates we earn on our earning assets.
The difference between our interest expense and interest income is also affected by the shape of the yield curve and the speed
at which our assets and liabilities reprice in response to interest rate changes.
The yield curve was inverted on
term interest rates are higher than longer interest rates.
This results in a lower spread between our costs of funds and our interest income.
In addition, net interest income could be affected by asymmetrical changes in the different
interest rate indexes, given that not all of our assets or liabilities are priced with the same index. Higher market interest rates and sales
of securities held by the
demand and growth. Table of Contents 45 Inflation is running at levels unseen in decades and well above theFederal Reserve's long term inflation goal of 2.0% annually.
Beginning in
federal funds interest rates and reducing its securities holdings in an effort to reduce inflation During 2022,
the
The target rate was increased another 25 basis points on each of
March 7 andMay 3, 2023 to 5.00-5.25%, and further increases in the target federal
funds rate appear likely if inflation remains elevated.
Our deposit costs may increase as the
federal funds rate, market interest rates increase, and as customer savings behaviors change as a result of inflation and seek higher market interest
rates on deposits and other alternative investments.
Monetary efforts to control inflation may also affect
unemployment which is an important component in our CECL model used to estimate our allowance for credit losses. CURRENT ACCOUNTING DEVELOPMENTS The following ASU has been issued by the FASB
but is not yet effective.
? ASU 2023-02, Investments -Equity Method and Joint Ventures
(Topic 323):
Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method Information about this pronouncement is described in more detail below. ASU 2023-02, Investments -Equity Method and Joint Ventures
(Topic 323):
Accounting for Investments in Tax
Credit
Structures Using the Proportional
Amortization Method , The amendments in this Update permit reporting entities to elect to account for their tax equity investments, regardless of the tax credit program from which
the income tax credits are received, using the proportional amortization method if certain conditions are
met. The new standard is effective for fiscal
years, and interim periods within those fiscal years, beginning after
2023. The Company is currently evaluating the impact of the new standard on the Company's
consolidated financial statements.
Table of Contents 46 Table 1
- Explanation of Non-GAAP Financial Measures
In addition to results presented in accordance with
(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.
2023 2022 First Fourth Third Second First (in thousands) Quarter Quarter Quarter Quarter Quarter Net interest income (GAAP)$ 7,109 7,471 7,243 6,374 6,078 Tax-equivalent adjustment 108 117 117 110 112 Net interest income (Tax -equivalent)$ 7,217 7,588 7,360 6,484 6,190 Table of Contents 47 Table 2
- Selected Quarterly Financial Data
2023 2022 First Fourth Third Second First (Dollars in thousands, except per share amounts) Quarter Quarter Quarter Quarter Quarter Results of Operations Net interest income (a)$ 7,217 7,588 7,360 6,484 6,190 Less: tax-equivalent adjustment 108 117 117 110 112 Net interest income (GAAP) 7,109 7,471 7,243 6,374 6,078 Noninterest income 792 3,898 852 848 908 Total revenue 7,901 11,369 8,095 7,222 6,986 Provision for credit losses 66 1,000 250 - (250) Noninterest expense 5,604 4,449 5,415 5,058 4,901 Income tax expense 267 1,454 432 363 254 Net earnings$ 1,964 4,466 1,998 1,801 2,081 Per share data: Basic and diluted net earnings$ 0.56 1.27 0.57 0.51 0.59 Cash dividends declared 0.27 0.265 0.265 0.265 0.265 Weighted average shares outstanding: Basic and diluted 3,502,143 3,504,344 3,507,318 3,513,353 3,518,657 Shares outstanding, at period end 3,500,879 3,503,452 3,505,355 3,509,940 3,516,971 Book value$ 21.03 19.42 17.06 21.68 24.57 Common stock price High$ 24.50 24.71 29.02 33.57 34.49 Low 22.55 22.07 23.02 27.04 31.75 Period end: 22.66 23.00 23.02 27.04 33.21 To earnings ratio 7.79 7.82 10.46 12.52 14.44 To book value 108 % 118 135 125 135 Performance ratios: Return on average equity 11.44 % 28.23 10.35 8.26 7.97 Return on average assets 0.77 % 1.75 0.75 0.66 0.75 Dividend payout ratio 48.21 % 20.87 46.49 51.96 44.92 Asset Quality: Allowance for credit losses as a % of: Loans 1.35 % 1.14 1.05 1.07 1.09 Nonperforming loans 255 % 211 1,431 1,314 1,256 Nonperforming assets as a % of: Loans and other real estate owned 0.53 % 0.54 0.07 0.08 0.17 Total assets 0.26 % 0.27 0.03 0.03 0.07 Nonperforming loans as a % of total loans 0.53 % 0.54 0.07 0.08 0.09 Annualized net charge-offs (recoveries) as % of average loans - % 0.16 - (0.05) 0.03 Capital Adequacy: (c) CET 1 risk-based capital ratio 15.45 % 15.39 15.39 16.59 17.26 Tier 1 risk-based capital ratio 15.45 % 15.39 15.39 16.59 17.26 Total risk-based capital ratio 16.48 % 16.25 16.16 17.38 18.08 Tier 1 leverage ratio 10.07 % 10.01 9.29 9.16 9.09 Other financial data: Net interest margin (a) 3.17 % 3.27 3.00 2.60 2.43 Effective income tax rate 11.97 % 24.56 17.78 16.77 10.88 Efficiency ratio (b) 69.97 % 38.73 65.94 68.99 69.05 Selected average balances: Securities available-for-sale$ 402,684 407,792 432,393 427,426 435,097 Loans 502,158 490,163 457,722 428,612 439,713 Total assets 1,022,938 1,022,863 1,069,973 1,092,759 1,114,407 Total deposits 948,393 951,122 987,614 999,867 1,003,394 Total stockholders' equity 68,655 63,283 77,191 87,247 104,493 Selected period end balances: Securities available-for-sale$ 405,692 405,304 411,538 429,220 417,459 Loans 505,041 504,458 474,035 440,872 428,417 Allowance for credit losses 6,821 5,765 4,966 4,716 4,658 Total assets 1,017,746 1,023,888 1,042,559 1,084,251 1,109,664 Total deposits 939,190 950,337 977,938 1,002,698 1,017,742 Total stockholders' equity 73,640 68,041 59,793 76,107 86,411
(a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures." (b) Efficiency ratio is the result of noninterest expense divided by
the sum of noninterest income and tax-equivalent net interest
income.
(c) Regulatory capital ratios presented are for the Company's
wholly-owned subsidiary,
Table of Contents 48 Table 3 - Average Balances
and Net Interest Income Analysis
Quarter endedMarch 31, 2023 2022 Interest Interest Average Income/ Yield/ Average Income/ Yield/ (Dollars in thousands) Balance Expense Rate Balance Expense Rate Interest-earning assets: Loans and loans held for sale (1)$ 502,158 $ 5,754 4.65%$ 440,608 $ 4,850 4.46% Securities - taxable 344,884 1,865 2.19% 374,825 1,336 1.45% Securities - tax-exempt (2) 57,800 511 3.59% 60,272 531 3.57% Total securities 402,684 2,376 2.39% 435,097 1,867 1.74% Federal funds sold 7,314 85 4.71% 73,575 31 0.17% Interest bearing bank deposits 11,607 128 4.47% 83,161 32 0.16% Total interest-earning assets 923,763$ 8,343 3.66% 1,032,441$ 6,780 2.66% Cash and due from banks 15,527 15,105 Other assets 83,648 66,861 Total assets$ 1,022,938 $ 1,114,407 Interest-bearing liabilities: Deposits: NOW$ 187,566 $ 248 0.54%$ 200,907 $ 57 0.12% Savings and money market 300,657 290 0.39% 345,549 172 0.20% Time deposits 155,676 580 1.51% 159,785 356 0.90% Total interest-bearing deposits 643,899 1,118 0.70% 706,241 585 0.34% Short-term borrowings 3,046 8 1.11% 3,943 5 0.50% Total interest-bearing liabilities 646,945$ 1,126 0.71% 710,184$ 590 0.34% Noninterest-bearing deposits 304,494 297,153 Other liabilities 2,844 2,577 Stockholders' equity 68,655 104,493 Total liabilities and stockholders' equity$ 1,022,938 $ 1,114,407 Net interest income and margin (tax-equivalent)$ 7,217 3.17%$ 6,190 2.43%
(1) Loans on nonaccrual status have been included in the computation of average balances. (2) Yields on tax-exempt securities have been computed on a tax-equivalent basis
using a federal income tax rate of 21%. Table of Contents 49 Table 4
- Allocation of Allowance for Credit Losses
2023 2022 First Quarter Fourth Quarter Third Quarter Second Quarter First Quarter (Dollars in thousands) Amount %* Amount %* Amount %* Amount %* Amount %* Commercial and industrial$ 1,232 11.8$ 747 13.1$ 732 14.9$ 761 15.9$ 774 17.1 Construction and land development 1,021 13.2 949 13.2 789 11.6 576 8.8 508 7.7 Commercial real estate 3,966 53.0 3,109 52.4 2,561 52.6 2,523 54.4 2,536 54.8 Residential real estate 497 20.2 828 19.4 783 19.3 753 19.3 737 18.4 Consumer installment 105 1.8 132 1.9 101 1.6 103 1.6 103 2.0 Total allowance for credit losses$ 6,821 $ 5,765 $ 4,966 $ 4,716 $ 4,658
* Loan balance in each category expressed as a percentage of total loans.
Table of Contents 50 Table 5
- Estimated Uninsured Time Deposits by Maturity
(Dollars in thousands)March 31, 2023 Maturity of: 3 months or less$ 175 Over 3 months through 6 months 12,975 Over 6 months through 12 months 16,969 Over 12 months 14,321 Total estimated uninsured time deposits$ 44,440 Table of Contents 51 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.
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