AUBURN NATIONAL BANCORPORATION, INC 10-K

ITEM 1. BUSINESS Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company was incorporated in Delaware in 1990, and in 1994 it succeeded its Alabama predecessor as the bank holding company controlling AuburnBank, an Alabama state member bank with its principal office in Auburn, Alabama (the “Bank”). The Company and its predecessor have controlled the Bank since 1984. As a bank holding company, the Company may diversify into a broader range of financial services and other business activities than currently are permitted to the Bank under applicable laws and regulations. The holding company structure also provides greater financial and operating flexibility than is presently permitted to the Bank. Table of Contents 5 The Bank has operated continuously since 1907 and currently conducts its business primarily in East Alabama, including Lee County and surrounding areas. The Bank has been a member of the Federal Reserve Bank of Atlanta (the “Federal Reserve Bank”) since April 1995. The Bank’s primary regulators are the Federal Reserve and the Alabama Superintendent of Banks (the “Alabama Superintendent”). The Bank has been a member of the Federal Home Loan Bank of Atlanta (the “FHLB-Atlanta”) since 1991. General The Company’s business is conducted primarily through the Bank and its subsidiaries. Although it has no immediate plans to conduct any other business, the Company may engage directly or indirectly in a number of activities closely related to banking permitted by the Federal Reserve. The Company’s principal executive offices are located at 100 N. Gay Street, Auburn, Alabama 36830, and its telephone number at such address is (334) 821-9200. The Company maintains an Internet website at www.auburnbank.com . The Company’s website and the information appearing on the website are not included or incorporated in, and are not part of, this report. The Company files annual, quarterly and current reports, proxy statements, and other information with the SEC. You may read and copy any document we file with the SEC at the SEC’s public reference room at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for more information on the operation of the public reference rooms. The SEC maintains an Internet site at www.sec.gov that contains reports, proxy, and other information, where SEC filings are available to the public free of charge. Services The Bank offers checking, savings, transaction deposit accounts and certificates of deposit, and is an active residential mortgage lender in its primary service area. The Bank’s primary service area includes the cities of Auburn and Opelika, Alabama and nearby surrounding areas in East Alabama, primarily in Lee County. The Bank also offers commercial, financial, agricultural, real estate construction and consumer loan products and other financial services. The Bank is one of the largest providers of automated teller machine (“ATM”) services in East Alabama and operates ATM machines in 12 locations in its primary service area. The Bank offers Visa ® Checkcards, which are debit cards with the Visa logo that work like checks and can be used anywhere Visa is accepted, including ATMs. The Bank’s Visa Checkcards can be used internationally through the Plus ® network. The Bank offers online banking, bill payment and other electronic banking services through its Internet website, www.auburnbank.com . Our online banking services, bill payment and electronic services are subject to certain cybersecurity risks. See “Risk Factors – Our information systems may experience interruptions and security breaches.” The Bank does not offer any services related to any Bitcoin or other digital or crypto instruments or stablecoins or businesses. Competition The Bank had the largest share of the Auburn-Opelika MSA’s deposits (20.1%) at June 30, 2023. The banking business in East Alabama, including Lee County, is highly competitive with respect to loans, deposits, and other financial services. The area is served by 19 banks, 11 of which are headquartered outside of Alabama and have 26 offices in our market. Larger national and regional competitors that have offices in our market include J.P. Morgan Chase, Wells Fargo, Truist, PNC, Regions, Valley National and SouthState. The regional and national banks and bank holding companies that we compete with have substantially greater resources, and numerous offices and affiliates operating over wide geographic areas. The Bank competes for deposits, loans and other business with these banks, as well as with credit unions, mortgage companies, insurance companies, and other local and nonlocal financial institutions, including institutions offering services through the mail, by telephone and over the Internet. As more and different kinds of businesses enter the market for financial services, competition from nonbank financial institutions may be expected to intensify further. Among the advantages that larger financial institutions have over the Bank are their ability to finance extensive advertising campaigns, to diversify their funding sources, and to allocate and diversify their assets among loans and securities of the highest yield in locations with the greatest demand. Many of the major commercial banks or their affiliates operating in the Bank’s service area offer services which are not presently offered directly by the Bank, and these other banks typically have substantially higher lending limits than the Bank. Table of Contents 6 Banks also have experienced significant competition for deposits from mutual funds, insurance companies and other investment companies and from money center banks’ offerings of high-yield investments and deposits, including CDs and savings accounts. Certain of these competitors are not subject to the same regulatory restrictions as the Bank. Selected Economic Data The Auburn-Opelika Metropolitan Statistical Area is Lee County, Alabama, including Auburn, Opelika and part of Phenix City, Alabama. The U.S. Census Bureau estimates Lee County’s population was 180,773 in 2022, and has increased approximately 29% from 2010 to 2022. The largest employers in the area are Auburn University, East Alabama Medical Center, Lee County School System, Auburn City Schools, Wal-Mart Distribution Center, Aptar CSP Technologies, Pharmavite, LLC, HL Mando America Corporation (automobile brakes and steering), Golden State Foods and Briggs & Stratton. Auto manufacturing and related suppliers are increasingly important along Interstate Highway 85 to the east and west of Auburn. Kia Motors has a large automobile factory in nearby West Point, Georgia, and Hyundai Motors has a large automobile factory near Montgomery, Alabama. Various suppliers to the automotive industry have facilities in Lee County. The unemployment rate in Lee County was 2.4% at year end 2023 according to the U.S. Bureau of Labor Statistics. Between 2010 and 2022, the Auburn-Opelika MSA was the second fastest growing MSA in Alabama. The Auburn- Opelika MSA population is estimated to grow 6.6% from 2023 to 2028. During the same time, household income is estimated to increase 14.25%, to $69,213. Loans and Loan Concentrations The Bank makes loans for commercial, financial and agricultural purposes, as well as for real estate mortgages, real estate acquisition, construction and development and consumer purposes. While there are certain risks unique to each type of lending, management believes that there is more risk associated with commercial, real estate acquisition, construction and development, agricultural and consumer lending than with residential real estate mortgage loans. To help manage these risks, the Bank has established underwriting standards used in evaluating each extension of credit on an individual basis, which are substantially similar for each type of loan. These standards include a review of the economic conditions affecting the borrower, the borrower’s financial strength and capacity to repay the debt, the underlying collateral and the borrower’s past credit performance. We apply these standards at the time a loan is made and monitor them periodically throughout the life of the loan. See “Lending Practices” for a discussion of regulatory guidance on commercial real estate lending. Our commercial real estate (“CRE”) loans, including $66.8 million of loans on owner occupied property, as of December 31, 2023 totaled $287.3 million (52% of total loans). Our regulators’ CRE Guidance excludes loans on owner occupied property from CRE. Excluding our owner occupied loans, our CRE loans were $220.5 million (40% of total loans) at year end 2023. See “Lending Practices – CRE. ” The Bank has loans outstanding to borrowers in all industries within our primary service area. Any adverse economic or other conditions affecting these industries would also likely have an adverse effect on the local workforce, other local businesses, and individuals in the community that have entered into loans with the Bank. For example, the auto manufacturing business and its suppliers have positively affected our local economy, but automobile sales manufacturing is cyclical and adversely affected by increases in interest rates. Decreases in automobile sales, including adverse changes due to interest rate increases, and the remaining economic effects of the COVID-19 pandemic, including continuing supply chain disruptions and a tight labor market, could adversely affect nearby Kia and Hyundai automotive plants and their suppliers' local spending and employment, and could adversely affect economic conditions in the markets we serve. However, management believes that due to the diversified mix of industries located within our markets, adverse changes in one industry may not necessarily affect other area industries to the same degree or within the same time frame. The Bank’s primary service area also is subject to both local and national economic conditions and fluctuations. While most loans are made within our primary service area, some residential mortgage loans are originated outside the primary service area, and the Bank from time to time has purchased loan participations from outside its primary service area. We also may make loans to other borrowers outside these areas, especially where we have a relationship with the borrower, or its business or owners. Table of Contents 7 Human Capital At December 31, 2023, the Company and its subsidiaries had 149.5 full-time equivalent employees, including 38 officers. Our average term of service is approximately 10 years. We successfully implemented plans to protect our employees’ health consistent with CDC and State of Alabama guidelines during the COVID-19 pandemic, while maintaining critical banking services to our communities. In addition, we developed our remote and electronic banking services, and established remote work access to help employees stay at home where job duties permitted. This promoted employee retention, and these efforts will provide us proven experience and flexibility to meet other disruptive events and conditions, and still provide our customers and communities continuity of service. We experienced little turnover as a result of the COVID-19 pandemic and made no staff reductions. As a result, we received a federal employee retention tax credit of approximately $1.6 million in 2022. We have a talented group of employees, many of whom, have a college or associate degree. We believe the Auburn- Opelika MSA is a desirable place to live and work with excellent schools and quality of life. Our MSA was the second fastest growing MSA in Alabama from 2010 to 2022. Auburn University is a major employer that attracts talented students and employee families. Various of our employees have a family member that is employed by or is attending the University. We had a successful management transition in 2022 where our CEO became Chairman, and was succeeded by our CFO, whose role was then filled by our Chief Accounting Officer. At the time of transition, our Chairman had served the Bank his entire 39-year career, our President and CEO had been with us 16 years and our Chief Accounting Officer had been with us for 7 years. Our new President and CFO had careers with major national and regional accounting firms and focused on financial services before joining the Bank. We seek to provide competitive compensation and benefits. We provide employer matches for employee contributions to our 401(k) retirement plan. We encourage and support the growth and development of our employees and, wherever possible, seek to fill positions by promotion and transfer from within the organization. Career development is advanced through ongoing performance and development conversations with employees, internally developed training programs and other training and development opportunities. Our employees are encouraged to be active in our communities as part of our commitment to these communities and our employees. Statistical Information Certain statistical information is included in responses to Items 6, 7, 7A and 8 of this Annual Report on Form 10-K. SUPERVISION AND REGULATION The Company and the Bank are extensively regulated under federal and state laws applicable to bank holding companies and banks. The supervision, regulation and examination of the Company and the Bank and their respective subsidiaries by the bank regulatory agencies are primarily intended to maintain the safety and soundness of depository institutions and the federal deposit insurance system, as well as the protection of depositors, rather than holders of Company capital stock and other securities. Any change in applicable law or regulation may have a material effect on the Company’s business, and our results of operations and financial condition. The following discussion is qualified in its entirety by reference to the particular laws and rules referred to below. Bank Holding Company Regulation The Company, as a bank holding company, is subject to supervision, regulation and examination by the Federal Reserve under the BHC Act. Bank holding companies generally are limited to the business of banking, managing or controlling banks, and certain related activities. The Company is required to file periodic reports and other information with the Federal Reserve. The Federal Reserve examines the Company and its subsidiaries. The State of Alabama currently does not regulate bank holding companies. Table of Contents 8 The BHC Act requires prior Federal Reserve approval for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares or substantially all the assets of any bank, or for a merger or consolidation of a bank holding company with another bank holding company. The BHC Act generally prohibits a bank holding company from acquiring direct or indirect ownership or control of voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or performing services for its authorized subsidiar ies. A bank holding company may, however, engage in or acquire an interest in a company that engages in activities that the Federal Reserve has determined by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. On January 30, 2020, the Federal Reserve adopted new rules, effective September 30, 2020 simplifying determinations of control of banking organizations for BHC Act purposes. Bank holding companies that are and remain “well-capitalized” and “well-managed,” as defined in Federal Reserve Regulation Y, and whose insured depository institution subsidiaries maintain “satisfactory” or better ratings under the Community Reinvestment Act of 1977 (the “CRA”), may elect to become “financial holding companies.” Financial holding companies and their subsidiaries are permitted to acquire or engage in activities such as insurance underwriting, securities underwriting, travel agency activities, broad insurance agency activities, merchant banking and other activities that the Federal Reserve determines to be financial in nature or complementary thereto. In addition, under the BHC Act’s merchant banking authority and Federal Reserve regulations, financial holding companies are authorized to invest in companies that engage in activities that are not financial in nature, as long as the financial holding company makes its investment, subject to limitations, including a limited investment term, no day-to-day management, and no cross-marketing with any depositary institutions controlled by the financial holding company. The Federal Reserve recommended repeal of the merchant banking powers in its September 16, 2016 study pursuant to Section 620 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), but has taken no action. The Company has not elected to become a financial holding company, but it may elect to do so in the future. Financial holding companies continue to be subject to Federal Reserve supervision, regulation and examination, but the Gramm-Leach-Bliley Act of 1999 the “GLB Act”) applies the concept of functional regulation to subsidiary activities. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. The BHC Act permits acquisitions of banks by bank holding companies, subject to various restrictions, including that the acquirer is “well capitalized” and “well managed”. Bank mergers are also subject to the approval of the resulting bank’s primary federal regulator pursuant to the Bank Merger Act. The BHC Act and the Bank Merger Act provide various generally similar statutory factors. Under the Alabama Banking Code, with the prior approval of the Alabama Superintendent, an Alabama bank may acquire and operate one or more banks in other states pursuant to a transaction in which the Alabama bank is the surviving bank. In addition, one or more Alabama banks may enter into a merger transaction with one or more out-of-state banks, and an out-of-state bank resulting from such transaction may continue to operate the acquired branches in Alabama. The Dodd-Frank Act permits banks, including Alabama banks, to branch anywhere in the United States. See “Bank Regulation”. The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W thereunder. Section 23A defines “covered transactions,” which include extensions of credit, and limits a bank’s covered transactions with any affiliate to 10% of such bank’s capital and surplus. All covered and exempt transactions between a bank and its affiliates must be on terms and conditions consistent with safe and sound banking practices, and banks and their subsidiaries are prohibited from purchasing low-quality assets from the bank’s affiliates. Finally, Section 23A requires that all of a bank’s extensions of credit to its affiliates be appropriately secured by permissible collateral, generally United States government or agency securities. Section 23B of the Federal Reserve Act generally requires covered and other transactions among affiliates to be on terms and under circumstances, including credit standards, that are substantially the same as or at least as favorable to the bank or its subsidiary as those prevailing at the time for similar transactions with unaffiliated companies. Table of Contents 9 Federal Reserve policy and the Federal Deposit Insurance Act, as amended by the Dodd-Frank Act, require a bank holding company to act as a source of financial and managerial strength to its FDIC-insured subsidiaries and to take measures to preserve and protect such bank subsidiaries in situations where additional investments in a bank subsidiary may not otherwise be warranted. In the event an FDIC-insured subsidiary becomes subject to a capital restoration plan with its regulators, the parent bank holding company is required to guarantee performance of such plan up to 5% of the bank’s assets, and such guarantee is given priority in a bankruptcy of the bank holding company. In addition, where a bank holding company has more than one bank or thrift subsidiary, each of the bank holding company’s subsidiary depository institutions may be responsible for any losses to the FDIC’s Deposit Insurance Fund (“DIF”), if an affiliated depository institution fails. As a result, a bank holding company may be required to loan money to a bank subsidiary in the form of subordinate capital notes or other instruments which qualify as capital under bank regulatory rules. However, any loans from the holding company to such subsidiary banks likely will be unsecured and subordinated to such bank’s depositors and to other creditors of the bank. See “Capital.” As a result of legislation in 2014 and 2018, the Federal Reserve has revised its Small Bank Holding Company Policy Statement (the “Small BHC Policy”) to expand it to include thrift holding companies and increase the size of “small” for qualifying bank and thrift holding companies from $500 million to up to $3 billion of pro forma consolidated assets. The Federal Reserve confirmed in 2018 that the Company is eligible for treatment as a small banking holding company under the Small BHC Policy. As a result, unless and until the Company fails to qualify under the Small BHC Policy, the Company’s capital adequacy will continue to be evaluated on a bank only basis. See “Capital.” Bank Regulation The Bank is a state bank that is a member of the Federal Reserve. It is subject to supervision, regulation and examination by the Federal Reserve and the Alabama Superintendent, which monitor all areas of the Bank’s operations, including loans, reserves, mortgages, issuances and redemption of capital securities, payment of dividends, establishment of branches, capital adequacy and compliance with laws. The Bank is a member of the FDIC and, as such, its deposits are insured by the FDIC to the maximum extent provided by law, and the Bank is subject to various FDIC regulations applicable to FDIC- insured banks. See “FDIC Insurance Assessments.” Alabama law permits statewide branching by banks. The powers granted to Alabama-chartered banks by state law include certain provisions designed to provide such banks competitive equality with national banks. The Federal Reserve has adopted the Federal Financial Institutions Examination Council’s (“FFIEC”) Uniform Financial Institutions Rating System (“UFIRS”), which assigns each financial institution a confidential composite “CAMELS” rating based on an evaluation and rating of six essential components of an institution’s financial condition and operations: C apital Adequacy, A sset Quality, M anagement, E arnings, L iquidity and S ensitivity to market risk, as well as the quality of risk management practices. For most institutions, the FFIEC has indicated that market risk primarily reflects exposures to changes in interest rates. When regulators evaluate this component, consideration is expected to be given to management’s ability to identify, measure, monitor and control market risk; the institution’s size; the nature and complexity of its activities and its risk profile; and the adequacy of its capital and earnings in relation to its level of market risk exposure. Market risk is rated based upon, but not limited to, an assessment of the sensitivity of the financial institution’s earnings or the economic value of its capital to adverse changes in interest rates, foreign exchange rates, commodity prices or equity prices; management’s ability to identify, measure, monitor and control exposure to market risk; and the nature and complexity of interest rate risk exposure arising from non-trading positions. Composite ratings are based on evaluations of an institution’s managerial, operational, financial and compliance performance. The composite CAMELS rating is not an arithmetical formula or rigid weighting of numerical component ratings. Elements of subjectivity and examiner judgment, especially as these relate to qualitative assessments, are important elements in assigning ratings. The federal bank regulatory agencies are reviewing the CAMELS rating system and their consistency. In addition, and separate from the interagency UFIRS, the Federal Reserve assigns a risk -management rating to all state member banks. The summary, or composite, rating, as well as each of the assessment areas, including risk management, is delineated on a numerical scale of 1 to 5, with 1 being the highest or best possible rating. Thus, a bank with a composite rating of 1 requires the lowest level of supervisory attention while a 5-rated bank has the most critically deficient level of performance and therefore requires the highest degree of supervisory attention. Table of Contents 10 Bank mergers, which generally accompany holding company mergers, are also subject to the approval of the resulting bank’s primary federal regulator. On March 19, 2022, the FDIC published a “Request for Information and Comment on Rules, Regulations, Guidance, and Statements of Policy Regarding Bank Merger Transactions” (the “FDIC Notice”). The FDIC solicited comments from interested parties regarding the application of the laws, practices, rules, regulations, guidance, and statements of policy (together, regulatory framework) that apply to merger transactions involving one or more insured depository institution, including the merger between an insured depository institution and a noninsured institution. The FDIC is interested in receiving comments regarding the effectiveness of the existing framework in meeting the requirements of the Bank Merger Act. On January 29, 2024, the Office of the Comptroller of the Currency (“OCC”) issue a notice of proposed rulemaking to change its standards for reviewing business combination applications and issue a policy statement of principles used by the OCC in its merger reviews. The FDIC Notice described the consolidation of the banking industry, the increase in the number of large and systemically important banking organizations and the need to evaluate large mergers’ financial stability and the resolution of failing bank risks consistent with the Dodd-Frank Act changes to the BHC Act and the Bank Merger Act, and the effects of banking mergers on competition. The FDIC Notice also stated that Executive Order Promoting Competition in the American Economy (July 9, 2021) (the “Executive Order”), among other things, “instructs U.S. agencies to consider the impact that consolidation may have on maintaining a fair, open, and competitive marketplace, and on the welfare of workers, farmers, small businesses, startups, and consumers.” The FDIC requested comments on all aspects of the bank regulatory framework, including qualitative and quantitative support for such responses. The other Federal bank regulators as well as the United States Department of Justice (“DoJ”), are also considering the framework for mergers involving banking organizations, including the competitive effects of such combinations. The federal bank regulators have not announced any conclusions, but these reviews could result in changes to the frameworks used to evaluate banking combinations which could make such combinations more difficult, time consuming and expensive. Federal Reserve Governor Bowman, in a March 7, 2024 speech, stated that “regulatory reforms in this area should prioritize speed and timeliness. Stakeholders who are concerned about current bank M&A procedures and policies should consider direct engagement with regulators.” The GLB Act and related regulations require banks and their affiliated companies to adopt and disclose privacy policies, including policies regarding the sharing of personal information with third parties. The GLB Act also permits bank subsidiaries to engage in financial activities, which are similar to those permitted to financial holding companies. In December 2015, Congress amended the GLB Act as part of the Fixing America’s Surface Transportation Act. This amendment provided financial institutions, which meet certain conditions, an exemption from the requirement to deliver an annual privacy notice. On August 10, 2018, the federal Consumer Financial Protection Bureau (“CFPB”) announced that it had finalized conforming amendments to its implementing regulation, Regulation P. A variety of federal and state privacy laws govern the collection, safeguarding, sharing and use of customer information, and require that financial institutions have policies regarding information privacy and security. Some state laws also protect the privacy of information of state residents and require adequate security of such data, and certain state laws may, in some circumstances, require us to notify affected individuals of security breaches of computer databases that contain their personal information. These laws may also require us to notify law enforcement, regulators or consumer reporting agencies in the event of a data breach, as well as businesses and governmental agencies that own data. H.R. 1165, The Data Privacy Act of 2023, was introduced in Congress on February 24, 2023 by Rep. McHenry, the Chairman of the House Financial Services Committee, to which the Bill was referred. It amends various sections of the GLB Act and preempts certain state privacy laws. Its preemption provisions have triggered opposition by the minority in the House of Representatives. Table of Contents 11 Community Reinvestment Act and Consumer Laws The Bank is subject to the provisions of the CRA and the Federal Reserve’s CRA regulations. Under the CRA, all FDIC- insured institutions have a continuing and affirmative obligation, consistent with their safe and sound operation, to help meet the credit needs for their entire communities, including low- and moderate-income (“LMI”) neighborhoods. The CRA requires a depository institution’s primary federal regulator to periodically assess the institution’s record of assessing and meeting the credit needs of the communities served by that institution, including low - and moderate-income neighborhoods. The bank regulatory agency’s CRA assessment is publicly available. Further, consideration of the CRA is required of any FDIC-insured institution that has applied to: (i) charter a national bank; (ii) obtain deposit insurance coverage for a newly- chartered institution; (iii) establish a new branch office that accepts deposits; (iv) relocate an office; or (v) merge or consolidate with, or acquire the assets or assume the liabilities of, an FDIC-insured financial institution. A less than satisfactory CRA rating will slow, if not preclude, acquisitions, and new branches and other expansion activities and may prevent a company from becoming a financial holding company. The federal CRA regulations require that evidence of discriminatory, illegal or abusive lending practices be considered in the CRA evaluation. CRA agreements with private parties must be disclosed and annual CRA reports must be made to a bank’s primary federal regulator. Community benefit plans have become common in banking mergers, especially larger bank combinations. The National Community Resolution Coalition reported in February 2023 that it had executed more than 20 community benefit plans with banking organizations. A financial holding company election, and such election and financial holding company activities are permitted to be continued, only if any affiliated bank has not received less than a “satisfactory” CRA rating. The federal CRA regulations require that evidence of discriminatory, illegal or abusive lending practices be considered in the CRA evaluation. The Bank had a “satisfactory” CRA rating in its latest CRA public evaluation dated February 28, 2022, with satisfactory ratings on both its lending and community development tests. The federal CRA regulations require that evidence of discriminatory, illegal or abusive lending practices be considered in the CRA evaluation. A financial holding company election, and the continuation of such election and financial holding company activities are permitted, if any affiliated bank has not received less than a “satisfactory” CRA rating. The Federal Reserve considers the effect of a bank acquisition proposal on the convenience and needs of the markets served by the combining organizations. In the case of bank holding company applications to acquire a bank, the Federal Reserve will assess and emphasize CRA records of each subsidiary depository institution of the applicant bank holding company and the target bank in meeting the needs of their entire communities, including low- and moderate-income (“LMI”) neighborhoods, and such records may be the basis for denying the application. CRA agreements with private parties must be disclosed and annual CRA reports must be made to a bank’s primary federal regulator. Community benefit plans have become common in banking mergers, especially larger bank combinations. The National Community Reinvestment Coalition reported in January 2024 that it had executed more than 21 community benefit plans with banking organizations, with an estimated value of $580 billion to LMI and under-resourced communities. The Bank is also subject to, among other things, the Equal Credit Opportunity Act (the “ECOA”) and the Fair Housing Act and other fair lending laws, which prohibit discrimination based on race or color, religion, national origin, sex and familial status in any aspect of a consumer or commercial credit or residential real estate transaction. The DoJ, and the federal bank regulatory agencies have issued an Interagency Policy Statement on Discrimination in Lending to provide guidance to financial institutions in determining whether discrimination exists, how the agencies will respond to lending discrimination, and what steps lenders might take to prevent discriminatory lending practices. The DOJ has prosecuted what it regards as violations of the ECOA, the Fair Housing Act, and the fair lending laws, generally. Table of Contents 12 New CRA Regulations The federal banking regulators jointly proposed (the “CRA Proposal”) revised CRA regulations on June 3, 2022. Final new joint CRA regulations were adopted by the Federal Reserve, the OCC and the FDIC on October 24, 2023, and were finalized and published in the Federal Register on February 1, 2024. Most of the new rules’ requirements become effective January 1, 2026, and other requirements, including required data reporting become effective January 1, 2027. The new CRA regulations confirm that the CRA and fair lending responsibilities and compliance are mutually reinforcing and that these regimes recognize the importance of ensuring that the credit markets are inclusive. The agencies are also retaining the provision in the CRA regulations that allows downgrading a bank for discriminatory or other illegal credit practices. The objectives of the new CRA regulations include: ● Update CRA regulations to strengthen the achievement of the core purpose of the statute; ● Adapt to changes in the banking industry, including the expanded role of mobile and online banking; ● Provide greater clarity and consistency in the application of the regulations; ● Tailor performance standards to account for differences in bank size and business models and local conditions; ● Tailor data collection and reporting requirements and use existing data whenever possible; ● Promote transparency and public engagement; ● Confirm that CRA and fair lending responsibilities are mutually reinforcing; and ● Create a consistent regulatory approach that applies to banks regulated by all three agencies. The new CRA regulations like the old rules, is based on bank size and business model create a new framework for evaluating CRA performance. Banks are classified as either “small”, “intermediate”, “large”, or “limited purpose” banks. The asset size thresholds would be adjusted annually for inflation and have been increased relative to the bank asset size thresholds in the old CRA rule. The Bank is currently an “intermediate small bank,” but will become an “intermediate bank” under the new CRA regulations because it has assets of $600 million to $2.0 billion in both of the two prior years. The new performance evaluation framework establishes two tests for intermediate banks: • the Retail Lending Test; and • the Intermediate Bank Community Development Test, or if elected by the Bank, the Community Development Financing Test. Intermediate banks would be evaluated and assigned conclusions of reflecting their performance under these tests in their facility based assessment area of “Outstanding”; “High Satisfactory”; “Low Satisfactory”; “Needs to Improve”; or “Substantial Noncompliance.” These conclusions applied to each test would be weighted and combined to form a rating of “Outstanding,” “Satisfactory,” “Needs to Improve,” or “Substantial Noncompliance.” A “facility based assessment area” is an area that encompasses or is adjacent to deposit-taking facilities, including main offices, branches, and deposit-taking remote service facilities. Intermediate banks could delineate facility-based areas of part of a county. The banking agencies will evaluate retail lending in a bank’s “outside retail lending area” for large banks, as well as for intermediate banks, if the majority of their retail lending is outside their facility-based assessment areas. A retail lending volume screen would be used to measure the volume of a bank’s lending relative to its deposit base in its facility-based assessment area and would compare that ratio to the aggregate ratio for all reporting banks with at least one branch in the same facility-based assessment area. Second, the agencies would evaluate the geographic distribution and borrower distribution of a bank’s major product lines in the bank’s Retail Lending Test Areas (i.e., the bank’s facility-based assessment areas, and, as applicable, retail lending assessment areas and outside retail lending area). using a series of metrics and benchmarks. After the agency determines a recommended conclusion for Retail Lending Test Area, the agency would consider a list of additional factors that are intended to account for circumstances in which the retail lending distribution metrics and benchmarks may not accurately or fully reflect a bank’s retail lending performance, or in which the benchmarks may not appropriately represent the credit needs and opportunities in an area. Table of Contents 13 Banks will receive consideration for any qualified community development loans, investments, or services, regardless of location. The extent of an agency's consideration of community development loans, community development investments, and community development services outside of the bank's facility-based assessment areas will depend on the adequacy of the bank's responsiveness to community development needs and opportunities within the bank's facility-based assessment areas and applicable performance context information. The new CRA rules codify agency interpretations under the former CRA regulations, and provide 11 community development categories. The agencies will evaluate the extent to which a bank’s community development loans, investments, and services are impactful and responsive in meeting community development needs. An intermediate bank's community development test performance is evaluated pursuant to the following criteria: • the number and dollar amount of community development loans; • the number and dollar amount of community development investments; • the extent to which the bank provides community development services; and • the bank's responsiveness through community development loans, community development investments, and community development services to community development needs. The banking agency's evaluation of the responsiveness of the bank's activities is informed by information provided by the bank, and may be informed by the impact and responsiveness review factors described in the new regulations. The release proposing these new CRA rules stated that “the agencies believe retail lending remains a core part of a bank's affirmative obligation under the CRA to meet the credit needs of their entire communities. At the same time, the agencies recognize that, compared to large banks, intermediate banks might not offer as wide a range of retail products and services, have a more limited capacity to conduct community development activities, and may focus on the local communities where their branches are located.” The proposal reflected “the agencies’ views that banks of this size should have meaningful capacity to conduct community development financing, as they do under the current approach. The new rule exempts small and intermediate banks from certain new data requirements that apply to banks with assets of at least $2 billion and limits certain new data requirements to large banks with assets greater than $10 billion. Overdrafts The federal bank regulators have updated their guidance several times on overdrafts, including overdrafts incurred at automated teller machines and point of sale terminals. Overdrafts also have been a CFPB concern, and in 2021 began refocusing on this issue with a view to “insure that banks continue to evolve their businesses to reduce reliance on overdraft and not sufficient funds fees.” Among other things, the federal regulators require banks to monitor accounts and to limit the use of overdrafts by customers as a form of short-term, high-cost credit, including, for example, giving customers who overdraw their accounts on more than six occasions where a fee is charged in a rolling 12 month period a reasonable opportunity to choose a less costly alternative and decide whether to continue with fee-based overdraft coverage. It also encourages placing appropriate daily limits on overdraft fees, and asks banks to consider eliminating overdraft fees for transactions that overdraw an account by a de minimis amount. Overdraft policies, processes, fees and disclosures are frequently the subject of litigation against banks in various jurisdictions. The federal bank regulators continue to consider responsible small dollar lending, including overdrafts and related fee issues and issued principals for offering small-dollar loans in a responsible manner on May 20, 2020. CFPB Consumer Financial Protection Circular 2022-06 (Oct. 26, 2022) concluded that overdraft fee practices must comply with Regulation Z, Regulation E, and the prohibition against unfair, deceptive, and abusive acts or practices in Section 1036 of the Consumer Financial Protection Act. Further, overdraft fees assessed by financial institutions on transactions that a consumer would not reasonably anticipate are likely unfair even if these comply with these other consumer laws and regulations. The CFPB proposed on February 6, 2019 to rescind its mandatory underwriting standards for loans covered by its 2017 Payday, Vehicle Title and Certain High-Cost Installment Loans rule, and has separately proposed delaying the effectiveness of such 2017 rule. The CFPB has a broad mandate to regulate consumer financial products and services, whether or not offered by banks or their affiliates. The CFPB has the authority to adopt regulations and enforce various laws, including fair lending laws, the Truth in Lending Act, the Electronic Funds Transfer Act, mortgage lending rules, the Truth in Savings Act, the Fair Credit Reporting Act and Privacy of Consumer Financial Information rules. Although the CFPB does not examine or supervise banks with less than $10 billion in assets, banks of all sizes are affected by the CFPB’s regulations, and the precedents set in CFPB enforcement actions and interpretations. Table of Contents 14 Residential Mortgages CFPB regulations require that lenders determine whether a consumer has the ability to repay a mortgage loan. These regulations establish certain minimum requirements for creditors when making ability to repay determinations, and provide certain safe harbors from liability for mortgages that are "qualified mortgages" and are not “higher-priced.” Generally, these CFPB regulations apply to all consumer, closed-end loans secured by a dwelling including home-purchase loans, refinancing and home equity loans—whether first or subordinate lien. Qualified mortgages must generally satisfy detailed requirements related to product features, underwriting standards, and requirements where the total points and fees on a mortgage loan cannot exceed specified amounts or percentages of the total loan amount. Qualified mortgages must have: (1) a term not exceeding 30 years; (2) regular periodic payments that do not result in negative amortization, deferral of principal repayment, or a balloon payment; (3) and be supported with documentation of the borrower and its credit. On December 10, 2020, the CFPB issued final rules related to “qualified mortgage” loans. Lenders are required under the law to determine that consumers have the ability to repay mortgage loans before lenders make those loans. Loans that meet standards for QM loans are presumed to be loans for which consumers have the ability to repay. We focus our residential mortgage origination on qualified mortgages and those that meet our investors’ requirements, but we may make loans that do not meet the safe harbor requirements for “qualified mortgages.” The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (the “2018 Growth Act”) provides that certain residential mortgages held in portfolio by banks with less than $10 billion in consolidated assets automatically are deemed “qualified mortgages.” This relieves smaller institutions from many of the requirements to satisfy the criteria listed above for “qualified mortgages.” Mortgages meeting the “qualified mortgage” safe harbor may not have negative amortization, must follow prepayment penalty limitations included in the Truth in Lending Act, and may not have fees greater than 3% of the total value of the loan. The Bank generally services the loans it originates, including those it sells. The CFPB’s mortgage servicing standards include requirements regarding force-placed insurance, certain notices prior to rate adjustments on adjustable rate mortgages, and periodic disclosures to borrowers. Servicers are prohibited from processing foreclosures when a loan modification is pending, and must wait until a loan is more than 120 days delinquent before initiating a foreclosure action. Servicers must provide borrowers with direct and ongoing access to its personnel, and provide prompt review of any loss mitigation application. Servicers must maintain accurate and accessible mortgage records for the life of a loan and until one year after the loan is paid off or transferred. These standards increase the cost and compliance risks of servicing mortgage loans, and the mandatory delays in foreclosures could result in loss of value on collateral or the proceeds we may realize from the sale of foreclosed property. The Federal Housing Finance Authority (“FHFA”) updated, effective January 1, 2016, The Federal National Mortgage Association’s (“Fannie Mae’s”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac’s”) (individually and collectively, “GSE”) repurchase rules, including the kinds of loan defects that could lead to a repurchase request to, or alternative remedies with, the mortgage loan originator or seller. These rules became effective January 1, 2016. FHFA also has updated these GSEs’ representations and warranties framework and provided an independent dispute resolution (“IDR”) process to allow a neutral third party to resolve demands after the GSEs’ quality control and appeal processes have been exhausted. The Bank is subject to the CFPB’s integrated disclosure rules under the Truth in Lending Act and the Real Estate Settlement Procedures Act, referred to as “TRID”, for credit transactions secured by real property. Our residential mortgage strategy, product offerings, and profitability may change as these regulations are interpreted and applied in practice, and may also change due to any restructuring of Fannie Mae and Freddie Mac as part of the resolution of their conservatorships. The 2018 Growth Act reduced the scope of TRID rules by eliminating the wait time for a mortgage, if an additional creditor offers a consumer a second offer with a lower annual percentage rate. Congress encouraged federal regulators to provide better guidance on TRID in an effort to provide a clearer understanding for consumers and bankers alike. The law also provides partial exemptions from the collection, recording and reporting requirements under Sections 304(b)(5) and (6) of the Home Mortgage Disclosure Act (“HMDA”), for those banks with fewer than 500 closed-end mortgages or less than 500 open-end lines of credit in both of the preceding two years, provided the bank’s rating under the CRA for the previous two years has been at least “satisfactory.” On August 31, 2018, the CFPB issued an interpretive and procedural rule to implement and clarify these requirements under the 2018 Growth Act. Table of Contents 15 The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted on March 27, 2020. Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” provides banks the option to temporarily suspend certain requirements under ASC 340-10 TDR classifications for a limited period of time to account for the effects of COVID-19. On April 7, 2020, the Federal Reserve and the other banking agencies and regulators issued a statement, “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected by the Coronavirus (Revised)” (the “Interagency Statement on COVID-19 Loan Modifications”), to encourage banks to work prudently with borrowers and to describe the agencies’ interpretation of how accounting rules under ASC 310-40, “Troubled Debt Restructurings by Creditors,” apply to covered modifications. The Interagency Statement on COVID-19 Loan Modifications was supplemented on June 23, 2020 by the Interagency Examiner Guidance for Assessing Safety and Soundness Considering the Effect of the COVID-19 Pandemic on Institutions. If a loan modification is eligible, a bank may elect to account for the loan under section 4013 of the CARES Act. If a loan modification is not eligible under section 4013, or if the bank elects not to account for the loan modification under section 4013, the Revised Statement includes criteria when a bank may presume a loan modification is not a TDR in accordance with ASC 310-40. Section 4021 of the CARES Act allows borrowers under 1-to-4 family residential mortgage loans sold to Fannie Mae to request forbearance to the servicer after affirming that such borrower is experiencing financial hardships during the COVID-19 emergency. Such forbearance will be up to 180 days, subject to up to a 180-day extension. During forbearance, no fees, penalties or interest shall be charged beyond those applicable if all contractual payments were fully and timely paid. Except for vacant or abandoned properties, Fannie Mae servicers may not initiate foreclosures on similar procedures or related evictions or sales until December 31, 2020. The forbearance period was extended to February 28, 2021 and then again to March 31, 2021 after being extended earlier to February 28, 2021. Borrowers who are on a COVID-19 forbearance plan as of February 28, 2021 may apply for an additional forbearance extension of up to three additional months. The Bank sells mortgage loans to Fannie Mae and services these on an actual/actual basis. As a result, the Bank is not obligated to make any advances to Fannie Mae on principal and interest on such mortgage loans where the borrower is entitled to forbearance. Anti-Money Laundering and Sanctions The International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001 specifies “know your customer” requirements that obligate financial institutions to take actions to verify the identity of the account holders in connection with opening an account at any U.S. financial institution. Bank regulators are required to consider compliance with anti- money laundering laws in acting upon merger and acquisition and other expansion proposals under the BHC Act and the Bank Merger Act, and sanctions for violations of this Act can be imposed in an amount equal to twice the sum involved in the violating transaction, up to $1 million. Under the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as to enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. The USA PATRIOT Act requires financial institutions to establish anti-money laundering programs, and sets forth minimum standards, or “pillars” for these programs, including: ● the development of internal policies, procedures, and controls; ● the designation of a compliance officer; ● an ongoing employee training program; ● an independent audit function to test the programs; and ● ongoing customer due diligence and monitoring. Federal Financial Crimes Enforcement Network (“FinCEN”) rules effective May 2018 require banks to know the beneficial owners of customers that are not natural persons, update customer information in order to develop a customer risk profile, and generally monitor such matters. On August 13, 2020, the federal bank regulators issued a joint statement clarifying that isolated or technical violations or deficiencies are generally not considered the kinds of problems that would result in an enforcement action. The statement addresses how the agencies evaluate violations of individual pillars of the Bank Secrecy Act and anti-money laundering (“AML/BSA”) compliance program. It describes how the agencies incorporate the customer due diligence regulations and recordkeeping requirements issued by the U.S. Department of the Treasury (“Treasury”) as part of the internal controls pillar of a financial institution's AML/BSA compliance program. Table of Contents 16 On September 16, 2020, FinCEN issued an advanced notice of proposed rulemaking seeking public comment on a wide range of potential regulatory amendments under the Bank Secrecy Act. The proposal seeks comments on incorporating an “effective and reasonably designed” AML/BSA program component to empower financial institutions to allocate resources more effectively. This component also would seek to implement a common understanding between supervisory agencies and financial institutions regarding the necessary AML/BSA program elements, and would seek to impose minimal additional obligations on AML programs that already comply under the existing supervisory framework. On October 23, 2020, FinCEN and the Federal Reserve invited comment on a proposed rule that would amend the recordkeeping and travel rules under the Bank Secrecy Act, which would lower the applicable threshold from $3,000 to $250 for international transactions and apply these rules to transactions using convertible virtual currencies and digital assets with legal tender status. On January 1, 2021, Congress enacted the Anti-Money Laundering Act of 2020 and the Corporate Transparency Act (collectively, the “AML Act”), to strengthen anti-money laundering and countering terrorism financing programs. Among other things, the AML Act: ● specifies uniform disclosure of beneficial ownership information for all U.S. and foreign entities conducting business in the U.S.; ● increases potential fines and penalties for BSA violations and improves whistleblower incentives; ● codifies the risk-based approach to AML compliance; ● modernizes AML systems; ● expands the duties and powers FinCEN; and ● emphasizes coordination and information-sharing among financial institutions, U.S. financial regulators and foreign financial regulators. The Corporate Transparency Act (the”CTA”) was adopted as Title LXIV of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021. FinCEN adopted a final regulation as 31 C.F.R. 101.380 on September 30, 2022 to implement the CTA. This became effective on January 1, 2024. These regulations require entities to report information about their beneficial owners and the individuals who created the entity (together, “beneficial ownership information” or “BOI”). FinCEN explained that the proposed rule would help protect the U.S. financial system from illicit use by making it more difficult for bad actors to conceal their financial activities through entities with opaque ownership structures. FinCEN also explained that the proposed reporting obligations would provide essential information to law enforcement and others to help prevent corrupt actors, terrorists, and proliferators from hiding money or other property in the United States.” The new rules expand financial institutions’ obligations under the Customer Due Diligence Rule (“CDD Rule”) to collect information and verify the beneficial ownership of legal entities. Although the Company and the Bank are exempt from the CTA’s requirements to report their respective beneficial owners, the new laws are likely to increase the Bank’s anti-money laundering diligence activities and costs. FinCEN published a request for information and comment on December 15, 2021 seeking ways to streamline, modernize the United States AML and countering the financing of terrorists. The United States has imposed various sanctions upon various foreign countries, such as China, Iran, North Korea, Russia and Venezuela, and their certain government officials and persons. Banks are required to comply with these sanctions, which require additional customer screening and transaction monitoring. Russia’s February 2022 invasion of Ukraine has generated a significant number of new sanctions on Russia, Russian persons and suppliers of military or dual-purpose products to Russia, The Federal bank regulators have issued alerts that Russia and others may step up cyber-attacks and data intrusions following the invasion. FinCen has issued four alerts on potential Russian illicit financial activity since February 2022. On January 25, 2023 FinCEN issued an alert to financial institutions on potential investments in the U.S. commercial real estate sector by sanctioned Russian elites, oligarchs, their family members, and the entities through which they act. The alert listed potential red flags and typologies involving attempted sanctions evasion in the commercial real estate sector, and reminds financial institutions of their Bank Secrecy Act (BSA) reporting obligations. H.R. 1164, the OFAC Outreach and Engagement Capabilities and Enhancement Act, was introduced in Congress on February 24, 2023. It would set up a review of and improve OFAC outreach and communications to assist financial institutions to better understand and comply with OFAC sanctions. Table of Contents 17 Other Laws and Regulations The Company is also required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as related rules and regulations adopted by the SEC, the Public Company Accounting Oversight Board and Nasdaq. In particular, the Company is required to report annually on internal controls as part of its annual report pursuant to Section 404 of the Sarbanes-Oxley Act. The Company has evaluated its controls, including compliance with the SEC and FDIC rules on internal controls, and expects to continue to spend significant amounts of time and money on compliance with these rules. If the Company fails to comply with these internal control rules in the future, it may materially adversely affect its reputation, its ability to obtain the necessary certifications to its financial statements, its relations with its regulators and other financial institutions with which it deals, and its ability to access the capital markets and offer and sell Company securities on terms and conditions acceptable to the Company. The Company’s assessment of its financial reporting controls as of December 31, 2022 are included in this report with no material weaknesses reported. Bank Dividends The Company is a legal entity separate and distinct from the Bank. Federal Reserve Regulation Q limits “distributions,” including discretionary bonus payments from eligible retained income” by state member banks, such as the Bank, unless its capital conservation buffer of common equity Tier 1 capital (“CET1”) exceeds 2.5%. “Distributions” include dividends declared or paid on common stock, discretionary bonuses and stock repurchases, redemptions or repurchases of Tier 2 capital instruments (unless replaced by a capital instrument in the same quarter). “Eligible retained income” for the Bank and other Federal Reserve regulated institutions is the greater of: ● net income for the four preceding calendar quarters, net of any distributions and associated tax effects not already reflected in net income; or ● the average net income over the preceding four quarters. The Company’s primary source of cash is dividends from the Bank. The Bank’s Call Report are used for its calculation of “eligible retained income.” The Bank’s capital conservation buffer exceeded 2.5% at December 31, 2023. As of December 31, 2023, the Bank is “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the Bank must maintain minimum common equity Tier 1, total risk-based, Tier 1 risk- based, and Tier 1 leverage ratios as set forth in the following table. Management has not received any notification from the Bank's regulators that changes the Bank’s regulatory capital status. Prior regulatory approval also is required by statute if the total of all dividends declared by a state member bank (such as the Bank) in any calendar year will exceed the sum of such bank’s net profits for the year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. During 2023, the Bank paid total cash dividends of approximately $3.8 million to the Company. At December 31, 2023, the Bank had net profits for the year and its retained net profits for the preceding two calendar years, less any required transfers to surplus, of $8.2 million. In addition, the Company and the Bank are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain capital above regulatory minimums. The appropriate federal and state regulatory authorities are authorized to determine when the payment of dividends would be an unsafe or unsound practice, and may prohibit such dividends. The Federal Reserve has indicated that paying dividends that deplete a state member bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve has indicated that depository institutions and their holding companies should generally pay dividends only out of current year’s operating earnings. See “Regulatory Capital Changes” and Note 16 to the Company’s consolidated financial statements. Table of Contents 18 Federal Reserve Supervisory Letter SR-09-4 (February 24, 2009), as revised December 21, 2015, applies to dividend payments, stock redemptions and stock repurchases. Prior consultation with the Federal Reserve supervisory staff is required before: ● redemptions or repurchases of capital instruments when the bank holding company is experiencing financial weakness; and ● redemptions and purchases of common or perpetual preferred stock which would reduce such Tier 1 capital at end of the period compared to the beginning of the period. Bank holding company directors must consider different factors to ensure that its dividend level is prudent relative to maintaining a strong financial position, and is not based on overly optimistic earnings scenarios, such as potential events that could affect its ability to pay, while still maintaining a strong financial position. As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should consult with the Federal Reserve and eliminate, defer or significantly reduce the bank holding company’s dividends if: ● its net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; ● its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or ● It will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Capital The Federal Reserve has risk-based capital guidelines for bank holding companies and state member banks, respectively. These guidelines required, beginning December 31, 2019, a minimum ratio of capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) and capital conservation buffer, totaling 10.5%. Tier 1 capital includes common equity and related retained earnings and a limited amount of qualifying preferred stock, less goodwill and certain core deposit intangibles. Voting common equity must be the predominant form of capital. Tier 2 capital consists of non–qualifying preferred stock, qualifying subordinated, perpetual, and/or mandatory convertible debt, term subordinated debt and intermediate term preferred stock, up to 45% of pretax unrealized holding gains on available for sale equity securities with readily determinable market values that are prudently valued, and a limited amount of general loan loss allowance. Tier 1 and Tier 2 capital equals total capital. In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies not subject to the Small BHC Policy, and state member banks, which provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets (“leverage ratio”) equal to 4%. However, bank regulators expect banks and bank holding companies to operate with a higher leverage ratio. The guidelines also provide that institutions experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Higher capital may be required in individual cases and depending upon a bank holding company’s risk profile. All bank holding companies and banks are expected to hold capital commensurate with the level and nature of their risks including the volume and severity of their problem loans. Lastly, the Federal Reserve’s guidelines indicate that the Federal Reserve will continue to consider a “tangible Tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or new activities. The level of Tier 1 capital to risk-adjusted assets is becoming more widely used by the bank regulators to measure capital adequacy. The Federal Reserve has not advised the Company or the Bank of any specific minimum leverage ratio or tangible Tier 1 leverage ratio applicable to them. Under Federal Reserve policies, bank holding companies are generally expected to operate with capital positions well above the minimum ratios. The Federal Reserve believes the risk-based ratios do not fully take into account the quality of capital and interest rate, liquidity, market and operational risks. Accordingly, supervisory assessments of capital adequacy may differ significantly from conclusions based solely on the level of an organization’s risk-based capital ratio. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, requires the federal banking agencies to take “prompt corrective action” regarding depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation. See “Prompt Corrective Action Rules.” Table of Contents 19 Basel III Capital Rules The Federal Reserve and the other bank regulators adopted in June 2013 final capital rules for bank holding companies and banks implementing the Basel Committee on Banking Supervision’s “Basel III: A Global Regulatory Framework for more Resilient Banks and Banking Systems.” These U.S. capital rules are called the “Basel III Capital Rules,” and generally were fully phased-in on January 1, 2019. These are included in Federal Reserve Regulation Q. The Basel III Capital Rules limit Tier 1 capital to common stock and noncumulative perpetual preferred stock, as well as certain qualifying trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010, each of which were grandfathered in Tier 1 capital for bank holding companies with less than $15 billion in assets. The Company had no qualifying trust preferred securities or cumulative preferred stock outstanding at December 31, 2021 or 2022. The Basel III Capital Rules also introduced a new capital measure, “Common Equity Tier I Capital” or “CET1.” CET1 includes common stock and related surplus, retained earnings, and subject to certain adjustments, minority common equity interests in subsidiaries. CET1 is reduced by deductions for: ● Goodwill and other intangibles, other than mortgage servicing assets (“MSRs”), which are treated separately, net of associated deferred tax liabilities (“DTLs”); ● Deferred tax assets (“DTAs”) arising from operating losses and tax credit carryforwards net of allowances and DTLs; ● Gains on sale from any securitization exposure; and ● Defined benefit pension fund net assets (i.e., excess plan assets), net of associated DTLs. The Company made a one-time election in 2015 and, as a result, the Company’s CET1 is not adjusted for certain accumulated other comprehensive income (“AOCI”). Additional “threshold deductions” of the following that are individually greater than 10% of CET1 or collectively greater than 15% of CET1 (after the above deductions are also made): ● MSAs, net of associated DTLs; ● DTAs arising from temporary differences that could not be realized through net operating loss carrybacks, net of any valuation allowances and DTLs; and ● Significant common stock investments in unconsolidated financial institutions, net of associated DTLs. Noncumulative perpetual preferred stock and Tier 1 minority interest not included in CET1, subject to limits, will qualify as additional Tier I capital. All other qualifying preferred stock, subordinated debt and qualifying minority interests will be included in Tier 2 capital. Regulatory Capital Changes Simplification The federal bank regulators issued final rules on July 22, 2019 simplifying their capital rules. The last of these changes become effective on April 1, 2020. The principal changes for standardized approaches institutions, such the Company and the Bank are: ● Deductions from capital for certain items, such as temporary difference DTAs, MSAs and investments in unconsolidated subsidiaries were decreased to those amounts that individually exceed 25% of CET1; ● Institutions can elect to deduct investments in unconsolidated subsidiaries or subject them to capital requirements; and ● Minority interests would be includable up to 10% of (i) CET1 capital, (ii) Tier 1 capital and (iii) total capital. Table of Contents 20 HVCRE In December 2019, the federal banking regulators published a final rule, effective April 1, 2020, to implement the “high volatility commercial real estate,” or “HVCRE” changes in Section 214 of the 2018 Growth Act. Any HVCRE exposure excludes loans made before January 1, 2015. The rules define HVCRE loans as loans secured by land or improved real property that: ● primarily finance or refinance the acquisition, development, or construction of real property; ● the purpose of such loans must be to acquire, develop, or improve such real property into income producing property; and ● the repayment of the loan must depend on the future income or sales proceeds from, or refinancing of, such real property. Various exclusions from HVCRE are specified. The full value of any borrower contributed land (net of any liens on the land securing HVCRE exposure) count toward the 15% capital contribution to the appraised as completed value, which is one of the criteria for exemption form the heightened risk weight. Banking institutions and their holding companies are required to assign 150% risk weight to HVCRE loans. Capital Conservation Buffer In addition to the minimum risk-based capital requirements, a “capital conservation buffer” of CET1 capital of at least 2.5%, is required. The capital conservation buffer will be calculated as the lowest of: ● the banking organization’s CET1 capital ratio minus 4.5%; ● the banking organization’s tier 1 risk-based capital ratio minus 6.0%; and ● the banking organization’s total risk-based capital ratio minus 8.0%. Full compliance with the capital conservation buffer was required beginning January 1, 2019. Thereafter, permissible dividends, stock repurchases and discretionary bonuses will be limited to the following percentages based on the capital conservation buffer as calculated above, subject to any further regulatory limitations, including those based on risk assessments and enforcement actions: Capital Conservation Buffer % Buffer % Limit More than 2.50% None > 1.875% - 2.50% 60.0% > 1.250% - 1.875% 40.0% > 0.625% - 1.250% 20.0% ≤ 0.625 - 0 - On March 20, 2020, the Federal Reserve and the other federal banking regulators adopted an interim final rule that amended the capital conservation buffer in light of the disruptive effects of the COVID-19 pandemic. This clarifying rule revises the definition of “eligible retained income” for purposes of the maximum payout ratio to allow banking organizations to more freely use their capital buffers to promote lending and other financial intermediation activities, by making the limitations on capital distributions more gradual. The eligible retained income, as used in the Federal Reserve’s Regulation Q capital rule, as corrected on January 13, 2021, is the greater of (i) net income for the four preceding quarters, net of distributions and associated tax effects not reflected in net income; and (ii) the average of all net income over the preceding four quarters. Banking organizations were encouraged to make prudent capital distribution decisions. Table of Contents 21 Basel III Capital The various capital elements and total capital under the Basel III Capital Rules, as fully phased in on January 1, 2019 are: Fully Phased In January 1, 2019 Minimum CET1 4.50% CET1 Conservation Buffer 2.50% Total CET1 7.0% Deductions from CET1 100% Minimum Tier 1 Capital 6.0% Minimum Tier 1 Capital plus conservation buffer 8.5% Minimum Total Capital 8.0% Minimum Total Capital plus conservation buffer 10.5% Changes in Risk-Weightings The Basel III Capital Rules significantly change the risk weightings used to determine risk weighted capital adequacy. Among various other changes, the Basel III Capital Rules apply a 250% risk-weighting to MSRs, DTAs that cannot be realized through net operating loss carrybacks and significant (greater than 10%) investments in other financial institutions. A 150% risk-weighted category applies to “high volatility commercial real estate loans,” or “HVCRE,” which are credit facilities for the acquisition, construction or development of real property, excluding one-to-four family residential properties or commercial real estate projects where: (i) the loan-to-value ratio is not in excess of interagency real estate lending standards; and (ii) the borrower has contributed capital equal to not less than 15% of the real estate’s “as completed” value before the loan was made. The Basel III Capital Rules also changed some of the risk weightings used to determine risk -weighted capital adequacy. Among other things, the Basel III Capital Rules: ● Assigned a 250% risk weight to MSRs; ● Assigned up to a 1,250% risk weight to structured securities, including private label mortgage securities, trust preferred CDOs and asset backed securities; ● Retained existing risk weights for residential mortgages, but assign a 100% risk weight to most commercial real estate loans and a 150% risk-weight for HVCRE; ● Assigned a 150% risk weight to past due exposures (other than sovereign exposures and residential mortgages); ● Assigned a 250% risk weight to DTAs, to the extent not deducted from capital (subject to certain maximums); ● Retained the existing 100% risk weight for corporate and retail loans; and ● Increased the risk weight for exposures to qualifying securities firms from 20% to 100%. In December 2019 the federal bank regulators revised their definition of HVCRE and related capital requirements consistent with Section 214 of the 2018 Growth Act. The Financial Accounting Standards Board’s (“FASB”) Accounting Standards Update (“ASU”) No. 2016-13 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” on June 16, 2016, which changed the loss model to take into account current expected credit losses (“CECL”) in place of the incurred loss method. The Federal Reserve and the other federal banking agencies adopted rules effective on April 1, 2019 that allows banking organizations to phase in the regulatory capital effect of a reduction in retained earnings upon adoption of CECL over a three-year period. On May 8, 2020, the agencies issued a statement describing the measurement of expected credit losses using the CECL methodology, and updated concepts and practices in existing supervisory guidance that remain applicable. CECL became effective for the Company beginning January 1, 2023. Table of Contents 22 Federal Reserve Capital Review The Federal Reserve’s Vice Chair for Supervision has indicated he is considering a holistic review of regulatory capital requirements, which are expected to focus on banking organizations larger than the Company. Prompt Corrective Action Rules All of the federal bank regulatory agencies’ regulations establish risk-adjusted measures and relevant capital levels that implement the “prompt corrective action” standards. The relevant capital measures are the total risk-based capital ratio, Tier 1 risk-based capital ratio, Common equity tier 1 capital ratio, as well as the leverage capital ratio. Under the regulations, a state member bank will be: ● well capitalized if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 8% or greater, a Common equity tier 1 capital ratio of 6.5% or greater, a leverage capital ratio of 5% or greater and is not subject to any written agreement, order, capital directive or prompt corrective action directive by a federal bank regulatory agency to maintain a specific capital level for any capital measure; ● “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a Common Equity Tier 1 capital ratio of 4.5% or greater, and generally has a leverage capital ratio of 4.0% or greater; ● “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a Common Equity Tier 1 capital ratio of less than 4.5% or generally has a leverage capital ratio of less than 4.0%; ● “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a Common Equity Tier 1 capital ratio of less than 3%, or a leverage capital ratio of less than 3.0%; or ● “critically undercapitalized” if its tangible equity is equal to or less than 2.0% to total assets. The federal bank regulatory agencies have authority to require additional capital where they determine it is necessary, including where a bank is unsafe or unsound condition or where the bank is determined to have less than a satisfactory rating on any of its CAMELS ratings. The regulators have confirmed that higher capital levels may be required in light of market conditions and risk. Depository institutions that are “adequately capitalized” for bank regulatory purposes must receive a waiver from the FDIC prior to accepting or renewing brokered deposits, and cannot pay interest rates or brokered deposits that exceeds market rates by more than 75 basis points. Banks that are less than “adequately capitalized” cannot accept or renew brokered deposits. FDICIA generally prohibits a depository institution from making any capital distribution, including paying dividends or any management fee to its holding company, if the depository institution thereafter would be “undercapitalized”. Institutions that are “undercapitalized” are subject to growth limitations and are required to submit a capital restoration plan for approval. A depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of 5% of the depository institution’s total assets at the time it became undercapitalized and the amount necessary to bring the institution into compliance with applicable capital standards. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized”. If the controlling holding company fails to fulfill its obligations under FDICIA and files (or has filed against it) a petition under the federal Bankruptcy Code, the claim against the holding company’s capital restoration obligation would be entitled to a priority in such bankruptcy proceeding over third-party creditors of the bank holding company. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized”, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator. Because the Company and the Bank exceed applicable capital requirements, Company and Bank management do not believe that the prompt corrective action provisions of FDICIA have had or are expected to have any material effect on the Company and the Bank or their respective operations. Table of Contents 23 Community Bank Leverage Ratio Framework Section 201 of the 2018 Growth Act provides that banks and bank holding companies with consolidated assets of less than $10 billion that meet a “community bank leverage ratio,” established by the federal bank regulators as part of the community bank leverage ratio framework (“CBLR”). The federal banking agencies have the discretion to determine that an institution does not qualify for such treatment due to its risk profile. An institution’s risk profile may be assessed by its off-balance sheet exposure, trading of assets and liabilities, notional derivatives’ exposure, and other methods. The CBLR framework which became effective January 1, 2020, allows qualifying CBOs to adopt a simple leverage ratio to measure capital adequacy. The CBLR may be elected by depository institutions and their holding companies and is intended to reduce regulatory burdens for qualifying community banking organizations that do not use advanced approaches capital measures, and otherwise qualify. Eligible institutions must have: ● less than $10 billion of assets; ● a leverage ratio greater than 9%; ● off-balance sheet exposures of 25% or less of total consolidated assets; and ● trading assets plus trading liabilities of less than 5% of total consolidated assets. The CBLR leverage ratio is Tier 1 capital divided by average total consolidated asset for the latest quarter, taking into account the capital simplification discussed above and the CECL related capital transitions. A CBLR banking organization with a ratio above the requirement will not be subject to other capital and leverage requirements. If elected by a banking organization, The CBLR leverage ratio will be the sole capital measure, and electing institutions will not have to calculate or use any other capital measure for regulatory purposes. The Company has not adopted the CBLR, although it believes it is eligible to elect to use the CBLR framework. Management believes that current risk-based capital measures are useful and reflect the risks of the Company’s earning assets in a manner most comparable to other banking organizations and which may be useful to investors. It may consider the CBLR in the future. FDICIA FDICIA directs that each federal bank regulatory agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth composition, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares, safety and soundness, and such other standards as the federal bank regulatory agencies deem appropriate. Enforcement Policies and Actions The Federal Reserve and the Alabama Superintendent examine and regulate our compliance with laws and regulations, including the CFPB’s regulations. The CFPB issues regulations, interpretations and enforcement actions under the laws applicable to consumer financial products and services. Violations of laws and regulations, including those administered by the CFPB, or other unsafe and unsound practices, may result in the Federal Reserve and the Alabama Superintendent imposing fines, penalties and/or restitution, cease and desist orders, or taking other formal or informal enforcement actions. Under certain circumstances, these agencies may enforce these remedies directly against officers, directors, employees and others participating in the affairs of a bank or bank holding company, in the form of fines, penalties, or the recovery, or claw-back, of compensation. Fiscal and Monetary Policies Banking is a business that depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a bank’s earnings. Thus, the earnings and growth of the Company and the Bank, as well as the values of, and earnings on, its assets and the costs of its deposits and other liabilities are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of money through various means, including open market dealings in United States government securities, the setting of discount rate at which banks may borrow from the Federal Reserve, and the reserve requirements on deposits. Table of Contents 24 The Federal Reserve has been paying interest on depository institutions’ required and excess reserve balances since October 2008. The payment of interest on excess reserve balances was expected to give the Federal Reserve greater scope to use its lending programs to address conditions in credit markets while also maintaining the federal funds rate close to the target rate established by the Federal Open Market Committee. The Federal Reserve has indicated that it may use this authority to implement a mandatory policy to reduce excess liquidity, in the event of inflation or the threat of inflation. In April 2010, the Federal Reserve Board amended Regulation D (Reserve Requirements of Depository Institutions) authorizing the Reserve Banks to offer term deposits to certain institutions. Term deposits, which are deposits with specified maturity dates, will be offered through a Term Deposit Facility. Term deposits will be one of several tools that the Federal Reserve could employ to drain reserves when policymakers judge that it is appropriate to begin moving to a less accommodative stance of monetary policy. In 2011, the Federal Reserve repealed its historical Regulation Q to permit banks to pay interest on demand deposits. In light of disruptions in economic conditions caused by the outbreak of COVID-19 and the stress in U.S. financial markets, the Federal Reserve, Congress and the Department of the Treasury took a host of fiscal and monetary measures to minimize the economic effect of COVID-19. On March 3, 2020, the Federal Reserve reduced the Federal Funds rate target by 50 basis points to 1.00-1.25%. The Federal Reserve further reduced the Federal Funds Rate target by an additional 100 basis points to 0-0.25% on March 16, 2020. The Federal Reserve established various liquidity facilities pursuant to section 13(3) of the Federal Reserve Act to help stabilize the financial system and purchased large amounts of government and mortgaged backed securities. The CARES Act provided a $2 trillion stimulus package and various measures to provide relief from the COVID-19 pandemic, including: ● The Paycheck Protection Program (“PPP”), which expands eligibility for special new SBA guaranteed loans, forgivable loans and other relief to small businesses affected by COVID-19. ● A new $500 billion federal stimulus program for air carriers and other companies in severely distressed sectors of the American economy. The lending programs impose stock buyback, dividend, executive compensation, and other restrictions on direct loan recipients. ● Optional temporary suspension of certain requirements under ASC 340-10 TDR classifications for a limited period of time to account for the effects of COVID-19. ● The creation of rapid tax rebates and expansion of unemployment benefits to provide relief to individuals. ● Substantial federal spending and significant changes for health care companies, providers, and patients. ● Over $525 billion of PPP loans were made in 2020. On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”) was signed into law. The Economic Aid Act provided a second $900 billion stimulus package, including $325 billion in additional PPP loans, changed the eligibility rules to focus more on smaller business, further enhances other Small Business Association programs. During 2021 and at the beginning of 2022, the Federal Reserve described inflation as “transitory,” but as inflation continued at increasing rates the Federal Reserve’s policy changed. The Federal Reserve announced a 25 basis point increase in the target federal funds range on March 17, 2022, the first change since March 2020 when the target was set to 0-0.25%. Further increases were announced in 2022: 50 basis points on May 4, 75 basis points on each of June 15, July 27, September 21, and November 2, and 50 basis points on December 14, 2022. During 2023, the Federal Reserve announced additional target rate increases of 25 basis points on each of February 1, 2023, March 2022, May 3 and July 26, 2023. The federal funds target rate range remains at 5.25-5.50% at March 12, 2024. Table of Contents 25 The Federal Reserve’s securities holdings in its System Open Market Account (“SOMA”) increased from $4.1 trillion on December 30, 2019 to $9.0 trillion at April 11, 2021, largely as a result of securities purchases as the Federal Reserve injected liquidity as a result of the COVID-19 pandemic. On May 4, 2022, the Federal Reserve announced its plan to reduce its securities holdings in an effort to reduce inflation: ● Reinvestments of principal of maturing Treasury securities would be reduced by $30 billion per month for three months and thereafter would be $80 billion per month. ● Reinvestments of principal of maturing agency debt and mortgage-backed securities would be reduced by $17.5 billion per month for three months and thereafter would be $35 billion per month. ● These declines would slow and then stop when the Federal Reserve’s balance sheet was somewhat above the balance it deemed ample. The Federal Reserve’s SOMA was $7.0 trillion on February 28, 2024 compared to $8.4 trillion on February 13, 2023. The Federal Reserve seeks to target longer term inflation of 2% based on annual changes in the personal consumption expenditures. The Federal Reserve stated on February 1, 2023 that its Federal Open Market Committee is highly attentive to inflation risks and the war in Ukraine is contributing to elevated global uncertainty. Inflation remained above that rate through February 2023. The Chairman of the Federal Reserve’s testimony to the Senate Banking Committee on March 7, 2023 that inflation remains well above the target, gross domestic product in 2022 was 0.9%, below the trend. Higher rates have adversely affected the housing sector and combined with slower output growth, “appear to be weighing on business fixed investment.” The labor market is “extremely tight.” The Chairman concluded: “We continue to anticipate that ongoing increases in the target range for the federal funds rate will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time. In addition, we are continuing the process of significantly reducing the size of our balance sheet. Although inflation has been moderating in recent months, the process of getting inflation back down to 2% has a long way to go and is likely to be bumpy. As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes. Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time.” Although the Federal Reserve Chairman continues to maintain the 2% long term target inflation, he has indicated that the Federal Reserve is “data dependent” and that it could cut rates depending on the data and whether recent declines in inflation appear sustained, and alternatively, raise rates if appropriate in pursuit of its long term target inflation. The nature and timing of these ongoing changes in monetary policies and their effects on the Company and the Bank cannot be predicted. On March 12, 2023, as a result of unrealized securities losses resulting from increased market rates, liquidity issues at two banks with over $100 billion of assets which failed, the Federal Reserve established a new Bank Term Funding Program (“BTFP”). The BTFP offered loans of up to one year to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets were valued at par and the margin was 100% of par. The BTFP expires March 11, 2024, except for loans outstanding prior to its expiration. The Company did not participate in the BTFP in 2023. The Federal Reserve on March 12, 2023 stated that depository institutions also may obtain liquidity against a wide range of collateral through the Federal Reserve’s discount window, which was available with the same collateral margins as the BTFP, but which offers loans of up to 90 days. Collateral is valued under the discount window is based on fair market values, collateral margins subsequently have been reduced to less than 100% of collateral fair market value, with the amount of discount depending on the type of collateral. FDIC Insurance Assessments The Bank’s deposits are insured by the FDIC’s DIF, and the Bank is subject to FDIC assessments for its deposit insurance. Since 2011, and as discussed above under “Recent Regulatory Developments”, the FDIC has been calculating assessments based on an institution’s average consolidated total assets less its average tangible equity (the “FDIC Assessment Base”) in accordance with changes mandated by the Dodd-Frank Act. The FDIC changed its assessment rates which shifted part of the burden of deposit insurance premiums toward depository institutions relying on funding sources other than deposits. Table of Contents 26 In 2016, the FDIC again changed its deposit insurance pricing and eliminated all risk categories and now uses “financial ratios method” based on CAMELS composite ratings to determine assessment rates for small established institutions with less than $10 billion in assets (“Small Banks”). The financial ratios method sets a maximum assessment for CAMELS 1 and 2 rated banks, and set minimum assessments for lower rated institutions. All basis points are annual amounts. The following table shows the FDIC assessment schedule for Small Banks, such as the Bank, for the first assessment period of 2023 to be billed in June 2023, which is the latest available: Established Small Institution CAMELS Composite 1 or 2 3 4 or 5 Initial Base Assessment Rule 5 to 18 basis points 8 to 32 basis points 18 to 32 basis points Unsecured Debt Adjustment. Cannot exceed the lesser of 5 basis points or 50% of the bank’s initial FDIC assessment rate -5 to 0 basis points -5 to 0 basis points -5 to 0 basis points Brokered Deposit Adjustment N/A N/A N/A Total Base Assessment Rate 2.5 to 18 basis points 4 to 32 basis points 13 to 32 basis points As shown above. these assessments are adjusted based on the bank’s CAMELS rating. For example, Small Banks, with CAMELS ratings of 1 or 2, have a current total assessment rate of 2.5 to 18 basis points for the period to be billed in June 2023. The FDIC issued a special assessment of 3.36 basis points for a projected eight quarters on large banks with more than $5 billion of uninsured deposits as a result of the systemic risk determination to insure all depositors in connection with the March 2023 failures of Silicon Valley Bank and Signature Bank. These special assessments do not apply to the Bank. The minimum FDIC’s DIF reserve ratio is 1.35%, which was set by the Dodd-Frank Act. The FDIC Board of directors is required by the Federal Deposit Insurance Act to designate a reserve ratio before the beginning of each calendar year. There is no upper limit on the reserve ratio and thus, no statutory limit on the size of the fund. The FDI Act provides for dividends from the fund when the reserve ratio exceeds 1.5 percent, but grants the Board sole discretion in determining whether to suspend or limit the declaration or payment of dividends. The reserve ratio reached 1.36% on September 30, 2018, exceeding the minimum requirement. As a result, deposit insurance surcharges on Large Banks ceased, and smaller banks received credits against their deposit assessments from the FDIC for their portion of assessments that contributed to the growth in the reserve ratio from 1.15% to 1.35%. The Bank’s credit was $0.2 million, and was received and applied against the Bank’s deposit insurance assessments during 2019 and 2020. Because of the extraordinary growth in deposits in the first six months of 2020 due to the pandemic and government stimulus, the DIF’s reserve ratio declined below 1.35% to 1.30%. The FDIC issued a restoration plan on September 15, 2020 designed to restore the reserve ratio to at least the statutory minimum of 1.35% within 8 years. Although the FDIC, at that time, maintained its then current assessment rates, the FDIC may increase deposit assessment rates by up to two basis points without notice, or more following notice and a comment period, to meet the required reserve ratio. The designated reserve ratio has been 2% since 2010, and was set at this same level for 2024. On June 22, 2020, the FDIC issued a final rule designed to mitigate the deposit insurance assessment effect of the PPP and the related liquidity programs (the “PPPLF”) established by the Federal Reserve. Specifically, the rule removes the effects of participating in PPP and liquidity facilities from the various risk measures used to calculate assessment rates and provides an offset to assessments for the increase in assessment base rates attributed to participation in the PPP and liquidity facilities. This had a limited effect on the Bank since it had only one PPP loan of approximately $0.1 million outstanding on December 31, 2023, and because the Bank never participated in the PPPLF. The Company recorded FDIC insurance premiums expenses of $0.5 and $0.3 million in 2023 and 2022, respectively, which reflects the FDIC’s amended restoration plan increases in the initial base deposit insurance assessment rate schedules uniformly by 2 basis points, beginning with the first quarterly assessment period of 2023. Table of Contents 27 Lending Practices CRE The federal bank regulatory agencies released guidance in 2006 on “Concentrations in Commercial Real Estate Lending” (the “CRE Guidance”). The CRE Guidance defines CRE loans as exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential 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 this property. Loans to REITs and unsecured loans to developers that closely correlate to the inherent risks in CRE markets would also be considered CRE loans under the CRE Guidance. Loans on owner occupied CRE are generally excluded. In December 2015, the Federal Reserve and other bank regulators issued an interagency statement to highlight prudent risk management practices from existing guidance that regulated financial institutions and made recommendations regarding maintaining capital levels commensurate with the level and nature of their CRE concentration risk. The CRE Guidance requires that banks have appropriate processes be in place to identify, monitor and control risks associated with real estate lending concentrations. This could include enhanced strategic planning, CRE underwriting policies, risk management, internal controls, portfolio stress testing and risk exposure limits as well as appropriately designed compensation and incentive programs. Higher allowances for loan losses and capital levels may also be required. The CRE Guidance is triggered when either: ● Total reported loans for construction, land development, and other land of 100% or more of a bank’s total capital; or ● Total reported loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development, and other land are 300% or more of a bank’s total risk-based capital. This CRE Guidance was supplemented by the Interagency Statement on Prudent Risk Management for Commercial Real Estate Lending (December 18, 2015). The CRE Guidance also applies when a bank has a sharp increase in CRE loans or has significant concentrations of CRE secured by a particular property type. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Balance Sheet Analysis” for concentrations of the various types of CRE loans. At December 31, 2023, the Bank had outstanding $68.3 million in construction and land development loans and $293.0 million in total CRE loans (excluding owner occupied properties), which represent approximately 62% and 264%, respectively, of the Bank’s total risk-based capital at December 31, 2023. The Company has always had significant exposures to loans secured by commercial real estate due to the nature of its markets and the loan needs of both its retail and commercial customers. The Company believes its long-term experience in CRE lending, underwriting policies, internal controls, and other policies currently in place, as well as its loan and credit monitoring and administration procedures, are generally appropriate to manage its concentrations as required under the Guidance. The Federal Reserve joined the other depository institution regulators in issuing a Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts on June 30, 2023. This Policy Statement builds on and updates existing guidance to enable financial institutions to work prudently and constructively with creditworthy borrowers during times of financial stress. The Policy Statement provides a broad set of risk management principles relevant to CRE short term loan accommodations and longer term workouts in all business cycles, particularly in challenging economic environments. It states that the regulatory agencies expect their examiners to take a balanced approach in assessing the adequacy of a financial institution's risk management practices for loan accommodation and workout activities. Financial institutions that implement prudent CRE loan accommodation and workout arrangements after performing a comprehensive review of a borrower's financial condition will not be subject to criticism for engaging in these efforts, even if these arrangements result in modified loans that have weaknesses that result in adverse classification. In addition, modified loans to borrowers who have the ability to repay their debts according to reasonable terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the outstanding loan balance. The Policy Statement also describes the classifications of CRE loan accommodations and workouts and addresses regulatory accounting and reporting in such situations, including CECL. Table of Contents 28 Leveraged Lending In 2013, the Federal Reserve and other banking regulators issued their “Interagency Guidance on Leveraged Lending” highlighting standards for originating leveraged transactions and managing leveraged portfolios, as well as requiring banks to identify their highly leveraged transactions, or HLTs. The Government Accountability Office issued a statement on October 23, 2017 that this guidance constituted a “rule” for purposes of the Congressional Review Act, which provides Congress with the right to review the guidance and issue a joint resolution for signature by the President disapproving it. No such action was taken, and instead, the federal bank regulators issued a September 11, 2018 “Statement Reaffirming the Role of Supervisory Guidance.” This Statement indicated that guidance does not have the force or effect of law or provide the basis for enforcement actions, but this guidance can outline supervisory agencies’ views of supervisory expectations and priorities, and appropriate practices. The federal bank regulators continue to identify elevated risks in leveraged loans and shared national credits. The Bank did not have any loans at year-end 2023 or 2022 that were leveraged loans subject to the Interagency Guidance on Leveraged Lending or that were shared national credits. Other Dodd-Frank Act Provisions In addition to the capital, liquidity and FDIC deposit insurance changes discussed above, some of the provisions of the Dodd-Frank Act we believe may affect us are set forth below. Executive Compensation, etc. The Dodd-Frank Act provides shareholders of all public companies with a say on executive compensation. Under the Dodd-Frank Act, each company must give its shareholders the opportunity to vote on the compensation of its executives, on a non-binding advisory basis, at least once every three years. The Dodd-Frank Act also adds disclosure and voting requirements for golden parachute compensation that is payable to named executive officers in connection with sale transactions. The SEC is required under the Dodd-Frank Act to issue rules obligating companies to disclose in proxy materials for annual shareholders meetings, information that shows the relationship between executive compensation actually paid to their named executive officers and their financial performance, taking into account any change in the value of the shares of a company’s stock and dividends or distributions. The Dodd-Frank Act also provides that a company’s compensation committee may only select a consultant, legal counsel or other advisor on methods of compensation after taking into consideration factors to be identified by the SEC that affect the independence of a compensation consultant, legal counsel or other advisor. Section 954 of the Dodd-Frank Act added section 10D to the Exchange Act. Section 10D directs the SEC to adopt rules prohibiting a national securities exchange or association from listing a company unless it develops, implements, and discloses a policy regarding the recovery or “claw-back” of executive compensation in certain circumstances. The policy must require that, in the event an accounting restatement due to material noncompliance with a financial reporting requirement under the federal securities laws, the company will recover from any current or former executive officer any incentive-based compensation (including stock options) received during the three year period preceding the date of the restatement, which is in excess of what would have been paid based on the restated financial statements. There is no requirement of wrongdoing by the executive, and the claw-back is mandatory and applies to all executive officers. Section 954 augments section 304 of the Sarbanes-Oxley Act, which requires the CEO and CFO to return any bonus or other incentive- or equity-based compensation received during the 12 months following the date of similarly inaccurate financial statements, as well as any profit received from the sale of employer securities during the period, if the restatement was due to misconduct. Unlike section 304, under which only the SEC may seek recoupment, the Dodd -Frank Act requires the Company to seek the return of compensation. The SEC adopted, effective January 27, 2023, Commission Rule 10D-1 under the Exchange Act, which requires each national securities exchange to adopt listing standards for the recovery of erroneously awarded executive compensation. The Commission approved Nasdaq Listing Rule 5608 (“Rule 5608”) on June 9, 2023. Under Rule 10D-1, listed companies must recover from current and former executive officers’ incentive-based compensation received during the three completed fiscal years preceding the date on which the issuer is required to prepare an accounting restatement. Table of Contents 29 Under these SEC and Nasdaq rules, the recovery of erroneously awarded compensation is required on a “no fault” basis, without regard to whether any misconduct occurred or an executive officer’s responsibility for the erroneous financial statements. A restatement due to material noncompliance with any financial reporting requirement under the securities laws triggers application of the recovery policy. The determination regarding materiality of an error should be based on facts and circumstances and existing judicial and administrative interpretations. The proposed Nasdaq Rule requires recovery for restatements that correct errors that are material to previously issued financial statements (commonly referred to as “Big R” restatements), as well as for restatements that correct errors that are not material to previously issued financial statements but would result in a material misstatement if the errors were left uncorrected in the current report or the error correction was recognized in the current period (commonly referred to as “little r” restatement). Nasdaq-listed companies, such as the Company, are required to recover the amount of incentive-based compensation received by an executive officer that exceeds the amount the executive officer would have received had the incentive-based compensation been determined based on the accounting restatement, computed without regard to any taxes paid. Nasdaq defines “incentive-based compensation” as any compensation that is granted, earned or vested based wholly or in part upon the attainment of any “financial reporting measure.” Incentive-based compensation is deemed received on or after October 2, 2023 and in the fiscal period during which the financial reporting measure specified in the incentive-based compensation award is attained, even if the grant or payment of the incentive-based compensation occurs after the end of that period. The Company adopted an Erroneously Awarded Executive Incentive Based Compensation Policy effective December 1, 2023 to comply with these rules. The SEC adopted a rule in August 2013 to implement pay ratios pursuant to Section 953 of the Dodd-Frank Act comparing their CEO’s total compensation to the median compensation of all other employees. These rules applied beginning to fiscal year 2017 annual reports and proxy statements. Smaller reporting companies, such as the Company, are exempted from this rule. The Dodd-Frank Act, Section 955, requires the SEC, by rule, to require that each company disclose in the proxy materials for its annual meetings whether an employee or board member is permitted to purchase financial instruments designed to hedge or offset decreases in the market value of equity securities granted as compensation or otherwise held by the employee or board member. The SEC adopted changes to its Reg. S-K Item 407(i) implementing this Section. The Company expects to adopt appropriate policies upon shareholder approval an equity incentive plan at the Annual Stockholders’ meeting in 2024. The Company’s has had no equity-based compensation plans or arrangements, but expects to seek stockholder approval of an equity incentive plan at the Annual Stockholders’ meeting in 2024. The Company’s insider trading policy, which applies to all Company and Bank directors, officers, employees and certain independent contractors and specified related persons (collectively, “Covered Persons”). This Policy prohibits Covered Persons, from short-selling Company securities or engaging in transactions involving Company “Derivative Securities.” This prohibition includes, without limitation, trading in Company-based put option contracts, including straddles, and the like. Derivative Securities include options, warrants, restricted stock units, stock appreciation rights or similar rights whose value is derived from the value of an equity or other security, including Company Securities. Section 956 of the Dodd-Frank Act prohibits incentive-based compensation arrangements that encourage inappropriate risk taking by covered financial institutions, are deemed to be excessive, or that may lead to material losses. In June 2010, the federal bank regulators adopted Guidance on Sound Incentive Compensation Policies, which, although targeted to larger, more complex organizations than the Company, includes principles that have been applied to smaller organizations similar to the Company. This Guidance applies to incentive compensation to executives as well as employees, who, “individually or a part of a group, have the ability to expose the relevant banking organization to material amounts of risk.” Incentive compensation should: ● Provide employees incentives that appropriately balance risk and reward; ● Be compatible with effective controls and risk-management; and ● Be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. The federal bank regulators stated that this Guidance is expected to generally have less effect on smaller banking organizations, which typically are less complex and make less use of incentive compensation arrangements than larger banking organizations. Table of Contents 30 The federal bank regulators, the SEC and other regulators proposed regulations implementing Section 956 in April 2011, which would have been applicable to, among others, depository institutions and their holding companies with $1 billion or more in assets. An advance notice of a revised proposed joint rulemaking under Section 956 was published by the financial services regulators in May 2016, but these rules have not been adopted. Following the failures of Silicon Valley Bank and Signature Bank in early March 2023, Senator Elizabeth Warren and co- sponsors, filed S.1045 “Failed Bank Executives Clawback Act.” This bill provides that when a bank is placed into FDIC receivership, all or part of the compensation paid the previous five years to an institution-affiliated party responsible for the condition of the institution must be paid to FDIC to prevent unjust enrichment and to assure that the party bears losses consistent with their responsibility. Compensation includes salary, bonuses, awards, and profits from buying or selling securities. The bill also expands the FDIC’s authority to claw back compensation of parties responsible for financial losses incurred by a financial company regardless of the process by which FDIC is appointed receiver. Debit Card Interchange Fees The “Durbin Amendment” to the Dodd-Frank Act and implementing Federal Reserve regulations provide that interchanged transaction fees for electronic debit transactions be “reasonable” and proportional to certain costs associated with processing the transactions. The Durbin Amendment and the Federal Reserve rules thereunder are not applicable to banks with assets less than $10 billion, however such banks compete with banks that are subject to the Durbin Amendment, and therefore may have to limit their interchange fees, also. Other Legislative and Regulatory Changes Various legislative and regulatory proposals, including substantial changes in banking, and the regulation of banks, thrifts and other financial institutions, compensation, and the regulation of financial markets and their participants, and financial instruments and securities, and the regulators of all of these, as well as the taxation of these entities, are being considered by the executive branch of the federal government, Congress and various state governments, including Alabama. President Biden froze new rulemaking generally when he became President in January 2021, and rescinded various of his predecessor’s executive orders, including the February 3, 2017 executive order containing “Core Principles for Regulating the United States Financial System” (“Core Principles”). The Core Principles directed the Secretary of the Treasury to consult with the heads of Financial Stability Oversight Council’s members and report to the President periodically thereafter on how laws and government policies promote the Core Principles and to identify laws, regulations, guidance and reporting that inhibit financial services regulation. The President has also issued an Executive Order 14036 on Promoting Competition in the American Economy (July 9, 2021), which may affect the federal bank regulators’ reviews of bank and bank holding company mergers. The OCC, the FDIC and the CFPB have made proposals to further scrutinize mergers, especially where the confirming institutions have assets greater than $100 million. The President’s Working Group and various agencies have also been working on the regulation of crypto assets, including stable coins, and access to the payments system. The DoJ’s Antitrust Division of the United States and the Federal Trade Commission issued revised Merger Guidelines on December 18, 2023. The DoJ, the Federal Reserve and the OCC have confirmed that these new Guidelines did not modify the 1995 Bank Merger Guidelines, however. Representatives of the Federal Reserve have indicated that updated Bank Merger Guidelines are being considered. Table of Contents 31 The 2018 Growth Act, which, was enacted on May 24, 2018, amended the Dodd-Frank Act, the BHC Act, the Federal Deposit Insurance Act and other federal banking and securities laws to provide regulatory relief in these areas: ● consumer credit and mortgage lending; ● capital requirements; ● Volcker Rule compliance; ● stress testing and enhanced prudential standards; ● increased the asset threshold under the Federal Reserve’s Small BHC Policy from $1 billion to $3 billion; and ● capital formation. We believe the 2018 Growth Act has positively affected our business. The following provisions of the 2018 Growth Act may be especially helpful to banks of our size after regulations were adopted in 2019: ● “qualifying community banks,” defined as institutions with total consolidated assets of less than $10 billion, which meet a “community bank leverage ratio, which is currently 9.0%, may be deemed to have satisfied applicable risk- based capital requirements as well as the capital ratio requirements; ● section 13(h) of the BHC Act, or the “Volcker Rule,” is amended to exempt from the Volcker Rule, banks with total consolidated assets valued at less than $10 billion (“community banking organizations”), and trading assets and liabilities comprising not more than 5.00% of total assets; and ● “reciprocal deposits” will not be considered “brokered deposits” for FDIC purposes, provided such deposits do not exceed the lesser of $5 billion or 20% of the bank’s total liabilities. On July 9, 2019, the federal banking agencies, together with the SEC and the Commodities Futures Trading Commission (“CFTC”), issued a final rule excluding qualifying community banking organizations from the Volcker Rule pursuant to the 2018 Growth Act. The Volcker Rule change may enable us to invest in certain collateralized loan obligations that are treated as “covered funds” and other investments prohibited to banking entities by the Volcke r Rule. The FDIC announced on December 19, 2018 a final rule allows reciprocal deposits to be excluded from “brokered deposits” up to the lesser of $5 billion or 20% of their total liabilities. Institutions that are not both well capitalized and well rated are permitted to exclude reciprocal deposits from brokered deposits in certain circumstances. The FDIC issued comprehensive changes to its brokered deposit rules effective April 1, 2021. The revised rules establish new standards for determining whether an entity meets the statutory definition of “deposit broker,” and identifies a number of businesses that automatically meet the “primary purpose exception” from a “deposit broker.” The revisions also provide an application process for entities that seek a “primary purpose exception,” but do not meet one of the designated exceptions.” The new rules may provide us greater future flexibility, but we had no brokered deposits at December 31, 2021 or 2022, and historically have not relied on brokered deposits. Reciprocal deposits have expanded our funding and liquidity sources without being subjected to FDIC limitations and potential federal deposit insurance assessment increases for brokered deposits. The applicable agencies also issued final rules simplifying the Volcker Rule’s proprietary trading restrictions effective January 1, 2020. On June 25, 2020, the agencies adopted a final rule simplifying the Volcker Rule’s covered fund provisions effective October 1, 2020. On November 30, 2020, the bank regulators issued a statement urging banks to cease entering into new contracts using U.S. dollar LIBOR rates as soon as practicable and in any event by December 31, 2021, to effect orderly, and safe and sound LIBOR transition. Banks were reminded that operating with insufficient fallback interest rates could undermine financial stability and banks’ safety and soundness. Any alternative reference rate may be used that a bank determines is appropriate for its funding and customer needs. Table of Contents 32 The Alabama legislature passed the “LIBOR Discontinuance and Replacement Act of 2021” which became effective on April 29, 2021. On March 15, 2022, Congress enacted the Adjustable Interest Rate (LIBOR) Act (the “LIBOR Act”) as part of the Consolidated Appropriations Act, 2022. One purpose of the LIBOR Act was to establish a clear and uniform process, on a nationwide basis, for replacing LIBOR in existing contracts the terms of which do not provide for the use of a clearly defined or practicable replacement benchmark rate, without affecting the ability of parties to use any appropriate benchmark rate in new contracts. The LIBOR Act directed the Federal Reserve to issue regulations implementing the LIBOR Act. The Federal Reserve adopted final Regulation ZZ on January 26, 2023. These together with Internal Revenue Service regulation facilitate the conversion of existing LIBOR-based loans when most popular LIBOR rates cease to be quoted on June 30, 2023. The Bank generally prices its variable rate loans based on the prime rate or the five-year Treasury note rate and had no loans bearing LIBOR or other IBOR-based rates at December 31, 2022. Therefore, the transition from LIBOR did not affect the Bank’s loan portfolio. Certain of these new rules, and proposals, if adopted, could significantly change the regulation or operations of banks and the financial services industry. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation’s financial institutions.