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 2023:
●
The COVID-19 pandemic disrupted the economy beginning late in the first quarter of 2020.
Auburn University,
government agencies and businesses were limited to remote work and gatherings
were limited.
Supply chains
continue to be disrupted and labor markets remain tight.
Hotels, motels, restaurants, retail and shopping centers
were especially affected.
COVID-19 continues, but with diminishing direct economic effects
due to population
health, generally.
President Biden has terminated the COVID-19 national emergencies
effective May 11, 2023.
●
Extraordinary monetary and fiscal stimulus in 2020 and in early 2021
offset certain of the pandemic’s adverse
economic effects, but together with supply chain disruptions,
continued consumer demand, Russia’s invasion
of
Ukraine and its effects on energy and food prices, and tight labor
markets, have resulted in inflation.
Inflation is
running at levels unseen in decades and well above the Federal Reserve’s
long term inflation goal of 2.0%
annually.
Beginning in March 2022, the Federal Reserve has been raising target
federal funds interest rates and
reducing its securities holdings in an effort to reduce inflation.
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 Russia’s invasion
of Ukraine affect consumer confidence levels, economic activity
and inflation.
Increases in market interest rates, inflation and consumer and business confidence
may cause
changes in savings and payment behaviors, including potential increases in loan delinquencies
and default rates.
These could affect our earnings and credit quality.
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●
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 inflation and higher market
interest rates
We adopted
CECL on January 1, 2023 as required by generally accepted accounting principles
(“GAAP”).
CECL changed the loss model to take into account current expected credit losses in
place of the
incurred loss method used historically under GAAP.
This changes the process we use to estimate losses inherent
in our credit exposures.
The process for estimating expected losses 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.
Changes in economic conditions and factors
used in our CECL models may increase the variability of our provisions for loan losses and
our earnings.
●
Although we had no assets or liabilities that use LIBOR reference rates at the end
of 2022,
the end of the LIBOR
reference rate, scheduled for most tenors by June 30, 2023, could adversely affect
our counterparties and financial
markets.
Nonperforming and similar assets take significant time to resolve
and may adversely affect our results of operations
and
financial condition.
Our nonperforming loans were 0.54% of total loans as of December 31,
2022, and we had $2.7 million in other real estate
owned as result of foreclosures or otherwise in full or partial payments in respect of loans (“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 and the shift beginning in March 2022
from an extraordinarily expansionary
monetary policies to a tightening monetary policy to fight inflation, loan
modifications and deferrals, market conditions or
events adversely affecting specific customers, industries or markets,
including disruptions of supply chains and the war in
Ukraine, and changes in borrower behaviors.
Certain borrowers and their businesses and real estate and commercial
projects and businesses may be adversely affected by inflation
and higher interest rates, and economic slowdowns arising
from tighter monetary policies.
Various
businesses will be unable to fully pass on increased costs due to inflation, and their
profits may shrink.
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
expected future loan losses, is effective for the Company beginning January
1, 2023, and its effects upon the Company have
not yet been determined.
The CECL model incorporates various economic condition elements,
where changes in fiscal and
monetary policy, as well as
market interest rates, could result in more volatility in our provisions for loan losses under
CECL, which could adversely affect our net income.
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Changes in the real estate markets, including the
secondary market for residential mortgage loans, may continue
to
adversely affect us.
Beginning in March 2022, inflation and the Federal monetary policies to increase interest rates
to fight inflation have
caused mortgage rates to increase significantly.
Higher interest rates and the increased level of housing costs as a result
of
the COVID-19 pandemic, have caused housing starts and sales to slow.
House prices have begun to decline in certain
markets from their earlier highs.
This adversely affects our mortgage loan productions and the value of residential
mortgage collateral.
Commercial real estate projects economic assumptions may be adversely affected,
and certain projects
with short term and/or unhedged variable rate debt may be especially affected
by increased interest rates and a slower
economy.
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.
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 Fannie Mae, a government sponsored entity (‘GSE”) and other GSEs and
government agencies.
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.
The effects of reduced housing starts and mortgage activity due to
higher market interest rates, have decreased our
generation of new mortgage loans and related MSRs.
This may be offset by decreases in mortgage prepayments and
refinancings, and corresponding increases in the duration of our existing MSRs and their
values.
This net effect could
reduce our aggregate 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.
The Basel III Rules relating to MSRs may also increase the
potential capital required as a result of MSRs, when considered with other capital rule adjustments
and deductions.
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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.
Most
LIBOR reference interest rates used by many financial institutions to price
extensions of credit will no longer be quoted
beginning June 30, 2023 and their use has been strongly discouraged by regulatory agencies.
Most banks did not adopt
CECL until January 1, 2023.
These changes, together with any exposures other institutions may have
to crypto or digital
assets, could cause disruption and unexpected changes in the industry.
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 the 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
40.4%
of our portfolio in CRE loans at year-end 2022
compared to 42.6% at year-end 2021.
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.
Increases in interest rates beginning
in March 2022 may adversely affect the assumptions and performance
of CRE, and the ability of borrowers to refinance on
terms that CRE borrowers and their projects can support.
Lower demand for CRE, and reduced availability of, and higher
interest rates and costs for, CRE loans could adversely affect
our CRE loans and sales of our OREO, and therefore our
earnings and financial condition, including our capital and liquidity.
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.
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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
effects of higher market interest rates and inflation, supply chain disruptions,
changes in customer behaviors and in the
workforce and demand for space since the COVID-19 pandemic, and the timing and
magnitude of future inflation and
interest rates, 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 and housing
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, including loan 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.
The regulatory agencies are carefully scrutinizing financial institution
mergers, and
the merger application process has lengthened.
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, data breaches and anti-money laundering and other
potential violations of law. 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, payments,
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 and
similar situations may occur in the future.
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 timely 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, including the new CECL models, are based on assumptions and
projections. These models may not operate
properly or our inputs and assumptions may be inaccurate, or changes in economic and
market conditions, customer
behaviors or regulations.
As a result, these methods may not fully or timely predict future exposures,
which can be
significantly greater and/or faster 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,