ITEM 1A. RISK FACTORS
Any of the following risks could harm our business, results of
operations and financial condition and an investment in our
stock.
The risks discussed below also include forward-looking statements,
and our actual results may differ substantially
from those discussed in these forward-looking statements.
Operational Risks
Market conditions and economic cyclicality may adversely affect
our industry.
We believe the following,
among other things, may affect us in 2021:
●
The COVID-19 pandemic disrupted
the economy beginning late in the first quarter of 2020, and continues.
Auburn University, government
agencies and businesses were limited to remote work and gatherings
were limited.
Supply chains continue to be disrupted and unemployment spiked
and remains high.
Hotels, motels, restaurants,
retail and shopping centers were especially affected.
●
Extraordinary monetary and fiscal stimulus in 2020 and in early
2021 have offset certain of the pandemic’s
adverse economic effects, and are continuing.
The Federal Reserve is maintaining a targeted
federal funds rate of
0-0.25%, and has provided stimulus by buying bonds and providing
market liquidity.
Legislation is pending to
provide an additional $1.9 trillion of fiscal stimulus, and foreclosure
moratoria have been extended.
The nature
and timing of any future changes in monetary and fiscal policies and
their effect on us cannot be predicted.
●
Market developments, including unemployment, price levels,
stock and bond market volatility,
and changes,
including those resulting from COVID-19 and the pace of vaccination
and expected declines in serious COVID-19
cases, continue to affect consumer confidence levels and
economic activity.
Changes in payment behaviors and
payment rates may increase in delinquencies and default rates,
which could affect our earnings and credit quality.
●
Our ability to assess the creditworthiness of our customers and
those we do business with, and the values of our
assets and loan collateral may be adversely affected and less
predictable as a result of the pandemic and
government responses.
The accounting for loan modifications and deferrals may provide
only temporary relief.
The process we use to estimate losses inherent in our credit exposure
or estimate the value of certain assets
requires difficult, subjective, and complex judgments, including
forecasts of economic conditions and how those
economic predictions might affect the ability of our borrowers
to repay their loans or the value of assets.
●
The end of the LIBOR reference rate is currently scheduled for
most tenors by June 30, 2023, although U.S. bank
regulators informed banks November 30, 2020 that they should
stop using LIBOR for new loans and contracts and
derivatives, including hedging, and involves risks of potential marked
disruption and costs of compliance and
conversion.
New hedges may not be as effective as hedges based
on LIBOR.
Nonperforming and similar assets take significant time to resolve
and may adversely affect our results of
operations and
financial condition.
Our nonperforming loans were 0.12% of total loans as of December
31, 2020, and had no other real estate owned
(“OREO”).
Twenty-five percent, or
$117.0 million, of our total loans were in hotels/motels,
retail and shopping centers
and restaurants, and $31.4 million of these had COVID-19 modifications
to require interest only payments.
Non-
performing assets may adversely affect our net income
in various ways.
We do
not record interest income on nonaccrual
loans or OREO and these assets require higher loan administration
and other costs, thereby adversely affecting our income.
Decreases in the value of these assets, or the underlying collateral,
or in the related borrowers’ performance or financial
condition, whether or not due to economic and market conditions beyond
our control, could adversely affect our business,
results of operations and financial condition.
In addition, the resolution of nonperforming assets requires commitments
of
time from management, which can be detrimental to the performance
of their other responsibilities. Our non-performing
assets may be adversely affected by loan deferrals and
modifications made in response to the pandemic and the moratoria
on foreclosures and evictions.
There can be no assurance that we will not experience increases in
nonperforming loans in
the future.
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Our allowance for loan losses may prove
inadequate or we may be negatively affected by credit
risk exposures.
We periodically
review our allowance for loan losses for adequacy considering economic
conditions and trends, collateral
values and credit quality indicators, including past charge
-off experience and levels of past due loans and nonperforming
assets.
We cannot
be certain that our allowance for loan losses will be adequate
over time to cover credit losses in our
portfolio because of unanticipated adverse changes in the economy,
including the continuing effects of the pandemic
and
fiscal and monetary response to COVID-19 loan modifications
and deferrals, market conditions or events adversely
affecting specific customers, industries or markets,
and changes in borrower behaviors.
Certain borrowers may not recover
fully or may fail as a result of COVID-19 effects.
If the credit quality of our customer base materially decreases,
if the risk
profile of the market, industry or group of customers changes
materially or weaknesses in the real estate markets worsen,
borrower payment behaviors change, or if our allowance for loan
losses is not adequate, our business, financial condition,
including our liquidity and capital, and results of operations
could be materially adversely affected.
CECL, a new
accounting standard for estimating loan losses, is effective for
the Company beginning January 1, 2023, and its effects upon
the Company have not yet been determined.
Changes in the real estate markets, including
the secondary market for residential mortgage
loans, may continue to
adversely affect us.
The CFPB’s mortgage and servicing
rules, including TRID rules for closed end credit transactions,
enforcement actions,
reviews and settlements, affect the mortgage markets and
our mortgage operations.
The CFPB requires that lenders
determine whether a consumer has the ability to repay a mortgage loan
have limited the secondary market for and liquidity
of many mortgage loans that are not “qualified mortgages.”
Recently adopted changes to the CFPB’s
qualified mortgage
rules are reportedly being reconsidered.
The Tax Cuts and Jobs
Act’s (the “2017 Tax
Act”) limitations on the deductibility of residential mortgage interest
and state
and local property and other taxes and federal moratoria
on single-family foreclosures and rental evictions could adversely
affect consumer behaviors and the volumes of housing sales,
mortgage and home equity loan originations, as well as the
value and liquidity of residential property held as collateral by lenders
such as the Bank, and the secondary markets for
single and multi-family loans.
Acquisition, construction and development loans for residential development
may be
similarly adversely affected.
Fannie Mae and Freddie Mac (“GSEs”), have been in conservatorship
since September 2008.
Since Fannie Mae and
Freddie Mac dominate the residential mortgage markets, any
changes in their operations and requirements, as well as their
respective restructurings and capital, could adversely affect
the primary and secondary mortgage markets, and our
residential mortgage businesses, our results of operations and
the returns on capital deployed in these businesses.
The
timing and effects of resolution of these government sponsored
enterprises cannot be predicted.
Weaknesses in real
estate markets the FHFA’s
moratoria on foreclosures and real estate owned evictions may adversely
affect the length of time and costs required to
manage and dispose of, and the values realized from the sale
of our OREO.
We may be
contractually obligated to repurchase
mortgage loans we sold to third parties on terms unfavorable
to us.
As part of its routine business, the Company originates mortgage loans
that it subsequently sells in the secondary market,
including to governmental agencies and GSEs.
In connection with the sale of these loans, the Company makes customary
representations and warranties, the breach of which may result in
the Company being required to repurchase the loan or
loans.
Furthermore, the amount paid may be greater than the fair value of the
loan or loans at the time of the repurchase.
Although mortgage loan repurchase requests made to us have been
limited, if these increased, we may have to establish
reserves for possible repurchases and adversely affect our results of operation
and financial condition.
Mortgage servicing rights requirements
may change and require
us to incur additional costs and risks.
The CFPB’s residential mortgage
servicing standards may adversely affect our costs to
service residential mortgage loans,
and together with the Basel III Rules and the effects of
lower interest rates from COVID-19 stimulus, may decrease the
returns on, and values of, our MSRs.
This could reduce our income from servicing these types
of loans and make it more
difficult and costly to timely realize the value of collateral
securing such loans upon a borrower default.
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The soundness of other financial institutions could adversely affect
us.
We routinely execute
transactions with counterparties in the financial services industry,
including brokers and dealers,
central clearinghouses, banks, including our correspondent banks
and other financial institutions.
Our ability to engage in
routine investment and banking transactions, as well as the quality and
values of our investments in holdings of other
obligations of other financial institutions such as the FHLB, could
be adversely affected by the actions, financial condition,
and profitability of such other financial institutions, including
the FHLB and our correspondent banks.
Financial services
institutions are interrelated as a result of shared credits, trading, clearing,
counterparty and other relationships.
Any losses,
defaults by, or failures of, the
institutions we do business with could adversely affect our
holdings of the equity in such
other institutions, our participation interests in loans originated
by other institutions,
and our business, including our
liquidity, financial condition and
earnings.
Our concentration of commercial real
estate loans could result in further increased
loan losses, and adversely affect our
business, earnings, and financial condition.
Commercial real estate, or CRE, is cyclical and poses risks of possible
loss due to concentration levels and risks of the
assets being financed, which include loans for the acquisition and development
of land and residential construction.
The
federal bank regulatory
agencies released guidance in 2006 on “Concentrations
in Commercial Real Estate Lending.”
The
guidance defines CRE loans as exposures secured by raw land,
land development and construction loans (including 1-4
family residential construction loans), multi-family property,
and non-farm non-residential property,
where the primary or a
significant source of repayment is derived from rental income associated
with the property (that is, loans for which 50% or
more of the source of repayment comes from third party,
non-affiliated, rental income) or the proceeds
of the sale,
refinancing, or permanent financing of the property.
Loans to REITs
and unsecured loans to developers that closely
correlate to the inherent risks in CRE markets are also CRE loans.
Loans on owner occupied commercial real estate are
generally excluded from CRE for purposes of this guidance.
Excluding owner occupied commercial real estate, we had
43.6%
of our portfolio in CRE loans at year-end 2020 compared
to 48.0% at year-end 2019.
The banking regulators
continue to give CRE lending scrutiny and require banks with
higher levels of CRE loans to implement improved
underwriting, internal controls, risk management policies and
portfolio stress testing, as well as higher levels of allowances
for possible losses and capital levels as a result of CRE lending growth
and exposures.
Lower demand for CRE, and
reduced availability of, and higher interest rates and costs for,
CRE lending could adversely affect our CRE loans and sales
of our OREO, and therefore our earnings and financial condition,
including our capital and liquidity.
At year-end 2020, 25% of our total loans were CRE
loans to hotels/motels, retail and shopping centers and restaurants,
businesses that have been severely affected by the effects
of COVID-19.
Our future success is dependent on
our ability to compete effectively in highly competitive markets.
The East Alabama banking markets which we operate
are highly competitive and our future growth and success will
depend on our ability to compete effectively in these markets.
We compete for loans,
deposits and other financial services
with other local, regional and national commercial banks, thrifts, credit
unions, mortgage lenders, and securities and
insurance brokerage firms.
Lenders operating nationwide over the internet are growing rapidly.
Many of our competitors
offer products and services different from
us, and have substantially greater resources, name recognition and
market
presence than we do, which benefits them in attracting business.
In addition, larger competitors may be able to
price loans
and deposits more aggressively than we are able to and have broader
and more diverse customer and geographic bases to
draw upon.
Out of state banks may branch into our markets.
Failures of other banks with offices in our markets could
also
lead to the entrance of new,
stronger competitors in our markets.
Our success depends on local economic conditions.
Our success depends on the general economic conditions in the
geographic markets we serve in Alabama.
The local
economic conditions in our markets have a significant effect
on our commercial, real estate and construction loans, the
ability of borrowers to repay these loans and the value of the collateral
securing these loans.
Adverse changes in the
economic conditions of the Southeastern United States in general,
or in one or more of our local markets, including the
continuous effects from COVID-19 and the timing,
strength and breadth of the recovery from the pandemic,
could
negatively affect our results of operations and our
profitability.
Our local economy is also affected by the growth of
automobile manufacturing and related suppliers located in our
markets and nearby.
Auto sales are cyclical and are affected
adversely by higher interest rates.
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Attractive acquisition opportunities may not be available
to us in the future.
While we seek continued organic growth, we also may
consider the acquisition of other businesses.
We expect that other
banking and financial companies, many of which have significantly
greater resources, will compete with us to acquire
financial services businesses.
This competition could increase prices for potential acquisitions that
we believe are
attractive.
Also, acquisitions are subject to various regulatory approvals.
If we fail to receive the appropriate regulatory
approvals, we will not be able to consummate an acquisition that
we believe is in our best interests, and regulatory
approvals could contain conditions that reduce the anticipated
benefits of any transaction.
Among other things, our
regulators consider our capital, liquidity,
profitability, regulatory compliance
and levels of goodwill and intangibles when
considering acquisition and expansion proposals.
Any acquisition could be dilutive to our earnings and shareholders’
equity per share of our common stock.
Future acquisitions and expansion activities
may disrupt our business, dilute shareholder
value and adversely affect our
operating results.
We regularly evaluate
potential acquisitions and expansion opportunities, including new
branches and other offices.
To the
extent that we grow through acquisitions, we cannot assure you that
we will be able to adequately or profitably manage this
growth.
Acquiring other banks, branches, or businesses, as well as other geographic
and product expansion activities,
involve various risks including:
●
risks of unknown or contingent liabilities, and potential asset quality issues;
●
unanticipated costs and delays;
●
risks that acquired new businesses will not perform consistent with
our growth and profitability expectations;
●
risks of entering new markets or product areas where we have
limited experience;
●
risks that growth will strain our infrastructure, staff, internal
controls and management, which may require
additional personnel, time and expenditures;
●
difficulties, expenses and delays of integrating the operations
and personnel of acquired institutions;
●
potential disruptions to our business;
●
possible loss of key employees and customers of acquired institutions;
●
potential short-term decreases in profitability; and
●
diversion of our management’s
time and attention from our existing operations and business.
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Technological
changes affect our business, and we may have fewer resources
than many competitors to invest in
technological improvements.
The financial services industry is undergoing rapid
technological changes with frequent introductions of new technology
driven products and services and growing demands for mobile
and user-based banking applications. In addition to allowing
us to analyze our customers better,
the effective use of technology may increase efficiency
and may enable financial
institutions to reduce costs, risks associated with fraud and
compliance with anti-money laundering and other laws, and
various operational risks. Largely unregulated “fintech” businesses
have increased their participation in the lending and
payments businesses, and have increased competition in these
businesses. Our future success will depend, in part, upon our
ability to use technology to provide products and services that
meet our customers’ preferences and create additional
efficiencies in operations, while avoiding cyber-attacks
and disruptions, and data breaches. The COVID-19 pandemic
and
increased remote work has accelerated electronic banking activity
and the need for increased operational efficiencies.
We
may need to make significant additional capital investments in technology,
including cyber and data security,
and we may
not be able to effectively implement new technology
-driven products and services, or such technology may prove less
effective than anticipated. Many larger competito
rs have substantially greater resources to invest in technological
improvements and, increasingly,
non-banking firms are using technology to compete with traditional
lenders for loans and
other banking services.
Operational risks are inherent
in our businesses.
Operational risks and losses can result from internal and external
fraud; gaps or weaknesses in our risk management or
internal audit procedures; errors by employees or third parties,
including our vendors, failures to document transactions
properly or obtain proper authorizations; failure to comply with applicable
regulatory requirements in the various
jurisdictions where we do business or have customers; failures in our
estimates models that rely on; equipment failures,
including those caused by natural disasters, or by electrical, telecommunications
or other essential utility outages; business
continuity and data security system failures, including those caused by
computer viruses, cyberattacks, unforeseen
problems encountered while implementing major new computer
systems or, failures to timely and properly
upgrade and
patch existing systems or inadequate access to data or
poor response capabilities in light of such business continuity and
data security system failures; or the inadequacy or failure of
systems and controls, including those of our vendors or
counterparties.
The COVID-19 pandemic has presented operational challenges
to maintaining continuity of operations of
customer services while protecting our employees’ and customers’
safety.
In addition, we face certain risks inherent in the
ownership and operation of our bank premises and other real
-estate, including liability for accidents on our properties.
Although we have implemented risk controls and loss mitigation actions,
and substantial resources are devoted to
developing efficient procedures, identifying and rectifying
weaknesses in existing procedures and training staff,
it is not
possible to be certain that such actions have been or will be
effective in controlling these various operational risks
that
evolve continuously.
Potential gaps in our risk management policies and internal
audit procedures
may leave us exposed unidentified or
unanticipated risk, which could negatively affect our business.
Our enterprise risk management and internal audit program is
designed to mitigate material risks and loss to us. We
have
developed and continue to develop risk management and internal
audit policies and procedures to reflect the ongoing
review of our risks and expect to continue to do so in the future.
Nonetheless, our policies and procedures may not be
comprehensive and may not identify timely every risk to which we
are exposed, and our internal audit process may fail to
detect such weaknesses or deficiencies in our risk management
framework. Many of our risk management models and
estimates use observed historical market behavior to model
or project potential future exposure.
Models used by our
business are based on assumptions and projections. These
models may not operate properly or our inputs and assumptions
may be inaccurate, or changes in economic conditions, customer
behaviors or regulations.
As a result, these methods may
not fully predict future exposures, which can be significantly
greater than historically.
Other risk management methods
depend upon the evaluation of information regarding markets,
clients, or other matters that are publicly available or
otherwise accessible to us. This information may not always
be accurate, complete, up-to-date or properly evaluated.
Furthermore, there can be no assurance that we can effectively
review and monitor all risks or that all of our employees will
closely follow our risk management policies and procedures,
nor can there be any assurance that our risk management
policies and procedures will enable us to accurately identify all
risks and limit our exposures based on our assessments. In
addition, we may have to implement more extensive and perhaps
different risk management policies and procedu
res as our
regulation changes.
All of these could adversely affect our financial condition
and results of operations.
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Any failure to protect
the confidentiality of customer information could adversely affect our
reputation and have a material
adverse effect on our business, financial condition and
results of operations
.
Various
laws enforced by the bank regulators and other agencies protect
the privacy and security of customers’ non-public
personal information. Many of our employees have access to,
and routinely process personal information of clients through
a variety of media, including information technology systems.
Our internal processes and controls are designed to protect
the confidentiality of client information we hold and that is accessible
to us and our employees. It is possible that an
employee could, intentionally or unintentionally,
disclose or misappropriate confidential client information or
our data
could be the subject of a cybersecurity attack.
Such personal data could also be compromised via intrusions into
our
systems or those of our service providers or persons we do business
with such as credit bureaus, data processors and
merchants who accept credit or debit cards for payment. If we
fail to maintain adequate internal controls, or if our
employees fail to comply with our policies and procedures,
misappropriation or inappropriate disclosure or misuse of client
information could occur. Such
internal control inadequacies or non-compliance could materially damage
our reputation,
lead to remediation costs and civil or criminal penalties.
These could have a material adverse effect on our business,
financial condition and results of operations.
Our information systems may experience interruptions and
security breaches.
We rely heavily on communications
and information systems, including those provided
by third-party service providers, to
conduct our business.
Any failure, interruption, or security breach of these systems could
result in failures or disruptions
which could affect our customers’ privacy and our
customer relationships, generally.
Our business continuity plans,
including those of our service providers, to provide back-up and
restore service may not be effective in the case of
widespread outages due to severe weather,
natural disasters, pandemics, or power,
communications and other failures.
Our systems and networks, as well as those of our third-party service
providers, are subject to security risks and could be
susceptible to cyber-attacks, such as denial of service attacks,
hacking, terrorist activities or identity theft.
Cybercrime risks
have increased as electronic and mobile banking activities increased
as a result of the COVID-19 pandemic.
Other
financial service institutions and their service providers have reported
material security breaches in their websites or other
systems, some of which have involved sophisticated and targeted
attacks, including use of stolen access credentials,
malware, ransomware, phishing and distributed denial-of
-service attacks, among other means.
Such cyber-attacks may also
seek to disrupt the operations of public companies or their business
partners, effect unauthorized fund transfers, obtain
unauthorized access to confidential information, destroy data,
disable or degrade service, or sabotage systems.
Denial of
service attacks have
been launched against a number of financial services institutions,
and we may be subject to these types