Item 1A. Risk Factors
Item 1A - Risk Factors
The COVID-19 pandemic has adversely affected, and is likely to continue to adversely affect, our customers and other businesses in our market area, as well as counterparties and third party vendors. The resulting adverse impacts on our business, financial condition, liquidity and results of operations have been, and may continue to be significant.
The COVID-19 pandemic and the resulting containment measures have resulted in widespread economic and financial disruptions that have adversely affected, and are likely to continue to adversely effect, our customers and other businesses in our market area, as well as counterparties and third-party vendors. We continue to see the impact of the pandemic on our business, which may potentially worsen, particularly since there remains ongoing uncertainty as to how long the COVID-19 pandemic and related containment measures will continue, both in our market area and the rest of the country. This impact has been, in certain areas, and could continue to be significant, adverse and potentially material. The full extent of this impact, and the resulting impact on our business, financial condition, liquidity and results of operations, remains inestimable at this time, and will depend on a number of evolving factors and future developments beyond our control and that we are unable to predict, including the duration, spread and severity of the pandemic; the nature, extent and effectiveness of containment measures; the timing of development and widespread availability of medical treatments or vaccines; the extent and duration of the effect on the economy, unemployment, consumer confidence and consumer and business spending; the impact and continued availability of monetary, fiscal and other economic policies and programs designed to provide economic assistance to individuals and small businesses; and how quickly and to what extent normal economic and operating conditions can resume. It is also possible that any adverse impacts of the pandemic and containment measures may continue once the pandemic is controlled and the containment measures are lifted.
Many of the risks described in the risk factors and other cautionary language included in the Company's Annual Report on Form 10-K for the year ended December 31, 2020, and current reports filed by the Company with the Securities and Exchange Commission will likely be exacerbated, and the impact of such risks will likely be magnified, as a result of the COVID-19 pandemic. We expect the negative impacts of the COVID-19 pandemic on our business, financial condition, liquidity and results of operations to be the most severe in the following areas:
• Loan Credit Quality . The significant disruption resulting from the COVID-19 pandemic has been materially affecting the businesses of our customers and of their customers, which impacts their creditworthiness, their ability to pay amounts owed to us and our ability to collect those amounts. Further, volatile and unpredictable ongoing market conditions, both as a result of impacts from the COVID-19 pandemic and otherwise, may negatively impact our ability to achieve our long-term loan growth objectives. While there is no shortage of loan demand in current market conditions, the quality of many of the loans available is such that we may have to make trade-off decisions between reaching target loan origination quantities to keep up with our loan growth objectives and maintaining certain target levels of loan quality to protect our credit quality and portfolio. There can be no guarantee that any decisions made in this regard will be successful or lead to our achieving our long-term loan growth and credit quality objectives. If we are too conservative with loan quality, we may not be able to keep up with our peer competitors in terms of loan growth, and if we are too focused on loan growth, our credit quality risk profile may result in material negative impacts on our overall financial performance and results. As loan volume represents our largest contributor to our net interest income, such market conditions, including a continuation of the historically low interest rate environment, may have a material negative impact on our loan credit quality, our short-term and long-term strategy and our results of operations. Among the industry’s most clearly impacted by the pandemic are the Accommodation and Food Service industry, exposure to which represents 9 % o f our loan portfolio as of September 30, 2021, and the Retail Trade industry, which represents 1% o f our loan portfolio as of September 30, 2021. In addition, approximately 7% o f our loan portfolio as of September 30, 2021 is secured by commercial real estate loans secured by restaurants, hotels or retail properties. These areas may have a longer recovery period than other industries. Despite high home sales volumes and our strong performance in gains from residential mortgage loans for the first three quarters of 2021, such volumes and performance are not stable and economic conditions are may likely result in future material declines in real estate values and home sales volumes, and an increase in tenants failing to make or deferring
77
rent payments. A large portion of our loan portfolio is related to real estate, with 33% consisting of commercial real estate and real estate construction loans, and 83% of our loans being secured by real estate. As a result of actual or expected credit losses, we may downgrade loans, increase our allowance for loan losses, and write-down or charge-off credit relationships, any of which would negatively impact our results of operations. In addition, market upheavals are likely to affect the value of real estate and commercial assets. In the event of foreclosure, it is unlikely that we will be able to sell the foreclosed property at a price that will allow us to recoup a significant portion of the delinquent loan.
• PPP Administration and Compliance . Due to the short timeframe between the passing of the CARES Act and the beginning of the PPP, there continues to be some ambiguity in the laws, rules and guidance regarding the day-to-day mechanics and operations of the program, and particularly how banks should administer the program as we continue in the loan forgiveness stage. There is no guarantee that the Bank will, in all instances, be able to avoid potential processing issues, administrative pitfalls or other obstacles that may present from time to time, and any such issues, pitfalls or other obstacles that arise may result in adverse impacts on our operational and strategic objectives. Further, due to the “first come first served” nature of the PPP, the loans originated under this program may present potential fraud risk and operational risk, increasing the risk that loan forgiveness may not be obtained by the borrowers and that the government guaranty may not be honored. In particular, there is risk that some borrowers may not qualify for the loan forgiveness feature due to the conduct of the borrower after the loans were originated. These factors may result in us having to hold a significant amount of these low-yield loans in our portfolio for an extended period of time, which may negatively impact our broader business performance and results of operations.
• Deposit Business . As a result of the COVID-19 pandemic, deposit customers are expected to retain higher levels of cash. While increased low-interest deposits could have a positive impact in the short-term, we would not expect these funds to be replenished as customers use deposit funds for liquidity for their business and individual needs. If deposit levels decline, our available liquidity would decline, and we could be forced to obtain liquidity on terms less favorable than current deposit terms, which would in turn compress margins and negatively impact our results of operations.
• Interest Rate Risk . Our net interest income, lending activities, deposits and profitability have been and could continue to be negatively affected by volatility in interest rates caused by uncertainties stemming from the COVID-19 pandemic. In March 2020, the Federal Reserve lowered the target range for the federal funds rate to a range from 0 to 0.25 percent. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results or financial condition.
• Operational Risk . Current and future restrictions on our workforce's access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, the Company implemented a remote working strategy for many of its employees This action may result in increased spending on our business continuity efforts, such as technology and readiness procedures for returning to our offices. We could also experience an increased strain on our risk management policies, as remote working may impact some employees abilities to comply with certain policies. Further, technology in employees' homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including related to the effectiveness of our anti-money laundering and other compliance programs, as well as increased cybersecurity risk. These cyber risks include greater phishing, malware, and other cybersecurity attacks, vulnerability to disruptions of our information technology infrastructure and telecommunications systems for remote operations, increased risk of unauthorized dissemination of confidential information, limited ability to restore the systems in the event of a systems failure or interruption, greater risk of a security breach resulting in destruction or misuse of valuable information, and potential impairment of our ability to perform critical functions, including wiring funds, all of which could expose us to risks of data or financial loss, litigation and liability and could seriously disrupt our operations and the operations of any impacted customers. Furthermore, while the Company's non-branch personnel returned to work on a "hybrid" basis on November 1, 2021, state and local guidelines continue to evolve, and the operation of a hybrid workplace may negatively impact our ability to attract and retain qualified personnel. Even after the market fully recovers from the impacts of the COVID-19 pandemic, differences in the demands, expectations and priorities of the workforce may require us to rethink and amend our recruiting and retention strategies in order to attract and keep new employees. There is no guarantee that we will be successful in gaining or maintaining
78
a competitive edge against our peer banks in terms of hiring new talent in the near or long term, and any failure to do so may materially impact our business operations and long-term growth.
• External Vendors and Service Providers . We rely on many outside service providers that support our day-to-day operations including data processing and electronic communications, real estate appraisal, loan servicers and local and federal government agencies, offices and courthouses. In light of the containment measures responding to COVID-19, many of these entities may limit the availability and access of their services, which may impact our business. For example, loan origination could be delayed due to the limited availability of real estate appraisers for the collateral. Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses, which slows the process for title work, mortgage and UCC filings. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
• Strategic and Reputational Risk . The pandemic and containment measures have caused us to modify our strategic plans and business practices, and we may take further actions that we determine are in the best interests of our colleagues, customers and business partners. If we do not respond appropriately to the pandemic, or if customers or other stakeholders do not perceive our response to be adequate, we could suffer damage to our reputation and our brand, which could materially adversely affect our business. We also face an increased risk of litigation and governmental and regulatory scrutiny as a result of the effects of the pandemic on market and economic conditions and actions governmental authorities take in response to those conditions, as detailed in the Note 1 to the Consolidated Financial Statements.
Litigation and regulatory actions, possibly including enforcement actions, could subject us to significant fines, penalties, judgments or other requirements resulting in increased expenses or restrictions on our business activities.
In the normal course of our business, we are named as a defendant in various legal actions, arising in connection with our current and/or prior business activities or public disclosures. Legal actions could include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. Further, we may be subject to regulatory enforcement actions. We are also, from time to time, the subject of subpoenas, requests for information, reviews, investigations and proceedings (both formal and informal) by various agencies and other bodies regarding our current and/or prior business activities. Additionally, we also from time to time receive demand letters from shareholders, and such letters may lead to these shareholders filing claims or derivative suits against us if our engagement with such shareholders ends in a failure to successfully negotiate a settlement. The Company has received various document requests and subpoenas from securities and banking regulators and U.S. Attorney’s offices in connection with investigations, which the Company believes relate to the Company's identification, classification and disclosure of related party transactions; the retirement of certain former officers and directors; and the relationship of the Company and certain of its former officers and directors with a local public official, among other things. The Company is currently defending against shareholder litigation. Any such legal or regulatory actions may subject us to substantial compensatory or punitive damages, significant fines, penalties, obligations to change our business practices, required changes in our senior officers, or other requirements resulting in increased expenses, diminished income and damage to our business. Our involvement in any such matters, whether tangential or otherwise, and even if the matters are ultimately determined in our favor, could also cause significant harm to our reputation and divert management attention from the operation of our business. Further, any settlement, regulatory order or agreement, informal enforcement action, or adverse judgment in connection with any formal or informal proceeding or investigation by government agencies may result in adverse audit findings, or additional litigation, investigations or proceedings as other parties, including other litigants and/or government agencies begin independent reviews of the same activities. As a result, the outcome of legal and regulatory actions could have a material adverse effect on our business, results of operations, financial condition and stock price, including in any particular reporting period.
Further, in such matters, it is inherently difficult to determine whether any loss is probable or whether it is possible to estimate the amount of any reasonably possible loss. We cannot predict with certainty if, how or when such proceedings will be resolved or what the eventual fine, penalty or other relief, conditions or restrictions, if any, may be, particularly for actions that are in their early stages of investigation. We may be required to pay fines or civil money penalties, or make other payments in connection with certain of these issues. This uncertainty makes it difficult to estimate probable losses, which, in turn, can lead to substantial disparities between the reserves we may establish for such proceedings and the eventual settlements, fines, or penalties. While the Company and Bank carry insurance to protect us from material outlays (excluding regulatory fees and penalties), such insurance may not always fully or even substantially cover such outlays, and any adverse determinations in such actions could have a material adverse effect on our business, financial condition, results of operations and stock price. In the event such insurance is exhausted, any additional fees, costs, expenses and penalties incurred would be borne by the Company and could have a material adverse effect on our business, financial condition, results of operations and stock price.
79
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.