Auburn National Bancorporation(AUBN) - 2021 Q4 - Annual Report

PART I Business Overview Auburn National Bancorporation, Inc. operates through AuburnBank, offering diverse financial services in East Alabama, subject to extensive regulation and market competition General The Company is a Delaware-incorporated bank holding company, controlling AuburnBank, an Alabama state member bank - Auburn National Bancorporation, Inc. (Company) is a Delaware-incorporated bank holding company, registered with the Federal Reserve, controlling AuburnBank, an Alabama state member bank operating since 1907 in East Alabama[9][10] Services AuburnBank offers a comprehensive suite of banking services, including various deposit and loan products, and online banking - AuburnBank provides a comprehensive suite of banking services, including checking, savings, transaction deposit accounts, certificates of deposit, residential mortgages, commercial, financial, agricultural, real estate construction, and consumer loan products, alongside extensive ATM and online banking services[13] Competition The East Alabama banking market is highly competitive, with the Bank competing against larger regional and national institutions - The East Alabama banking market is highly competitive, with the Bank competing against larger regional and national institutions, credit unions, mortgage companies, insurance companies, and non-bank financial service providers, many of whom possess greater resources and broader service offerings[14][15] Selected Economic Data Lee County and the Auburn-Opelika MSA experienced significant population growth, with major employers including Auburn University - Lee County's population grew by approximately 24.2% from 2010 to 2020, with the Auburn-Opelika MSA growing 23.9% in the same period, making it Alabama's second-fastest-growing MSA. Major employers include Auburn University and East Alabama Medical Center, with auto manufacturing also gaining importance[16] Auburn-Opelika MSA Economic Forecast | Indicator | 2022-2027 Forecasted Growth | 2027 Estimated Value | | :--- | :--- | :--- | | Population | 6.73% | - | | Household Income | 13.34% | $67,593 | Loans and Loan Concentrations The Bank offers diverse loans, managing risks through underwriting standards and monitoring economic conditions - The Bank offers diverse loans, including commercial, financial, agricultural, real estate mortgages, construction, and consumer purposes, with management acknowledging higher risks in commercial, real estate acquisition, construction, development, agricultural, and consumer lending compared to residential mortgages[17] - Underwriting standards are applied individually and monitored periodically, focusing on economic conditions, borrower financial strength, repayment capacity, collateral, and credit performance to manage risks[17] - While the local economy benefits from diversified industries, including auto manufacturing, cyclical downturns or interest rate increases could adversely affect local spending and employment, though management believes diversification mitigates widespread impact[18] Human Capital The Company employs 152 full-time equivalents, prioritizing competitive compensation, internal promotions, and employee well-being - As of December 31, 2021, the Company had 152 full-time equivalent employees, including 39 officers, with an average term of service of approximately 10 years, indicating strong employee retention[19][20] - The Company prioritizes competitive compensation and benefits, internal promotions, ongoing performance development, and encourages employee community involvement[20] - In response to COVID-19, the Company implemented remote work options and limited branch lobby services to protect employee health while ensuring essential banking services[19] Supervision and Regulation The Company and Bank are extensively regulated by federal and state laws, with supervision aimed at maintaining safety and soundness - The Company and Bank are extensively regulated by federal and state laws, with supervision primarily aimed at maintaining the safety and soundness of depository institutions and protecting depositors, rather than shareholders[22] - The Company, as a bank holding company, is supervised by the Federal Reserve, subject to the BHC Act, which limits activities to banking and related services and requires prior approval for significant acquisitions[23][24] - The Bank, as a state member bank, is regulated by the Federal Reserve and the Alabama Superintendent, with its deposits insured by the FDIC, and is subject to various regulations covering operations, capital adequacy, and compliance[31] Bank Holding Company Regulation The Company is supervised by the Federal Reserve, limiting activities to banking and requiring prior approval for acquisitions - The Company is supervised by the Federal Reserve under the BHC Act, limiting its activities to banking and related services, and requiring prior approval for significant acquisitions[23][24] - Bank holding companies are required to act as a source of financial and managerial strength for their FDIC-insured subsidiaries, potentially necessitating additional investments in distressed bank subsidiaries[29] - The Company is eligible for treatment as a small banking holding company under the Small BHC Policy, meaning its capital adequacy is evaluated on a bank-only basis[30] Bank Regulation AuburnBank is regulated by the Federal Reserve and Alabama Superintendent, with deposits insured by the FDIC, subject to comprehensive oversight - AuburnBank is a state member bank regulated by the Federal Reserve and the Alabama Superintendent, with its deposits insured by the FDIC, and is subject to comprehensive oversight of its operations, capital, and compliance[31] - The Federal Reserve uses the confidential 'CAMELS' rating system to assess financial institutions' Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to market risk[32] - The Gramm-Leach-Bliley Act and related regulations mandate privacy policies for banks and affiliates, governing the collection, safeguarding, sharing, and use of customer information, with state laws also requiring data security and breach notifications[33][34] Community Reinvestment Act and Consumer Laws The Bank must comply with CRA and fair lending laws, addressing community credit needs and consumer protection - The Bank is subject to the CRA, requiring it to meet community credit needs, including low- and moderate-income neighborhoods, with CRA assessments impacting expansion activities and financial holding company eligibility[35] - The Bank must comply with fair lending laws like ECOA and the Fair Housing Act, prohibiting discrimination in credit transactions, with violations potentially leading to enforcement actions or litigation[37] - The CFPB has a broad mandate to regulate consumer financial products and services, affecting banks of all sizes through its regulations, enforcement actions, and interpretations, particularly concerning overdrafts and small-dollar lending[38][39] Residential Mortgages CFPB regulations require lenders to assess repayment ability for mortgage loans, with specific rules for 'qualified mortgages' - CFPB regulations require lenders to assess a consumer's ability to repay mortgage loans, establishing criteria for 'qualified mortgages' to provide safe harbors from liability[40] - The 2018 Growth Act provides that certain residential mortgages held in portfolio by banks with less than $10 billion in consolidated assets are automatically deemed 'qualified mortgages,' easing regulatory burdens for smaller institutions[41] - The CARES Act and subsequent extensions allowed borrowers of Fannie Mae-sold residential mortgages to request forbearance due to COVID-19 hardships, with the Bank, as servicer, not obligated to advance principal and interest during forbearance[45][46] Anti-Money Laundering and Sanctions Financial institutions are subject to 'know your customer' and anti-money laundering requirements under federal acts - Financial institutions are subject to 'know your customer' requirements under the International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001 and enhanced due diligence under the USA PATRIOT Act[48][49] - The USA PATRIOT Act mandates anti-money laundering programs with pillars including internal policies, compliance officers, training, independent audits, and ongoing customer due diligence[49] - The AML Act of 2020 strengthens anti-money laundering and countering terrorism financing programs by specifying beneficial ownership disclosure, increasing penalties, modernizing systems, and emphasizing information sharing[52][53] Other Laws and Regulations The Company must comply with corporate governance and financial reporting requirements, including internal controls - The Company must comply with corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, including annual reporting on internal controls[54] - Compliance with internal control rules is time-consuming and costly; failure could adversely affect reputation, financial statement certifications, regulatory relations, and access to capital markets[55] Payment of Dividends and Repurchases of Capital Instruments The Company's cash source is Bank dividends, restricted by regulatory approvals and capital policies - The Company's primary cash source is dividends from the Bank, which are restricted by regulatory approval requirements if total annual dividends exceed the sum of current year's net profits and retained net profits for the preceding two years[56] - At December 31, 2021, the Bank could have declared approximately $8.3 million in additional dividends without prior regulatory approval[56] - Federal Reserve policy requires prior consultation for redemptions or repurchases of capital instruments during financial weakness or if common/perpetual preferred stock reductions impact Tier 1 capital[57] Regulatory Capital Changes Federal bank regulators simplified capital rules and introduced new risk weightings and leverage ratio frameworks - Federal bank regulators simplified capital rules, effective April 1, 2020, by decreasing deductions from capital for certain items like temporary difference DTAs and MSAs, and allowing institutions to elect how to treat investments in unconsolidated subsidiaries[60] - New rules define 'high volatility commercial real estate' (HVCRE) loans, requiring a 150% risk weight for such loans, which finance the acquisition, development, or construction of income-producing real property[61][62] - An optional community banking leverage ratio framework, effective January 1, 2020, allows qualifying institutions with less than $10 billion in assets and a leverage ratio greater than 9% to use a single capital measure, potentially reducing regulatory burdens[63][64] Capital Federal Reserve guidelines require minimum capital ratios for bank holding companies and state member banks, including a capital conservation buffer - The Federal Reserve's risk-based capital guidelines require a minimum capital to risk-weighted assets ratio of 10.5% (including a 2.5% capital conservation buffer) and a minimum Tier 1 leverage ratio of 4% for bank holding companies and state member banks[65][66] - Tier 1 capital primarily includes common equity and retained earnings, while Tier 2 capital comprises non-qualifying preferred stock, subordinated debt, and a limited amount of general loan loss allowance[65] - The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) mandates 'prompt corrective action' for depository institutions failing to meet minimum capital requirements, establishing five capital tiers from 'well capitalized' to 'critically undercapitalized'[67] Basel III Capital Rules Basel III introduced Common Equity Tier I Capital and a capital conservation buffer, impacting capital distributions - The Basel III Capital Rules, fully phased-in by January 1, 2019, introduced 'Common Equity Tier I Capital' (CET1) and a new capital conservation buffer of 2.5% of total risk-weighted assets[68][71] - CET1 includes common stock, retained earnings, and minority common equity interests, with deductions for goodwill, other intangibles, and certain deferred tax assets[69] - The capital conservation buffer limits permissible dividends, stock repurchases, and discretionary bonuses if a bank's capital ratios fall below specified thresholds[72] Changes in Risk-Weightings Basel III significantly altered risk weightings for MSRs, DTAs, and HVCRE loans, with CECL impacting loan loss models - Basel III Capital Rules significantly altered risk weightings, applying a 250% risk-weighting to MSRs, certain DTAs, and significant investments in other financial institutions, and a 150% risk-weight to 'high volatility commercial real estate loans' (HVCRE)[76][77] - The 2018 Growth Act restricts the application of the 150% HVCRE risk weight to specific ADC loans, potentially reducing the Company's risk-weighted assets and increasing its risk-weighted capital[78] - The CECL accounting standard, effective for the Company on January 1, 2023, will change the loan loss model to a forward-looking approach, potentially impacting results of operations and regulatory capital[79] Prompt Corrective Action Rules FDICIA mandates prompt corrective action for institutions failing capital requirements, establishing five capital tiers - FDICIA establishes 'prompt corrective action' standards with five capital tiers ('well capitalized' to 'critically undercapitalized') based on total risk-based, Tier 1 risk-based, Common Equity Tier 1, and leverage capital ratios[80][81] - Institutions categorized as 'undercapitalized' face growth limitations and must submit capital restoration plans, with parent holding companies guaranteeing performance up to 5% of the bank's assets[82][83] - The 2018 Growth Act allows banks and bank holding companies with less than $10 billion in assets meeting a 'community bank leverage ratio' (8-10%) to be deemed 'well capitalized,' simplifying capital requirements[85][86] FDICIA FDICIA mandates federal bank regulatory agencies to prescribe standards for internal controls, audit systems, and credit underwriting - FDICIA mandates federal bank regulatory agencies to prescribe standards for depository institutions regarding internal controls, information systems, audit systems, loan documentation, credit underwriting, interest rate exposure, and asset growth composition[87] Enforcement Policies and Actions Violations of laws or unsafe practices can lead to regulatory fines, penalties, and enforcement actions - Violations of laws and regulations or unsafe practices can lead to fines, penalties, cease and desist orders, or other enforcement actions by regulatory agencies, potentially targeting officers, directors, and employees[88] Fiscal and Monetary Policy Company earnings are influenced by economic conditions and Federal Reserve monetary policy, particularly interest rates - The Company's earnings and growth are significantly influenced by general economic conditions and the monetary and fiscal policies of the U.S. government and the Federal Reserve, particularly through interest rate differentials[89] - In response to COVID-19, the Federal Reserve significantly reduced the Federal Funds rate target to 0-0.25% and implemented liquidity facilities, but is now considering increasing the discount rate and reducing securities holdings due to inflation[92] - The CARES Act and Economic Aid Act provided substantial fiscal stimulus, including the Paycheck Protection Program (PPP), to mitigate COVID-19's economic impact, but future monetary policy changes and their effects remain unpredictable[93][94] FDIC Insurance Assessments The Bank's deposits are FDIC-insured, subject to assessments based on financial ratios and CAMELS ratings - The Bank's deposits are insured by the FDIC's Deposit Insurance Fund (DIF), and it is subject to FDIC assessments, which are calculated using a 'financial ratios method' based on CAMELS composite ratings for small established institutions[95][96] - The FDIC's reserve ratio reached 1.36% in September 2018, exceeding the minimum, leading to the cessation of surcharges on large banks and credits for smaller banks; however, the ratio declined to 1.30% in mid-2020 due to deposit growth, prompting a restoration plan[98][99] FDIC Initial Base Assessment Rates (2020) | CAMELS Composite Rating | Initial Base Assessment Rate (Basis Points) | | :--- | :--- | | 1 or 2 | 3 to 16 | | 3 | 6 to 30 | | 4 or 5 | 16 to 30 | Lending Practices Federal agencies issued guidance on commercial real estate lending concentrations, requiring enhanced risk management - Federal bank regulatory agencies issued guidance on 'Concentrations in Commercial Real Estate Lending' (CRE), defining CRE loans and requiring enhanced risk management practices for banks with significant concentrations[100][101] - At December 31, 2021, the Bank's construction and land development loans ($32.4 million) and total CRE loans (excluding owner-occupied, $229.8 million) represented 30.8% and 218.5% of its total risk-based capital, respectively, but the Guidance did not apply to the Bank's CRE lending activities in 2020 or 2021[103] - The Bank did not have any leveraged loans or shared national credits subject to the Interagency Guidance on Leveraged Lending at year-end 2021 or 2020[105] Other Dodd-Frank Act Provisions Dodd-Frank mandates shareholder 'say on pay,' pay ratio disclosures, and prohibits inappropriate incentive compensation - The Dodd-Frank Act mandates shareholder 'say on pay' for executive compensation, disclosure of pay ratios, and requires companies to adopt claw-back policies for incentive-based compensation in case of accounting restatements[106][108][109] - Section 956 of the Dodd-Frank Act prohibits incentive-based compensation arrangements that encourage inappropriate risk-taking by covered financial institutions, with federal bank regulators issuing guidance on sound incentive compensation policies[111][112] - The 'Durbin Amendment' to the Dodd-Frank Act, regulating debit card interchange fees, is not applicable to banks with assets less than $10 billion[113] Other Legislative and Regulatory Changes Recent legislative changes provide regulatory relief for community banks and address COVID-19 related growth - The Biden Administration has initiated changes in bank regulation and corporate tax, including rescinding previous executive orders and focusing on promoting competition, which may affect bank mergers and crypto asset regulation[114][115] - The 2018 Growth Act amended the Dodd-Frank Act, providing regulatory relief for community banks by increasing the small BHC asset threshold to $3 billion, exempting qualifying community banks from the Volcker Rule, and reclassifying reciprocal deposits[116] - Federal bank regulators issued temporary relief for community banks with less than $10 billion in assets, allowing them to use asset data from December 31, 2019, to determine regulatory thresholds for 2020 and 2021 due to COVID-19 related growth[120] Risk Factors The Company faces significant risks across operational, financial, legal, regulatory, and COVID-19 related domains - The COVID-19 pandemic, extraordinary monetary/fiscal stimulus, and market volatility (unemployment, inflation, stock/bond markets) continue to disrupt the economy, affecting consumer confidence, economic activity, and potentially increasing loan delinquencies and defaults[123][124] - The Company's profitability and liquidity are highly sensitive to changes in interest rates, economic conditions, and the shape of the yield curve, with lower rates potentially reducing net interest income and higher rates affecting loan demand and collateral values[162][163][164] - The ongoing COVID-19 pandemic poses significant risks, including adverse effects on employee health, operational effectiveness, loan demand, credit quality, collateral values, and potential increases in loan losses, with the ultimate impact remaining uncertain[185][188][189] Operational Risks The Company faces operational risks from market cyclicality, nonperforming assets, real estate market changes, and technological disruptions - Market conditions and economic cyclicality, including the ongoing COVID-19 pandemic, inflation, and interest rate changes, can adversely affect the Company's industry, consumer confidence, and credit quality[123][124] - Nonperforming assets, though low at 0.10% of total loans as of December 31, 2021, require significant time to resolve, incur higher administration costs, and can negatively impact net income and financial condition[127] - The Company faces risks from rapid technological changes, requiring significant investments in new products, services, and cybersecurity, with larger competitors often having greater resources for such advancements[145] Financial Risks The Company's financial risks include deferred tax asset realization, increased cost of funds, interest rate fluctuations, and capital adequacy - The Company's ability to realize its deferred tax assets may be reduced if future taxable income estimates are not met, and net operating loss carry-forwards could be reduced by sales of capital securities[159][160] - Profitability and liquidity are highly sensitive to changes in interest rates, economic conditions, and the yield curve, with a flattening yield curve potentially pressuring net interest margin[162][163] - An inability to raise funds through deposits, borrowings, or asset sales could negatively affect liquidity, while excess liquidity may reduce returns on assets and equity[166][167] Legal and Regulatory Risks Extensive federal and state regulation, capital requirements, and potential litigation pose significant legal and regulatory risks - The Company is a separate legal entity from the Bank, relying on Bank dividends for liquidity, which are limited by law and regulatory policies[173] - Extensive federal and state regulation, primarily intended to protect depositors, can limit the Company's activities, increase compliance costs, and adversely affect earnings[174][175] - Failure to meet regulatory capital requirements, including Basel III capital conservation buffers, could adversely affect customer confidence, growth, funding costs, and the ability to pay dividends or make acquisitions[177][178][179] COVID-19 Risks The COVID-19 pandemic continues to pose substantial risks to asset quality, credit losses, and overall business operations - The COVID-19 pandemic continues to adversely affect the Company's business, financial condition, and operations through impacts on employee health, operational effectiveness, loan demand, credit quality, and collateral values[185][188][189] - The pandemic has led to supply chain disruptions, labor shortages, increased housing prices, and inflation, prompting the Federal Reserve to consider raising interest rates[188] - As a participating lender in the Paycheck Protection Program (PPP), the Bank faces risks of litigation regarding loan processing and the possibility that the SBA may not fully fund loan guaranties due to deficiencies[191][192][193] Unresolved Staff Comments The Company has no unresolved staff comments from the SEC - There are no unresolved staff comments[195] Properties The Bank operates from its main office, seven full-service branches, and loan production offices in East Alabama - The Bank conducts business from its main office, seven full-service branches, and loan production offices in Auburn and Phenix City, Alabama[195] - Phase I of the main campus redevelopment plan, including a new 90,000 sq ft headquarters (AuburnBank Center) and a 500-space parking deck, commenced in H2 2020. The parking deck was completed in April 2021, and the headquarters is expected in Q2 2022[197] - In February 2022, the Company agreed to sell an adjoining 0.85-acre parcel to a hotel developer, expecting this sale to be accretive to 2022 earnings by approximately $0.70 per share upon closing[198] Legal Proceedings The Company and the Bank are involved in routine legal proceedings, but management believes no pending or threatened actions will have a material adverse effect on their financial condition or results of operations - The Company and the Bank are involved in legal proceedings in the normal course of business, but management believes no pending or threatened legal proceedings are expected to have a material adverse effect on their financial condition or results of operations[207] Mine Safety Disclosures This item is not applicable to the Company - Mine Safety Disclosures are not applicable to the Company[208] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The Company's Common Stock trades on the Nasdaq Global Market under 'AUBN', with a history of cash dividends and recent share repurchases - The Company's Common Stock is listed on the Nasdaq Global Market under the symbol 'AUBN', with 3,516,971 shares outstanding held by approximately 369 shareholders of record as of March 7, 2022[208] - The Company has paid cash dividends since 1985 and intends to continue its present dividend policies, determined by the Board based on earnings, financial condition, capital requirements, and regulatory restrictions[209][210] Issuer Purchases of Equity Securities in Q4 2021 | Period | Total Shares Purchased | Average Price Per Share | | :--- | :--- | :--- | | October 1 – October 31, 2021 | 1,684 | $33.85 | | November 1 – November 30, 2021 | 7,169 | $33.85 | | December 1 – December 31, 2021 | –– | –– | | Total | 8,853 | $33.85 | Selected Financial Data This section refers to Table 2 'Selected Financial Data' and the general discussion in Item 7 for detailed financial information - Selected financial data is presented in Table 2 and discussed in Item 7, 'Management's Discussion and Analysis of Financial Condition and Results of Operations'[214] Management's Discussion and Analysis of Financial Condition and Results of Operations The Company reported increased net earnings in 2021, driven by a negative loan loss provision, despite margin compression and reduced noninterest income 2021 and 2020 Summary of Results of Operations | Indicator | 2021 (thousand dollars) | 2020 (thousand dollars) | | :--- | :--- | :--- | | 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 | - Net interest income (tax-equivalent) decreased 1% to $24.5 million in 2021 from $24.8 million in 2020, primarily due to net interest margin compression (2.55% in 2021 vs. 2.92% in 2020), partially offset by balance sheet growth[218] - The Company recorded a negative provision for loan losses of $0.6 million in 2021, compared to a $1.1 million charge in 2020, reflecting improvements in economic conditions and asset quality in its primary market area[219] Overview Auburn National Bancorporation, Inc. is a Delaware-incorporated bank holding company, operating through AuburnBank in East Alabama since 1907 - Auburn National Bancorporation, Inc. is a Delaware-incorporated bank holding company, established in 1990, with its principal subsidiary, AuburnBank, operating since 1907 in East Alabama, primarily Lee County[216] Summary of Results of Operations The Company reported net earnings of $8.0 million in 2021, with basic and diluted EPS of $2.27, reflecting a negative loan loss provision and reduced net interest income 2021 and 2020 Summary of Results of Operations | Indicator | 2021 (thousand dollars) | 2020 (thousand dollars) | | :--- | :--- | :--- | | Net Earnings | 8,039 | 7,454 | | Basic and Diluted Net Earnings Per Share | $2.27 | $2.09 | | Net Interest Income (Tax-Equivalent) | 24,460 | 24,830 | | Net Interest Margin (Tax-Equivalent) | 2.55% | 2.92% | | Provision for Loan Losses | (600) | 1,100 | | Noninterest Income | 4,288 | 5,375 | | Noninterest Expense | 19,433 | 19,554 | | Income Tax Expense | 1,406 | 1,605 | | Effective Tax Rate | 14.89% | 17.72% | COVID-19 Impact Assessment The Company implemented business continuity plans and participated in the PPP, with a significant reduction in loan deferrals by year-end 2021 - The COVID-19 pandemic continued to affect economic activity, leading the Company to implement business continuity plans, offer loan extensions and deferrals, and actively participate in the Paycheck Protection Program (PPP)[223] - The Company extended $36.5 million in PPP loans in 2020 and an additional $20.3 million in 2021 under the Economic Aid Act, recognizing $1.5 million and $0.7 million in fees, respectively[224][226] - As of December 31, 2021, the Company had only one COVID-19 loan deferral totaling $0.1 million, a significant reduction from $32.3 million (7% of total loans) at December 31, 2020, indicating improved borrower conditions[267] Critical Accounting Policies The Company's critical accounting policies involve significant judgments and estimates for loan losses, securities impairment, and fair value measurements - The Company's critical accounting policies involve significant judgments and estimates for the allowance for loan losses, other-than-temporary impairment of securities, fair value measurements, valuation of other real estate owned, and deferred tax assets[228] - The allowance for loan losses is assessed quarterly based on loan portfolio evaluation, past loss experience, asset quality trends, known risks, collateral values, economic conditions, and regulatory recommendations, with adjustments for qualitative and environmental factors[229][235] - Fair value measurements for assets and liabilities, including available-for-sale securities, are based on active market prices or estimated using pricing models with management's best estimates for discount rates, default rates, and market volatility[240][241] Results of Operations Net interest income decreased in 2021 due to margin compression, offset by a negative loan loss provision and reduced noninterest expense - Net interest income (tax-equivalent) decreased to $24.5 million in 2021 from $24.8 million in 2020, driven by a 57 basis point decline in the tax-equivalent yield on interest-earning assets to 2.81%, primarily due to a lower interest rate environment and changes in asset mix[246][247] - The Company recorded a negative provision for loan losses of $0.6 million in 2021, a significant change from the $1.1 million provision in 2020, reflecting improvements in economic conditions and asset quality[248] - Noninterest income decreased to $4.3 million in 2021 from $5.4 million in 2020, mainly due to an $0.8 million decrease in mortgage lending income as refinance activity declined, and a $0.3 million non-taxable death benefit received in 2020[220][250] - Noninterest expense slightly decreased to $19.4 million in 2021 from $19.6 million in 2020, primarily due to a $0.8 million reduction in headquarters redevelopment expenses, partially offset by a $0.4 million increase in salaries and benefits and a $0.2 million increase in FDIC and other regulatory assessments[220][255][256] - Income tax expense decreased to $1.4 million in 2021 from $1.6 million in 2020, resulting in an effective tax rate of 14.89% (2021) compared to 17.72% (2020), primarily due to an income tax benefit from a New Markets Tax Credit investment[221][257] Balance Sheet Analysis The balance sheet shows increased securities and deposits, a slight decrease in total loans (excluding PPP), and a reduction in the allowance for loan losses - Securities available-for-sale increased by $86.7 million to $421.9 million at December 31, 2021, from $335.2 million in 2020, reflecting increased allocation of funding to the investment portfolio due to significant customer deposit growth[258] - Total loans, net of unearned income, were $458.4 million at December 31, 2021, a slight decrease from $461.7 million in 2020. Excluding PPP loans, total loans increased by $7.5 million (2%) to $450.5 million, driven by commercial and industrial loans[261] - The allowance for loan losses decreased to $4.9 million (1.08% of total loans) at December 31, 2021, from $5.6 million (1.22% of total loans) at December 31, 2020, reflecting management's assessment of probable losses and improved economic conditions[273][275] - Total nonperforming assets increased to $0.8 million (0.07% of total assets) at December 31, 2021, from $0.5 million (0.06% of total assets) at December 31, 2020, primarily due to the addition of $0.4 million in other real estate owned[276][278] - Total deposits increased by $154.5 million (18%) to $994.2 million at December 31, 2021, compared to $839.8 million in 2020, driven by noninterest-bearing deposits and increased customer savings from government stimulus[287] Capital Adequacy Stockholders' equity decreased in 2021, but the Bank's regulatory capital ratios exceeded 'well capitalized' minimums, with a sufficient capital conservation buffer - Consolidated stockholders' equity decreased to $103.7 million at December 31, 2021, from $107.7 million in 2020, primarily due to a $6.7 million other comprehensive loss from unrealized securities gains, cash dividends, and stock repurchases, partially offset by net earnings[290] - The Bank's regulatory capital ratios at December 31, 2021, exceeded 'well capitalized' minimums: Tier 1 leverage ratio of 9.35%, CET1 risk-based capital ratio of 16.23%, Tier 1 risk-based capital ratio of 16.23%, and total risk-based capital ratio of 17.06%[293] - The Bank's capital conservation buffer was 9.06% at December 31, 2021, sufficient to meet the fully phased-in requirement, allowing for capital distributions without limitations[291][293] Market and Liquidity Risk Management The Company manages interest rate risk through ALCO models and maintains liquidity through deposits, borrowings, and credit lines - The Company manages interest rate risk through its Asset Liability Management Committee (ALCO), using earnings simulation and economic value of equity (EVE) models to assess sensitivity to interest rate fluctuations[294][296] - At December 31, 2021, the earnings simulation model indicated compliance with policy guidelines, showing a 1.54% variance in net interest income for a 100 basis point upward change in interest rates[298][300] - The Company's liquidity is managed at both the Company and Bank levels, with primary funding sources including customer deposits, other borrowings, and access to federal funds lines and FHLB advances[307][308] - The Bank had outstanding standby letters of credit of $1.4 million and unfunded loan commitments of $71.0 million at December 31, 2021, with sufficient liquidity sources to meet these obligations[311] Effects of Inflation and Changing Prices Interest rates have a more significant impact on the Company's performance than general inflation due to the monetary nature of assets and liabilities - Interest rates have a more significant impact on the Company's performance than general inflation, as virtually all assets and liabilities are monetary in nature[318] Current Accounting Developments The Company will implement the CECL accounting standard in January 2023, changing the loan loss model to a forward-looking approach - The Company will implement ASU 2016-13, 'Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments' in January 2023, which will change the loan loss model to a forward-looking expected credit loss (CECL) methodology[319][320] - The CECL model is expected to impact the Company's consolidated financial statements, particularly the level of the reserve for credit losses, with the extent depending on portfolio composition and economic conditions at adoption[320] Table 1 – Explanation of Non-GAAP Financial Measures The Company presents net interest income on a tax-equivalent basis to enhance comparability of income from taxable and tax-exempt sources - The Company presents net interest income on a tax-equivalent basis, a non-GAAP financial measure, to enhance comparability of income from taxable and tax-exempt sources within the industry[321] Net Interest Income (GAAP vs. Tax-Equivalent) | Indicator | 2021 (thousand dollars) | 2020 (thousand dollars) | | :--- | :--- | :--- | | Net Interest Income (GAAP) | 23,990 | 24,338 | | Tax-Equivalent Adjustment | 470 | 492 | | Net Interest Income (Tax-Equivalent) | 24,460 | 24,830 | Table 2 - Selected Financial Data This table provides a five-year summary of key financial metrics, including net earnings, EPS, dividends, and capital ratios Selected Financial Data (2017-2021) | Indicator | 2021 | 2020 | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | :--- | :--- | | Net Earnings (thousand dollars) | 8,039 | 7,454 | 9,741 | 8,834 | 7,846 | | Basic and Diluted Net Earnings Per Share ($) | 2.27 | 2.09 | 2.72 | 2.42 | 2.15 | | Cash Dividends ($) | 1.04 | 1.02 | 1.00 | 0.96 | 0.92 | | Return on Average Equity (%) | 7.54 | 7.12 | 10.35 | 10.14 | 9.17 | | Return on Average Assets (%) | 0.78 | 0.83 | 1.18 | 1.08 | 0.94 | | Allowance for Loan Losses as % of Total Loans (%) | 1.08 | 1.22 | 0.95 | 1.00 | 1.05 | | CET1 Risk-Weighted Capital Ratio (%) | 16.23 | 17.27 | 17.28 | 16.49 | 16.42 | | Total Assets (thousand dollars) | 1,105,150 | 956,597 | 828,570 | 818,077 | 853,381 | | Total Deposits (thousand dollars) | 994,243 | 839,792 | 724,152 | 724,193 | 757,659 | | Total Stockholders' Equity (thousand dollars) | 103,726 | 107,689 | 98,328 | 89,055 | 86,906 | Table 3 - Average Balance and Net Interest Income Analysis This table analyzes average balances, interest income/expense, and rates for interest-earning assets and interest-bearing liabilities Average Balance and Net Interest Income Analysis (2021 vs. 2020) | Item | 2021 Average Balance (thousand dollars) | 2021 Yield/Rate (%) | 2020 Average Balance (thousand dollars) | 2020 Yield/Rate (%) | | :--- | :--- | :--- | :--- | :--- | | Loans and Loans Held for Sale | 459,712 | 4.45 | 465,378 | 4.74 | | Securities - Taxable | 320,766 | 1.28 | 234,420 | 1.68 | | Securities - Tax-Exempt | 62,736 | 3.57 | 63,029 | 3.72 | | Federal Funds Sold | 38,659 | 0.15 | 30,977 | 0.41 | | Interest-Bearing Bank Deposits | 77,220 | 0.13 | 56,104 | 0.41 | | Total Interest-Earning Assets | 959,093 | 2.81 | 849,908 | 3.38 | | NOW Accounts | 178,197 | 0.12 | 154,431 | 0.34 | | Savings and Money Market | 296,708 | 0.22 | 242,485 | 0.44 | | Certificates of Deposit | 159,111 | 1.03 | 165,120 | 1.36 | | Total Interest-Bearing Deposits | 634,016 | 0.39 | 562,036 | 0.68 | | Short-Term Borrowings | 3,349 | 0.51 | 1,864 | 0.48 | | Total Interest-Bearing Liabilities | 637,365 | 0.39 | 563,900 | 0.68 | | Net Interest Income and Margin | 24,460 | 2.55 | 24,830 | 2.92 | Table 4 - Volume and Rate Variance Analysis This table analyzes the changes in net interest income between 2021 and 2020, attributing them to rate and volume variances Analysis of Changes in Net Interest Income (2021 vs. 2020) | Item | Net Change (thousand dollars) | Change Due to Rate (thousand dollars) | Change Due to Volume (thousand dollars) | | :--- | :--- | :--- | :--- | | Interest Income on Loans and Loans Held for Sale | (1,582) | (1,333) | (249) | | Interest Income on Securities | 74 | (1,024) | 1,098 | | Interest Income on Federal Funds Sold | (70) | (81) | 11 | | Interest Income on Interest-Bearing Bank Deposits | (131) | (159) | 28 | | Total Interest Income | (1,709) | (2,597) | 888 | | Interest Expense on Deposits | (1,347) | (1,437) | 90 | | Interest Expense on Short-Term Borrowings | 8 | — | 8 | | Total Interest Expense | (1,339) | (1,437) | 98 | | Net Interest Income | (370) | (1,160) | 790 | Table 5 - Net Charge-Offs (Recoveries) to Average Loans This table presents net charge-offs (recoveries) and their ratios to average loans by loan category for 2021 and 2020 2021 and 2020 Net Charge-Offs (Recoveries) to Average Loans | Loan Category | 2021 Net Charge-Offs (Recoveries) (thousand dollars) | 2021 Average Loans (thousand dollars) | 2021 Net Charge-Offs (Recoveries) Ratio (%) | 2020 Net Charge-Offs (Recoveries) (thousand dollars) | 2020 Average Loans (thousand dollars) | 2020 Net Charge-Offs (Recoveries) Ratio (%) | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Commercial and Industrial | (140) | 64,618 | (0.22) | (87) | 56,836 | (0.15) | | Construction and Land Development | — | 33,945 | — | — | 32,721 | — | | Commercial Real Estate | 254 | 253,113 | 0.10 | — | 256,444 | — | | Residential Real Estate | (52) | 81,526 | (0.06) | (63) | 87,888 | (0.07) | | Consumer Installment | 17 | 6,975 | 0.24 | 18 | 8,096 | 0.22 | | Total | 79 | 440,177 | 0.02 | (132) | 441,985 | (0.03) | Table 6 - Loan Maturities This table details the maturity distribution of the loan portfolio as of December 31, 2021, across various loan categories Loan Maturities as of December 31, 2021 (thousand dollars) | Loan Category | 1 Year or Less | 1 to 5 Years | 5 to 15 Years | Over 15 Years | Total | | :--- | :--- | :--- | :--- | :--- | :--- | | Commercial and Industrial | 26,593 | 17,474 | 38,125 | 1,785 | 83,977 | | Construction and Land Development | 26,346 | 5,191 | 849 | 46 | 32,432 | | Commercial Real Estate | 31,406 | 85,149 | 137,411 | 4,405 | 258,371 | | Residential Real Estate | 3,832 | 21,919 | 31,227 | 20,683 | 77,661 | | Consumer Installment | 2,215 | 4,111 | 356 | — | 6,682 | | Total Loans | 90,392 | 133,844 | 207,968 | 26,919 | 459,123 | Table 7 - Sensitivities to Changes in Interest Rates on Loans Maturing in More Than One Year This table shows the interest rate sensitivity of loans maturing in more than one year, categorized by floating and fixed rates Interest Rate Sensitivity of Loans Maturing in More Than One Year as of December 31, 2021 (thousand dollars) | Loan Category | Floating Rate | Fixed Rate | Total | | :--- | :--- | :--- | :--- | | Commercial and Industrial | 268 | 57,116 | 57,384 | | Construction and Land Development | 1,934 | 4,152 | 6,086 | | Commercial Real Estate | 8,220 | 218,745 | 226,965 | | Residential Real Estate | 24,058 | 49,771 | 73,829 | | Consumer Installment | 38 | 4,429 | 4,467 | | Total Loans | 34,518 | 334,213 | 368,731 | Table 8 - Allocation of Allowance for Loan Losses This table details the allocation of the allowance for loan losses by loan category for 2021 and 2020 2021 and 2020 Allocation of Allowance for Loan Losses (thousand dollars) | Loan Category | 2021 Amount | 2021 Percentage (%) | 2020 Amount | 2020 Percentage (%) | | :--- | :--- | :--- | :--- | :--- | | Commercial and Industrial | 857 | 18.3 | 807 | 17.9 | | Construction and Land Development | 518 | 7.1 | 594 | 7.2 | | Commercial Real Estate | 2,739 | 56.2 | 3,169 | 55.2 | | Residential Real Estate | 739 | 16.9 | 944 | 18.2 | | Consumer Installment | 86 | 1.5 | 104 | 1.5 | | Total Allowance for Loan Losses | 4,939 | - | 5,618 | - | Table 9 - Estimated Uninsured Time Deposits by Maturity This table provides an estimated breakdown of uninsured time deposits by maturity as of December 31, 2021 Estimated Uninsured Time Deposits by Maturity as of December 31, 2021 (thousand dollars) | Maturity Term | Amount | | :--- | :--- | | 3 Months or Less | 2,079 | | Over 3 Months to 6 Months | 1,747 | | Over 6 Months to 12 Months | 31,159 | | Over 12 Months | 6,505 | | Total Uninsured Time Deposits | 41,490 | Quantitative and Qualitative Disclosures About Market Risk Information regarding market risk disclosures is incorporated by reference from the 'Market and Liquidity Risk Management' section within Item 7 - Information on quantitative and qualitative disclosures about market risk is incorporated by reference from the 'Market and Liquidity Risk Management' section in Item 7[334] Financial Statements and Supplementary Data This section presents the Company's audited consolidated financial statements and detailed notes, with an unqualified audit opinion - The section includes the Company's audited consolidated financial statements for December 31, 2021 and 2020, comprising balance sheets, statements of earnings, comprehensive income, stockholders' equity, and cash flows[333][513] - Elliott Davis, LLC, the independent registered public accounting firm, issued an unqualified opinion on the financial statements, stating they present fairly, in all material respects, the Company's financial position and results of operations[336] - The allowance for loan losses was identified as a critical audit matter due to the high degree of subjectivity in management's judgments regarding qualitative factors, requiring challenging auditor judgment and specialized skill[341][342] Report of Independent Registered Public Accounting Firm Elliott Davis, LLC provided an unqualified opinion on the consolidated financial statements, highlighting the allowance for loan losses as a critical audit matter - Elliott Davis, LLC provided an unqualified opinion on the consolidated financial statements for Auburn National Bancorporation, Inc. and Subsidiary for the years ended December 31, 2021 and 2020, affirming fair presentation in accordance with GAAP[336] - The allowance for loan losses was identified as a critical audit matter due to the high subjectivity in management's judgments regarding qualitative factors, requiring challenging auditor judgment and specialized skill[341][342] Consolidated Balance Sheets This section presents the Company's consolidated financial position, detailing assets, liabilities, and stockholders' equity Consolidated Balance Sheets (December 31, 2021 vs. December 31, 2020) | Item | 2021 (thousand dollars) | 2020 (thousand dollars) | | :--- | :--- | :--- | | Cash and Cash Equivalents | 156,259 | 112,575 | | Securities Available-for-Sale | 421,891 | 335,177 | | Loans, Net | 453,425 | 456,082 | | Premises and Equipment, Net | 41,724 | 22,193 | | Bank-Owned Life Insurance | 19,635 | 19,232 | | Other Assets | 10,840 | 7,920 | | Total Assets | 1,105,150 | 956,597 | | Noninterest-Bearing Deposits | 316,132 | 245,398 | | Interest-Bearing Deposits | 678,111 | 594,394 | | Total Deposits | 994,243 | 839,792 | | Federal Funds Purchased and Securities Sold Under Repurchase Agreements | 3,448 | 2,392 | | Accrued Expenses and Other Liabilities | 3,733 | 6,723 | | Total Liabilities | 1,001,424 | 848,907 | | Total Stockholders' Equity | 103,726 | 107,690 | | Total Liabilities and Stockholders' Equity | 1,105,150 | 956,597 | Consolidated Statements of Earnings This section presents the Company's financial performance, detailing revenues, expenses, and net income Consolidated Statements of Earnings (2021 vs. 2020) | Item | 2021 (thousand dollars) | 2020 (thousand dollars) | | :--- | :--- | :--- | | Total Interest Income | 26,507 | 28,194 | | Total Interest Expense | 2,517 | 3,856 | | Net Interest Income | 23,990 | 24,338 | | Provision for Loan Losses | (600) | 1,100 | | Total Noninterest Income | 4,288 | 5,375 | | Total Noninterest Expense | 19,433 | 19,554 | | Earnings Before Income Taxes | 9,445 | 9,059 | | Income Tax Expense | 1,406 | 1,605 | | Net Earnings | 8,039 | 7,454 | | Basic and Diluted Net Earnings Per Share | $2.27 | $2.09 | Consolidated Statements of Comprehensive Income This section presents the Company's comprehensive income, including net income and other comprehensive income/loss Consolidated Statements of Comprehensive Income (2021 vs. 2020) | Item | 2021 (thousand dollars) | 2020 (thousand dollars) | | :--- | :--- | :--- | | Net Earnings | 8,039 | 7,454 | | Other Comprehensive (Loss) Income, Net of Tax: | | | | Unrealized Net Holding (Losses) Gains on Available-for-Sale Securities | (6,697) | 5,617 | | Reclassification Adjustment for Net Gains on Securities Recognized in Net Earnings | (11) | (77) | | Other Comprehensive (Loss) Income | (6,708) | 5,540 | | Comprehensive Income | 1,331 | 12,994 | Consolidated Statements of Stockholders' Equity This section details changes in the Company's stockholders' equity, including net income, dividends, and stock repurchases Consolidated Statements of Stockholders' Equity (December 31, 2021 vs. December 31, 2020) | Item | December 31, 2021 (thousand dollars) | December 31, 2020 (thousand dollars) | | :--- | :--- | :--- | | Common Stock | 39 | 39 | | Additional Paid-in Capital | 3,794 | 3,789 | | Retained Earnings | 109,974 | 105,617 | | Accumulated Other Comprehensive (Loss) Income | 891 | 7,599 | | Less: Treasury Stock, at Cost | (10,972) | (9,354) | | Total Stockholders' Equity | 103,726 | 107,690 | | Net Earnings | 8,039 | 7,454 | | Other Comprehensive (Loss) Income | (6,708) | 5,540 | | Cash Dividends Paid | (3,682) | (3,638) | | Stock Repurchases | (1,619) | — | Consolidated Statements of Cash Flows This section presents the Company's cash inflows and outflows from operating, investing, and financing activities Consolidated Statements of Cash Flows (2021 vs. 2020) | Item | 2021 (thousand dollars) | 2020 (thousand dollars) | | :--- | :--- | :--- | | Net Cash Provided by Operating Activities | 12,320 | 9,728 | | Net Cash Used in Investing Activities | (118,842) | (102,921) | | Net Cash Provided by Financing Activities | 150,206 | 113,325 | | Net Change in Cash and Cash Equivalents | 43,684 | 20,132 | | Cash and Cash Equivalents at End of Period | 156,259 | 112,575 | | Interest Paid | 2,560 | 4,055 | | Income Taxes Paid | 2,760 | 1,956 | | Real Estate Acquired Through Foreclosure | 374 | 99 | Notes To Consolidated Financial Statements This section provides detailed explanations and disclosures supporting the Company's consolidated financial statements NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This note outlines the Company's critical accounting policies, including estimates for loan losses and fair value measurements - The Company's consolidated financial statements conform with U.S. GAAP and banking industry practices, requiring management to make significant estimates for allowance for loan losses, fair value measurements, OREO valuation, and deferred tax assets[356][362] - All securities are classified as available-for-sale, recorded at fair value with unrealized gains/losses in OCI, and assessed quarterly for other-than-temporary impairment based on intent to sell or expected recovery of amortized cost[367][368][369] - Loans are reported at outstanding principal, net of unearned income and charge-offs, with interest accrual discontinued for nonaccrual loans (90+ days past due or significant financial deterioration)[372][373] NOTE 2: BASIC AND DILUTED NET EARNINGS PER SHARE This note details the calculation of basic and diluted net earnings per share, with no dilutive securities identified Basic and Diluted Net Earnings Per Share (2021 vs. 2020) | Indicator | 2021 | 2020 | | :--- | :--- | :--- | | Net Earnings (thousand dollars) | 8,039 | 7,454 | | Weighted Average Common Shares Outstanding | 3,545,310 | 3,566,207 | | Net Earnings Per Share ($) | 2.27 | 2.09 | - The Company had no securities or other rights that would have a dilutive effect on net earnings per share as of December 31, 2021 and 2020[389] NOTE 3: VARIABLE INTEREST ENTITIES This note describes the Company's nonconsolidated Variable Interest Entity related to a New Markets Tax Credit investment - As of December 31, 2021, the Company had one nonconsolidated Variable Interest Entity (VIE) related to a $2.2 million New Markets Tax Credit (NMTC) investment, included in other assets[391][392] - Despite exceeding 50% equity interest, the Company does not consolidate the NMTC VIE because it lacks the power to direct the entity's activities, thus not meeting the primary beneficiary characteristics[392] Maximum Exposure to Loss from Variable Interest Entity (December 31, 2021) | Type | Exposure to Loss (thousand dollars) | Recognized Assets (thousand dollars) | Classification | | :--- | :--- | :--- | :--- | | New Markets Tax Credit Investment | 2,176 | 2,176 | Other Assets | NOTE 4: SECURITIES This note details the Company's available-for-sale securities, including fair values and amortized costs - All of the Company's securities were classified as available-for-sale at December 31, 2021 and 2020, with fair values of $421.9 million and $335.2 million, respectively[394][395] Fair Value and Amortized Cost of Available-for-Sale Securities (December 31, 2021) | Security Category | Fair Value (thousand dollars) | Amortized Cost (thousand dollars) | | :--- | :--- | :--- | | Agency Bonds | 124,413 | 125,412 | | Agency Mortgage-Backed Securities (MBS) | 223,371 | 224,524 | | State and Local Government Bonds | 74,107 | 70,766 | | Total | 421,891 | 420,702 | - The Company held nonmarketable equity investments, including FHLB and FRB stock, valued at $1.2 million (2021) and $1.4 million (2020), which are accounted for at cost and periodically evaluated for impairment based on ultimate recoverability of par value[396][379] NOTE 5: LOANS AND ALLOWANCE FOR LOAN LOSSES This note provides a breakdown of the loan portfolio and the allowance for loan losses, reflecting asset quality Loan Portfolio (December 31, 2021 vs. December 31, 2020) | Loan Category | 2021 (thousand dollars) | 2020 (thousand dollars) | | :--- | :--- | :--- | | Commercial and Industrial | 83,977 | 82,585 | | Construction and Land Development | 32,432 | 33,514 | | Commercial Real Estate | 258,371 | 255,136 | | Residential Real Estate | 77,661 | 84,154 | | Consumer Installment | 6,682 | 7,099 | | Total Loans, Net of Unearned Income | 458,364 | 461,700 | - Loans secured by real estate constituted approximately 80.3% of the total loan portfolio at December 31, 2021, with geographic concentration primarily in Lee County, Alabama[404] - The allowance for loan losses decreased to $4.9 million at December 31, 2021, from $5.6 million at December 31, 2020, reflecting management's assessment of probable losses and improved economic conditions[415] NOTE 6: PREMISES AND EQUIPMENT This note details the Company's premises and equipment,