ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF
OPERATIONS
The following is a discussion of our financial condition at December 31,
2021 and 2020 and our results of operations for
the years ended December 31, 2021 and 2020. The purpose of this discussion is to provide
information about our financial
condition and results of operations which is not otherwise apparent from the
consolidated financial statements. The
following discussion and analysis should be read along with our consolidated
financial statements and the related notes
included elsewhere herein. In addition, this discussion and analysis contains forward-looking
statements, so you should
refer to Item 1A, “Risk Factors” and “Special Cautionary Notice Regarding Forward-Looking Statements”.
OVERVIEW
The Company was incorporated in 1990 under the laws of the State of Delaware and became a bank
holding company after
it acquired its Alabama predecessor,
which was a bank holding company established in 1984. The Bank, the Company's
principal subsidiary, is an Alabama
state-chartered bank that is a member of the Federal Reserve System and has operated
continuously since 1907. Both the Company and the Bank are headquartered
in Auburn, Alabama. The Bank conducts its
business primarily in East Alabama, including Lee County and surrounding areas.
The Bank operates full-service branches
in Auburn, Opelika, Notasulga and Valley,
Alabama.
The Bank also operates loan production offices in Auburn and
Phenix City, Alabama.
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46
Summary of Results of Operations
Year ended December 31
(Dollars in thousands, except per share data)
2021
2020
Net interest income (a)
$
24,460
$
24,830
Less: tax-equivalent adjustment
470
492
Net interest income (GAAP)
23,990
24,338
Noninterest income
4,288
5,375
Total revenue
28,278
29,713
Provision for loan losses
(600)
1,100
Noninterest expense
19,433
19,554
Income tax expense
1,406
1,605
Net earnings
$
8,039
$
7,454
Basic and diluted net earnings per share
$
2.27
$
2.09
(a) Tax-equivalent.
See "Table 1 - Explanation of Non-GAAP Financial Measures".
Financial Summary
The Company’s net earnings were $8.0
million for the full year 2021, compared to $7.5 million for the full year 2020.
Basic and diluted net earnings per share were $2.27 per share for the full year 2021,
compared to $2.09 per share for the full
year 2020.
Net interest income (tax-equivalent) was $24.5
million in 2021, a 1% decrease compared to $24.8 million in 2020. This
decrease was primarily due to net interest margin compression
,
partially offset by balance sheet growth.
Net interest
margin (tax-equivalent) decreased to 2.55% in 2021,
compared to 2.92% in 2020, primarily due to the lower interest rate
environment and changes in our asset mix resulting from the significant increase
in deposits from government stimulus and
relief programs and customers’ increased savings.
At December 31, 2021, the Company’s allowance
for loan losses was $4.9 million, or 1.08% of total loans, compared to
$5.6 million, or 1.22%
of total loans, at December 31, 2020.
Excluding
Paycheck Protection Program (“PPP”) loans, which
are guaranteed by the SBA,
the Company’s allowance for loan losses
was 1.10% and 1.27% of total loans at December 31,
2021 and 2020, respectively
.
The Company recorded a negative provision for loan losses of $0.6
million in 2021 compared
to a charge of $1.1 million during 2020.
The negative provision for loan losses was primarily related to improvements in
economic conditions in our primary market area, and related improvements in our
asset quality.
The provision for loan
losses is based upon various estimates and judgements, including the absolute level
of loans, loan growth, credit quality and
the amount of net charge-offs.
Net charge-offs as a percent of average loans were 0.02% in 2021
,
compared to net
recoveries as a percent of average loans of 0.03% in 2020.
Noninterest income was $4.3 million in 2021 compared to $5.4
million in 2020.
The decrease was primarily due to a $0.8
million decrease in mortgage lending income in 2021 as refinance activity declined
in our primary market area and a $0.3
million non-taxable death benefit from bank-owned life insurance received
in 2020.
Noninterest expense was $19.4
million in 2021 compared to $19.6
million in 2020. The decrease was primarily due to a
reduction of $0.8
million in various expenses related to the redevelopment of the Company’s
headquarters in downtown
Auburn.
This decrease was mostly offset by increases in salaries and benefits expe
nse of $0.4 million and a $0.2 million
increase in FDIC and other regulatory assessments during 2021.
Income tax expense was $1.4
million in 2021 and $1.6 million in 2020 reflecting an effective tax rate of 14.89
%
and
17.72%, respectively.
This decrease was primarily due to an income tax benefit related to a New Markets Tax
Credit
investment funded in the fourth quarter of 2021.
The Company’s effective income
tax rate is principally impacted by tax-
exempt earnings from the Company’s investments
in municipal securities, bank-owned life insurance, and New Markets
Tax Credits.
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47
The Company paid cash dividends of $1.04
per share in 2021, an increase of 2% from 2020. At December 31, 2021, the
Bank’s regulatory capital ratios
were well above the minimum amounts required to be “well capitalized” under current
regulatory standards with a total risk-based capital ratio of 17.06%,
a tier 1 leverage ratio of 9.35% and common equity tier
1 (“CET1”) of 16.23% at December 31, 2021.
COVID-19 Impact Assessment
The COVID-19 pandemic has occurred in waves of different
variants since the first quarter of 2020.
Vaccines
to protect
against and/or reduce the severity of COVID-19 were widely introduced at the beginning
of 2021.
At times, the pandemic
has severely restricted the level of economic activity in our markets. In response to the COVID
-19 pandemic, the State of
Alabama, and most other states, have taken preventative or protective actions to prevent the
spread of the virus, including
imposing restrictions on travel and business operations and a statewide mask mandate,
advising or requiring individuals to
limit or forego their time outside of their homes, limitations on gathering of people and social distancing,
and causing
temporary closures of businesses that have been deemed to be non-essential. Though certain
of these measures have been
relaxed or eliminated, especially as vaccination levels increased, such
measures could be reestablished in cases of new
waves, especially a wave of a COVID-19 variant that is more resistant
to existing vaccines.
COVID-19 has significantly affected local state, national and global
health and economic activity and its future effects are
uncertain and will depend on various factors, including, among others, the duration
and scope of the pandemic, especially
new variants of the virus, effective vaccines and drug treatments, together
with governmental, regulatory and private sector
responses. COVID-19 has had continuing significant effects
on the economy, financial
markets and our employees,
customers and vendors. Our business, financial condition and results of operations
generally rely upon the ability of our
borrowers to make deposits and repay their loans, the value of collateral underlying our
secured loans, market value,
stability and liquidity and demand for loans and other products and services we offer,
all of which are affected by the
pandemic.
We have implemented
a number of procedures in response to the pandemic to support the safety and well-being of our
employees, customers and shareholders.
•
We believe our business continuity
plan has worked to provide essential banking services to our communities and
customers, while protecting our employees’ health.
As part of our efforts to exercise social distancing in
accordance with the guidelines of the Centers for Disease Control and the Governor
of the State of Alabama,
starting March 23, 2020, we limited branch lobby service to appointment only while continuing
to operate our
branch drive-thru facilities and ATMs.
As permitted by state public health guidelines, on June 1, 2020, we re-
opened some of our branch lobbies.
In 2021, we opened our remaining branch lobbies.
We continue to provide
services through our online and other electronic channels.
In addition, we maintain remote work access to help
employees stay at home while providing continuity of service.
•
We are focused on servicing
the financial needs of our commercial and consumer clients with extensions
and
deferrals to loan customers effected by COVID-19, provided
such customers were not more than 30 days past due
at the time of the request; and
•
We
were an active PPP lender. PPP loans were forgivable,
in whole or in part, if the proceeds are used for payroll
and other permitted purposes in accordance with the requirements of the PPP.
These loans carry a fixed rate of
1.00% and a term of two years (loans made before June 5, 2020) or five years (loans
made on or after June 5,
2020), if not forgiven, in whole or in part.
Payments are deferred until either the date on which the Small Business
Administration (“SBA”) remits the amount of forgiveness proceeds
to the lender or the date that is 10 months after
the last day of the covered period if the borrower does not apply for forgiveness
within that 10-month period.
We
believe these loans and our participation in the program helped our customers and the communities
we serve.
COVID-19 has also had various economic effects, generally.
These include supply chain disruptions and manufacturing
delays, shortages of certain goods and services, reduced consumer expenditure on
hospitality and travel, and migration from
larger urban centers to less populated areas and remote work.
The demand for single family housing has exceeded existing
supplies.
When coupled with construction delays attributable to supply chain disruptions
and worker shortages, these
factors have caused housing prices and apartment rents to increase, generally.
Stimulative monetary and fiscal policy,
along with shortages of certain goods and services, and rising petroleum and food prices
have led to the highest inflation in
decades.
Although fiscal stimulus remains under consideration by the President and Congress,
the Federal Reserve is
considering increasing its target interest rates and reducing its holding of
securities to stem inflation.
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48
A summary of PPP loans extended during 2020 follows:
(Dollars in thousands)
# of SBA
Approved
Mix
$ of SBA
Approved
Mix
SBA Tier:
$2 million to $10 million
—
—
%
$
—
—
%
$350,000 to less than $2 million
23
5
14,691
40
Up to $350,000
400
95
21,784
60
Total
423
100
%
$
36,475
100
%
We collected
approximately $1.5 million in fees related to our PPP loans during 2020.
Through December 31, 2021, we
have recognized all of these fees, net of related costs.
As of December 31, 2021, we had received payments and
forgiveness on all PPP loans extended during 2020.
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits,
and Venues
Act (the “Economic Aid
Act”) was signed into law. The
Economic Aid Act provides a second $900 billion stimulus package, including
$325 billion
in additional PPP loans.
The Economic Aid Act also permits the collection of a higher amount of PPP
loan fees by
participating banks.
A summary of PPP loans extended during 2021 under the Economic Aid
Act follows:
(Dollars in thousands)
# of SBA
Approved
Mix
$ of SBA
Approved
Mix
SBA Tier:
$2 million to $10 million
—
—
%
$
—
—
%
$350,000 to less than $2 million
12
5
6,494
32
Up to $350,000
242
95
13,757
68
Total
254
100
%
$
20,251
100
%
We collected
approximately $1.0 million in fees related to PPP loans under the Economic Aid Act.
Through December 31,
2021, we have recognized $0.7 million of these fees, net of related costs.
As of December 31, 2021, we have received
payments and forgiveness on 116
PPP loans under the Economic Aid Act, totaling $12.1 million.
The outstanding balance
for the remaining 138 PPP loans under the Economic Aid Act
was approximately $8.1 million at December 31, 2021.
We continue to closely
monitor this pandemic, and are working to continue our services during the pandemic
and to address
developments as those occur.
Our results of operations for year ended December 31, 2021, and our financial condition
at
that date reflect only the ongoing effects of the pandemic, and
may not be indicative of future results or financial
conditions, including possible changes in monetary or fiscal stimulus, and
the possible effects of the expiration or extension
of temporary accounting and bank regulatory relief measures in response to the
COVID-19 pandemic.
As of December 31, 2021,
all of our capital ratios were in excess of all regulatory requirements to be well capitalized.
The
effects of the COVID-19 pandemic on our borrowers could result in adverse changes
to credit quality and our regulatory
capital ratios.
We continue to
closely monitor this pandemic, and are working to continue our services during the pandemic
and to address developments as those occur.
CRITICAL ACCOUNTING POLICIES
The accounting and financial reporting policies of the Company conform
with U.S. generally accepted accounting
principles and with general practices within the banking industry.
In connection with the application of those principles, we
have made judgments and estimates which, in the case of the determination of our allowance
for loan losses, our
assessment of other-than-temporary impairment, recurring and
non-recurring fair value measurements, the valuation of
other real estate owned, and the valuation of deferred tax assets, were critical to the determination
of our financial position
and results of operations. Other policies also require subjective judgment and assumptions
and may accordingly impact our
financial position and results of operations.
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49
Allowance for Loan Losses
The Company assesses the adequacy of its allowance for loan losses prior
to the end of each calendar quarter. The level of
the allowance is based upon management’s
evaluation of the loan portfolio, past loan loss experience, current asset quality
trends, known and inherent risks in the portfolio, adverse situations that may affect
a borrower’s ability to repay (including
the timing of future payment), the estimated value of any underlying collateral,
composition of the loan portfolio, economic
conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory
recommendations. This
evaluation is inherently subjective as it requires material estimates including the
amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible to significant change. Loans are
charged off, in whole or
in part, when management believes that the full collectability of the loan is unlikely.
A loan may be partially charged-off
after a “confirming event” has occurred which serves to validate that full repayment pursuant
to the terms of the loan is
unlikely.
The Company deems loans impaired when, based on current information and events, it is
probable that the Company will
be unable to collect all amounts due according to the contractual terms of the loan agreement.
Collection of all amounts due
according to the contractual terms means that both the interest and principal payments of a
loan will be collected as
scheduled in the loan agreement.
An impairment allowance is recognized if the fair value of the loan is less than the recorded
investment in the loan. The
impairment is recognized through the allowance. Loans that are impaired are
recorded at the present value of expected
future cash flows discounted at the loan’s effective
interest rate, or if the loan is collateral dependent, impairment
measurement is based on the fair value of the collateral, less estimated disposal costs.
The level of allowance maintained is believed by management to be adequate
to absorb probable losses inherent in the
portfolio at the balance sheet date. The allowance is increased by provisions charged
to expense and decreased by charge-
offs, net of recoveries of amounts previously charged-off.
In assessing the adequacy of the allowance, the Company also considers the results of its
ongoing internal, independent
loan review process. The Company’s loan
review process assists in determining whether there are loans in the portfolio
whose credit quality has weakened over time and evaluating the risk characteristics of the
entire loan portfolio. The
Company’s loan review process includes the judgment
of management, the input from our independent loan reviewers, and
reviews that may have been conducted by bank regulatory agencies as part of their examination
process. The Company
incorporates loan review results in the determination of whether or not it is probable
that it will be able to collect all
amounts due according to the contractual terms of a loan.
As part of the Company’s quarterly assessment
of the allowance, management divides the loan portfolio into five segments:
commercial and industrial, construction and land development, commercial real estate, residential
real estate, and consumer
installment loans. The Company
analyzes each segment and estimates an allowance allocation for each loan
segment.
The allocation of the allowance for loan losses begins with a process of estimating the
probable losses inherent for these
types of loans. The estimates for these loans are established by category and based
on the Company’s internal system of
credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s
internal system of
credit risk grades is based on its experience with similarly graded loans. For
loan segments where the Company believes it
does not have sufficient historical loss data, the Company may
make adjustments based, in part, on loss rates of peer bank
groups. At December 31, 2021 and 2020, and for the years then ended, the Company adjusted
its historical loss rates for the
commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.
The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s
estimate of
probable losses for several “qualitative and environmental” factors.
The allocation for qualitative and environmental
factors is particularly subjective and does not lend itself to exact mathematical calculation.
This amount represents
estimated probable inherent credit losses which exist, but have not yet been identified, as of
the balance sheet date, and are
based upon quarterly trend assessments in delinquent and nonaccrual loans, credit
concentration changes, prevailing
economic conditions, changes in lending personnel experience, changes in lending
policies or procedures and other
influencing factors.
These qualitative and environmental factors are considered for each of the five loan segments
and the
allowance allocation, as determined by the processes noted above, is increased or
decreased based on the incremental
assessment of these factors.
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50
The Company regularly re-evaluates its practices in determining the allowance
for loan losses. Since the fourth quarter of
2016, the Company has increased its look-back period each quarter to incorporate
the effects of at least one economic
downturn in its loss history. The Company believes
the extension of its look-back period is appropriate due to the risks
inherent in the loan portfolio. Absent this extension, the early cycle periods in
which the Company experienced significant
losses would be excluded from the determination of the allowance for loan losses and its balance
would decrease. For the
year ended December 31, 2021, the Company increased its look-back period to
51 quarters to continue to include losses
incurred by the Company beginning with the first quarter of 2009. The Company
will likely continue to increase its look-
back period to incorporate the effects of at least one economic downturn in
its loss history. During 2020,
the Company
adjusted certain qualitative and economic factors related to changes in economic conditions
driven by the impact of the
COVID-19 pandemic and resulting adverse economic conditions, including
higher unemployment in our primary market
area.
During 2021, the Company adjusted certain qualitative and economic factors to reflect
improvements in economic
conditions in our primary market area.
Further adjustments may be made in the future as a result of the ongoing COVID-19
pandemic.
Assessment for Other-Than-Temporary
Impairment of Securities
On a quarterly basis, management makes an assessment to determine
whether there have been events or economic
circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily
impaired.
For debt securities with an unrealized loss, an other-than-temporary
impairment write-down is triggered when (1) the
Company has the intent to sell a debt security,
(2) it is more likely than not that the Company will be required to sell the
debt security before recovery of its amortized cost basis, or (3) the Company does not expect
to recover the entire amortized
cost basis of the debt security.
If the Company has the intent to sell a debt security or if it is more likely than not that it
will
be required to sell the debt security before recovery,
the other-than-temporary write-down is equal to the entire difference
between the debt security’s amortized cost
and its fair value.
If the Company does not intend to sell the security or it is not
more likely than not that it will be required to sell the security before recovery,
the other-than-temporary impairment write-
down is separated into the amount that is credit related (credit loss component) and the amount due
to all other factors.
The
credit loss component is recognized in earnings and is the difference between
the security’s amortized cost basis and
the
present value of its expected future cash flows.
The remaining difference between the security’s
fair value and the present
value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive
income, net of applicable taxes.
The Company is required to own certain stock as a condition of membership, such as
Federal Home Loan Bank (“FHLB”)
and Federal Reserve Bank (“FRB”).
These non-marketable equity securities are accounted for at cost
which equals par or
redemption value.
These securities do not have a readily determinable fair value as their ownership is restricted and
there is
no market for these securities.
The Company records these non-marketable equity securities as a component
of other
assets, which are periodically evaluated for impairment. Management considers
these non-marketable equity securities to
be long-term investments. Accordingly,
when evaluating these securities for impairment, management considers
the
ultimate recoverability of the par value rather than by recognizing temporary declines in
value.
Fair Value
Determination
U.S. GAAP requires management to value and disclose certain of the Company’s
assets and liabilities at fair value,
including investments classified as available-for-sale and derivatives.
ASC 820,
Fair Value
Measurements and Disclosures
,
which defines fair value, establishes a framework for measuring fair value in accordance
with U.S. GAAP and expands
disclosures about fair value measurements.
For more information regarding fair value measurements and disclosures,
please refer to Note 14, Fair Value,
of the consolidated financial statements that accompany this report.
Fair values are based on active market prices of identical assets or liabilities when available.
Comparable assets or
liabilities or a composite of comparable assets in active markets are used when identical assets
or liabilities do not have
readily available active market pricing.
However, some of the Company’s
assets or liabilities lack an available or
comparable trading market characterized by frequent transactions between
willing buyers and sellers. In these cases, fair
value is estimated using pricing models that use discounted cash flows and
other pricing techniques. Pricing models and
their underlying assumptions are based upon management’s
best estimates for appropriate discount rates, default rates,
prepayments, market volatility and other factors, taking into account current observable
market data and experience.
These assumptions may have a significant effect on the reported
fair values of assets and liabilities and the related income
and expense. As such, the use of different models and assumptions, as
well as changes in market conditions, could result in
materially different net earnings and retained earnings results.
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