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 2022:
●
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.
Inflation is running at levels unseen in decades and the Federal Reserve is
contemplating raising target interest rates and reducing its securities
holdings.
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, and Russia’s invasion of Ukraine affect
consumer confidence levels, economic activity and inflation.
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.
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●
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 0.10% of total loans as of December 31,
2021, and we had $0.4 million in other real estate
owned (“OREO”).
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, much of which is affected
by the economy and the levels of interest rates,
generally.
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, including
disruptions of supply chains and war, 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.
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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.
In contrast, rising
interest rates would be expected to reduce mortgage refinancings and extend the duration
of our MSRs.
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
50.0% of our portfolio in CRE loans at year-end 2021 compared to 43.6% at year-end 2020.
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 2021, 21% of our total loans were CRE loans to
hotels/motels, retail and shopping centers and restaurants,
businesses that were severely affected
by the effects of COVID-19.
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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.
Fintech and other non-bank competitors also complete for our
customers, and may partner with other banks and/or seek to enter the payments system.
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.
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;
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●
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.
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, data breaches and anti-money laundering
violations. 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 competitors 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.
As a result, our competition from service providers not
located in our markets has increased.
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 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 and
potential environmental risks, 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.
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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 procedures
as our
regulation changes.
For example, the Federal Reserve and the OCC are in the initial stages of proposing
climate risk
management criteria and potential climate risk stress tests.
The SEC is expected to require more disclosure on climate
risks, also.
All of these could adversely affect our financial condition and results
of operations.
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, and may
increase as a result of the Russia invasion of Ukraine.
Other financial service institutions and their service providers have
reported material security breaches in their websites or other systems, some of
which have involved sophisticated and
targeted attacks, including use of stolen access credentials, malware,
ransomware, phishing and distributed denial-of-
service attacks, among other means.
Such cyber-attacks may also seek to disrupt the operations of public companies
or
their business partners, effect unauthorized fund transfers, obtain unauthorized
access to confidential information, destroy
data, disable or degrade service, or sabotage systems.
Denial of service attacks have been launched against a number of
financial services institutions, and we may be subject to these types of attacks in
the future. Hacking and identity theft risks,
in particular, could cause serious reputational harm.
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Despite our cybersecurity policies and procedures and our Board
of Director’s and Management’s efforts
to monitor and
ensure the integrity of the system we use, we may not be able to anticipate the rapidly evolving
security threats, nor may we
be able to implement preventive measures effective against
all such threats. The techniques used by cyber criminals change
frequently, may not be recognize
d
until launched and can originate from a wide variety of sources, including outside groups
such as external service providers, organized crime affiliates,
terrorist organizations or hostile foreign governments. These
risks may increase in the future as the use of mobile banking and other internet
electronic banking continues to grow.
Security breaches or failures may have serious adverse financial and other consequences,
including significant legal and
remediation costs, disruptions to operations, misappropriation of confidential information,
damage to systems operated by
us or our third-party service providers, as well as damages to our customers and our
counterparties. In addition, these events
could damage our reputation, result in a loss of customer business, subject us to additional
regulatory scrutiny, or expose
us
to civil litigation and possible financial liability,
any of which could have a material adverse effect on