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,
2024 and 2023 and our results of operations for
the years ended December 31, 2024 and 2023. 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”.
This includes
Table 2 “Selected
Financial Data.”
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 a loan production office in
Phenix City,
Alabama.
Summary of Results of Operations
Year ended December 31
(Dollars in thousands, except per share data)
2024
2023
Net interest income (a)
$
27,204
$
26,745
Less: tax-equivalent adjustment
79
417
Net interest income (GAAP)
27,125
26,328
Noninterest income
3,474
(2,981)
Total revenue
30,599
23,347
Provision for credit losses
36
135
Noninterest expense
22,166
22,594
Income tax expense (benefit)
2,000
(777)
Net earnings
$
6,397
$
1,395
Basic and diluted net earnings per share
$
1.83
$
0.40
(a) Tax-equivalent.
See "Table 1 - Explanation of Non-GAAP Financial Measures".
Financial Summary
The Company’s net earnings were
$6.4 million for the full year 2024, compared to $1.4 million for the full year 2023.
Basic and diluted net earnings per share were $1.83 per share for the full year 2024,
compared to $0.40 per share for the full
year 2023.
Net earnings for 2023 reflected the sale of $117.6 million
of available-for-sale securities for an after-tax loss of
$(4.7) million, or $(1.35) per share related to the Company’s
balance sheet repositioning strategy in December 2023.
Excluding this non-routine item, net earnings for the full year 2023
would have been $6.1 million, or $1.75 per share.
Net interest income (tax-equivalent) was $27.2 million in 2024, a
2% increase compared to $26.7 million in 2023. This
increase was primarily due to improved net interest margin.
The Company’s net interest margin
(tax-equivalent) was
3.06% in 2024, compared to 2.89% in 2023.
The increase in net interest margin (tax-equivalent) was primarily
due to loan
growth and the December 2023 balance sheet repositioning, which resulted
in a more favorable asset mix and higher yields
on interest-earning assets in 2024.
Average loans for 2024 were $568.7
million, a 9% increase from 2023.
At December 31, 2024, the Company’s
allowance for credit losses was $6.9 million, or 1.22% of total loans, compared to
$6.9 million, or 1.23% of total loans, at December 31, 2023.
Although the balance of the allowance for credit losses was
largely unchanged, the decrease in the allowance for credit
losses as a percentage of total loans was primarily due to
improved economic forecasts.
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59
The Company recorded a provision for credit losses of $36 thousand
in 2024 compared to $135 thousand during 2023.
The
provision for credit losses under CECL is reflective of the Company’s
credit risk profile and the future economic outlook
and forecasts. Our CECL model is largely influenced by economic
factors including, most notably,
the anticipated
unemployment rate.
Noninterest income was $3.5 million in 2024 compared to a loss of $3.0
million in 2023.
Excluding the pre-tax securities
loss of $6.3 million related to the balance sheet repositioning strategy in 2023,
noninterest income would have been $3.3
million for 2023.
Noninterest expense was $22.2 million in 2024 compared to $22.6
million in 2023.
This decrease in noninterest expense
reflects decreases in net occupancy and equipment expenses of $0.4
million, professional fees expense of $0.1
million,
other noninterest expense of $0.2 million.
These decreases were partially offset by increases in salaries and benefits
expense of $0.4
million.
The provision for income taxes expense was $2.0 million for an effective
tax rate of 23.82% for 2024, compared to a tax
benefit of $0.8 million for a negative effective tax rate of (125.73)%
for 2023.
The Company’s effective
income tax rate is
affected principally by tax-exempt earnings from the Company’s
investments in municipal securities, bank-owned life
insurance, and New Markets Tax
Credits.
The effective tax rate increased primarily due to a decrease in the Company’s
investment in municipal securities following the balance sheet restructuring
in the fourth quarter of 2023, and the adoption
of FASB ASU 2023-02
Investments – Equity Method and Joint Ventures
(Topic323) which allows the
proportional
amortization method for our NMTC investments, on January 1, 2024.
With the adoption of this ASU, amortization of
NMTCs are now included in income tax expense rather than noninterest
expense.
Additionally, the provision
for income
tax expense and the effective tax rates for 2024 included discrete tax
items associated with provision to return adjustments
in conjunction with the final 2023 tax return filing and the resolution of state examination
activities, which resulted in
additional tax expense.
The Company paid cash dividends of $1.08 per share in 2024, unchanged
from 2023. At December 31, 2024, 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 15.81%, a tier 1 leverage ratio of
10.49% and common equity tier 1 or
(CET1) of 14.80% at December 31, 2024.
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 credit losses, recurring and
non-recurring fair value measurements, and the valuation of deferred tax assets, were critical
to the determination of our
financial position and results of operations.
Allowance for Credit Losses – Loans
The allowance for credit losses is estimated under the CECL methodology set forth
in FASB ASC 326. The allowance
for
credit losses reflects management’s
estimate of the amount of credit losses expected to be recognized over
the remaining
life of the loans in our portfolio. This evaluation requires significant management
judgment and is based upon relevant
available information related to historical default and loss experience,
current and projected economic conditions, and other
portfolio-specific and environmental risk factors. Losses are predicted
over a reasonable and supportable forecast period,
and at the end of the reasonable and supportable period losses revert to long term historical
averages. The allowance for
credit losses is measured on a collective basis for pools of loans with similar risk characteristics,
and on an individual basis
for loans that do not share similar risk characteristics with the collectively evaluated
pools. There are factors beyond our
control, such as changes in projected economic conditions, real estate markets
or particular industry conditions which may
materially impact asset quality and the adequacy of the allowance for credit
losses and thus the resulting provision for credit
losses. The allowance is adjusted through provision for credit losses and decreased
by charge-offs, net of recoveries of
amounts previously charged-off. See Note
1 - Summary of Significant Accounting Policies and Note 5 - Loans and
Allowance for Credit Losses in the notes to our consolidated financial statements
in this report.
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60
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 1 - Summary of Significant Accounting Policies and Note
13, Fair Value
in the notes to 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.
Deferred Tax
Asset Valuation
A valuation allowance is recognized for a deferred tax asset if, based on the weight of
available evidence, it is more-likely-
than-not that some portion or the entire deferred tax asset will not be realized.
The ultimate realization of deferred tax assets
is dependent upon the generation of future taxable income during the periods
in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred
tax liabilities, projected future taxable income and tax
planning strategies in making this assessment. At December 31,
2024 we had total deferred tax assets of $10.2 million
included as “other assets”, including $9.9 million resulting from unrealized
losses in our securities portfolio.
Based upon
the level of taxable income over the last three years and projections for future
taxable income over the periods in which the
deferred tax assets are deductible, management believes it is more likely
than not that we will realize the benefits of these
deductible differences at December 31, 2024.
The amount of the deferred tax assets considered realizable, however,
could
be reduced if estimates of future taxable income are reduced.
See Note 1 - Summary of Significant Accounting Policies
and Note 10 – Income Taxes
in the notes to the consolidated financial statements that accompany this report.
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61
Average Balance
Sheet and Interest Rates
Year ended December 31
2024
2023
Average
Yield/
Average
Yield/
(Dollars in thousands)
Balance
Rate
Balance
Rate
Loans and loans held for sale
$
568,733
5.23%
$
523,838
4.76%
Securities - taxable
248,072
2.19%
335,366
2.15%
Securities - tax-exempt (a)
10,084
3.70%
52,122
3.81%
Total securities
258,156
2.25%
387,488
2.37%
Federal funds sold
17,907
5.24%
5,221
4.79%
Interest bearing bank deposits
44,634
5.23%
8,593
4.92%
Total interest-earning
assets
889,430
4.36%
925,140
3.76%
Deposits:
NOW
192,702
1.39%
193,451
0.99%
Savings and money market
251,778
0.86%
289,235
0.74%
Certificates of deposit
195,097
3.46%
175,085
2.25%
Total interest-bearing
deposits
639,577
1.81%
657,771
1.21%
Short-term borrowings
628
0.48%
3,255
2.21%
Total interest-bearing
liabilities
640,205
1.81%
661,026
1.22%
Net interest income and margin (a)
$
27,204
3.06%
$
26,745
2.89%
(a) Tax-equivalent.
See "Table 1 - Explanation
of Non-GAAP Financial Measures".
RESULTS
OF OPERATIONS
Net Interest Income and Margin
Net interest income (tax-equivalent) was $27.2 million in 2024, a
2% increase compared to $26.7 million in 2023. This
increase was primarily due to improved net interest margin.
The Company’s net interest margin
(tax-equivalent) was
3.06% in 2024, compared to 2.89% in 2023.
The increase in net interest margin (tax-equivalent) was primarily
due to loan
growth and the balance sheet repositioning strategy the Company
completed in the fourth quarter of 2023, which resulted in
a more favorable asset mix and higher yields on interest-earning assets in 2024.
This was partially offset by higher market
interest rates, which increased our cost of funds, generally,
and changes in our deposit mix to higher cost interest-bearing
deposits.
The tax-equivalent yield on total interest-earning assets increased by
60 basis points to 4.36% in 2024 compared to 3.76%
in 2023.
Average loans for 2024
were $568.7 million, a 9% increase from 2023.
The cost of total interest-bearing liabilities increased by 59 basis points to 1.81%
in 2024 compared to 1.22% in 2023.
Average interest-bearing
deposits were $639.6 million during 2024, a 3% decrease compared to $657.8 million
during
2023.
As of December 31, 2024, average interest-bearing deposits were 71% of average
total deposits compared to 69% on
December 31, 2023.
Since March 2022, the Federal Reserve increased the target
federal funds rate by 525 basis points
before announcing a 50-basis points rate reduction on September 18, 2024,
its first decrease in rates since its March 2020
COVID rate reduction,
followed by two 25 basis points reduction in October and December 2024.
At year end the target
federal funds rate ranged from 4.25% - 4.50%.
The Company continues to deploy various asset liability management
strategies to manage its risk from interest rate
fluctuations.
Deposit and loan pricing remains competitive in our markets.
We believe
that interest rates, inflation and
monetary policy may continue to fluctuate in 2025 and may be challenging
as a result.
Our ability to compete and manage
our deposits costs until our interest-earning assets reprice and we generate
new fixed rate loans with current market interest
rates will be important to our net interest margin during
2025.
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62
Provision for Credit Losses
The provision for credit losses represents a charge to
earnings necessary to establish an allowance for credit losses that, in
management’s evaluation,
is adequate to provide coverage for all expected credit losses.
The Company recorded a
provision for credit losses of $36 thousand during 2024, compared to $135
thousand for 2023.
Provision for credit losses
expense is affected by growth in our loan portfolio, our
internal assessment of the credit quality of the loan portfolio, our
expectations about future economic conditions and net charge-offs.
Our CECL model is largely influenced by economic
factors including, most notably,
the anticipated unemployment rate, which may be affected by monetary
policy.
Our allowance for credit losses reflects an amount we believe appropriate,
based on our allowance assessment
methodology, to adequately
cover all expected credit losses as of the date the allowance is determined.
At December 31,
2024, the Company’s allowance for
credit losses was $6.9
million, or 1.22% of total loans, compared to $6.9 million, or
1.23% of total loans, at December 31, 2023.
Although the balance of the allowance for credit losses was largely
unchanged, the decrease in the allowance for credit losses as a percentage of total
loans was primarily due to improved
economic forecasts.
Noninterest Income
Year ended December 31
(Dollars in thousands)
2024
2023
Service charges on deposit accounts
$
614
$
603
Mortgage lending
608
430
Bank-owned life insurance
403
411
Securities losses, net
—
(6,295)
Other
1,849
1,870
Total noninterest income
$
3,474
$
(2,981)
The Company’s noninterest income
from mortgage lending is primarily attributable to the (1) origination and sale of
new
mortgage loans and (2) servicing of mortgage loans. Origination income, net,
is comprised of gains or losses from the sale
of the mortgage loans originated, origination fees, underwriting fees and other
fees associated with the origination of
mortgage loans, which are netted against the commission expense associated
with these originations. The Company’s
normal practice is to originate mortgage loans for sale in the secondary market
and to either sell or retain the MSRs when
the loan is sold.
MSRs are recognized based on the fair value of the servicing right on
the date the corresponding mortgage loan is sold.
Subsequent to the date of transfer, the Company
has elected to measure its MSRs under the amortization method.
Servicing
fee income is reported net of any related amortization expense.
The Company evaluates MSRs for impairment quarterly.
Impairment is determined by grouping MSRs by common
predominant characteristics, such as interest rate and loan type.
If the aggregate carrying amount of a particular group of
MSRs exceeds the group’s aggregate
fair value, a valuation allowance for that group is established.
The valuation
allowance is adjusted as the fair value changes.
An increase in mortgage interest rates typically results in an increase in the
fair value of the MSRs while a decrease in mortgage interest rates typically results in
a decrease in the fair value of MSRs.
The following table presents a breakdown of the Company’s
mortgage lending income for 2024 and 2023.
Year ended December 31
(Dollars in thousands)
2024
2023
Origination income
$
261
$
71
Servicing fees, net
347
359
Total mortgage lending
income
$
608
$
430
The Company’s income from mortgage
lending typically fluctuates as mortgage interest rates change and is primarily
attributable to the origination and sale of new mortgage loans.
The increase in mortgage lending income was primarily
related to the Company increasing the number of mortgage loans originated
for sale during 2024 relative to the number of
mortgage loans originated and held for investment during 2023.
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63
Income from bank-owned life insurance was $403 thousand and
$411 thousand for 2024 and 2023 respectively.
Excluding
a $52 thousand non-taxable death benefit received during the first quarter of
2023, income from bank-owned life insurance
would have been $359 thousand for 2023.
Securities losses, net for 2023 were related to the Company selling approximately
$117.6 million of its available-for-sale
securities, resulting in a net loss of approximately $6.3 million as part of its balance
sheet repositioning strategy.
Noninterest Expense
Year ended December 31
(Dollars in thousands)
2024
2023
Salaries and benefits
$
12,534
$
12,101
Net occupancy and equipment
2,508
2,954
Professional fees
1,188
1,299
FDIC and other regulatory assessments
564
631
Other
5,372
5,609
Total noninterest expense
$
22,166
$
22,594
Salaries and benefits increased during 2024 compared to 2023 primarily due
to routine annual increases in salaries and
wages.
The decrease in net occupancy and equipment expense was primarily
due to an increase in leasing income.
The decrease in other noninterest expense was primarily due to the Company’s
adoption of ASU 2023-02 which allows the
proportional amortization method for our NMTC investments, on January
1, 2024.
With the adoption of this ASU,
amortization of NMTCs are now included in income tax expense.
During 2023 other noninterest expense included $0.4
million related to our equity method investment in NMTCs.
This decrease was partially offset by various increases in other
noninterest expense accounts during 2024.
Income Tax
Expense
The provision for income taxes expense was $2.0 million for an effective
tax rate of 23.82% for 2024, compared to a tax