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Item 1A. Risk Factors

2023-03-17 compared with 2022-03-18 · 42 added, 45 removed, 281 unchanged (24% of the section changed)

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RISK FACTORS RELATED TO OUR BUSINESS

Our operations, business, and financial condition have been and may continue to be impacted by the COVID-19 pandemic.

The COVID-19 outbreak which evolved into a worldwide pandemic has had a myriad of adverse impacts upon society as a whole.

The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability.

In response to the COVID-19 pandemic, Federal, State and Local governments have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forgo their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential.

The initial restrictions and other consequences of the pandemic resulted in significant adverse effects for many different types of businesses, including, among others, those in the retail sales, travel, hospitality and food and beverage industries, and resulted in a significant number of layoffs and furloughs of employees nationwide and in the markets in which we operate.

Restrictions have been at least partially lifted nationally and within the Company’s market area with some level of economic recovery resulting.

While progress towards vaccination has been made, an increase in virus spread or infection rates, or the emergence of new variants of the virus could result in restrictions being re-implemented with further negative impact to economic activity.

The ultimate effects of COVID-19 on the broader economy and our market area are not known nor is the ultimate length of the restrictions described above and any accompanying effects.

Moreover, Federal Reserve action to lower the Federal Funds rate, has and may continue to negatively affect our interest income and, therefore, earnings, financial condition and results of operations.

Additional impacts of COVID-19 on our business could be widespread and material, and may include, or exacerbate, among other consequences, the following:

employees contracting COVID-19;

unavailability of key personnel necessary to conduct our business activities;

disruption resulting from having a significant percentage of employees work remotely;

further declines in demand for loans and other banking services;

reduced consumer spending due to job losses or other impacts of the virus;

adverse conditions in financial markets may have a negative impact on our investment portfolio;

decline in credit quality of our loan portfolio leading to increased provisions for loan losses;

declines in the value of loan collateral, including residential and commercial real estate;

decline in the liquidity of borrowers and guarantors impairing their ability to honor financial commitments;

actions of governmental entities to limit business activities.

Furthermore, we rely upon our third-party vendors to conduct business and to process, record, and monitor transactions.

If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers.

The lingering economic impact of the COVID-19 pandemic combined with the current inflationary pressures could adversely affect our financial condition and results of operations.

The COVID-19 pandemic caused significant economic disruption throughout the United States.

Although the economic activity has improved and there is growth in demand for goods and services, the lingering impact the COVID-19 pandemic has created certain adverse and persistent macroeconomic consequences, including labor shortages and disruptions of global supply chain, which may continue for some time and which have contributed to rising inflationary pressures and the risk of recession.

As a result of the lingering impact of the COVID-19 pandemic and the related adverse economic consequences, we could be subject to the following risks, among others, any of which individually or in combination with others could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

Demand for our products and services may decline, making it difficult to grow assets and income;

If we have high levels of unemployment for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;

Collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;

Limitations may be placed on our ability to foreclose on properties we hold as collateral;

Our allowance for credit losses may have to be increased if borrowers experience financial difficulties which will adversely affect our net income;

The net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;

Our cybersecurity risks are increased if employees work remotely;

We rely on third-party vendors for certain services and the unavailability of a critical service could have an adverse effect on us;

FDIC premiums may increase if the FDIC experiences additional resolution costs.

Unfavorable economic conditions could adversely affect our business.

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Weakness in any of our market areas could have an adverse impact on our earnings, and consequently our financial condition and capital adequacy.

Inflation can have an adverse impact on our customers and their ability to repay.

Inflation risk is the risk that the value of assets or income from investments will be worth less in the future as inflation decreases the value of money.

Recently, there has been a pronounced rise in inflation and the Federal Reserve has raised certain benchmark interest rates in an effort to combat this trend.

Our customers may also be affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with us.

Recessionary conditions could result in increases in our level of nonperforming loans and/or reduce demand for our products and services, which would lead to lower revenue, higher loan losses and lower earnings.

Recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability.

Declines in real estate values and sales volumes and increased unemployment levels may result in higher than expected loan delinquencies, increases in our levels of nonperforming and classified assets and a decline in demand for our products and services.

These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.

We are subject to credit risk and may incur losses if loans are not repaid.

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Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.

These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity.

These loans also involve greater risk because they are generally not fully amortizing over the loan period, but rather have a balloon payment due at maturity.

A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property.

As of December 31, 2021, commercial real estate loans comprised approximately 38% of the Bank’s total loan portfolio.

Commercial Loans.

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In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business.

As of December 31, 2021, commercial loans comprised approximately 10% of the Bank’s total loan portfolio, including $18.0 million in Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans.

Construction and land development loans.

The risk of loss is largely dependent on our initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing.

The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing.

During the construction phase, a number of factors can result in delays or cost overruns.

If our estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing our loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral.

As of December 31, 2021, construction and land development loans comprised approximately 11% of the Bank’s total loan portfolio.

If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral.

Single-family residential loans .

Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.

As of December 31, 2021, single-family residential loans comprised approximately 33% of the Bank’s total loan portfolio, including Banco single-family residential non-traditional loans which were approximately 3% of the Bank’s total loan portfolio.

A significant amount of the Bank’s business is concentrated in lending which is secured by property located in the Catawba Valley and surrounding areas.

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In addition, the measure of our allowance for loan losses is dependent on the adoption of new accounting standards.

The FASB issued an Accounting Standards Update related to CECL, the new credit impairment model, which is expected to be implemented by the Company for reporting periods beginning on January 1, 2023.

The FASB issued an Accounting Standards Update related to CECL, the new credit impairment model, which was implemented by the Company for reporting periods beginning on January 1, 2023.

This new model requires financial institutions to estimate and develop a provision for credit losses at origination for the lifetime of the loan, as opposed to reserving for probable incurred losses up to the balance sheet date.

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In general, the larger the spread, the more the Bank earns.

When market rates of interest change, the interest the Bank receives on its assets and the interest the Bank pays on its liabilities will fluctuate.

When market rates of interest change, and in particular during periods of rapid rate movements as experienced in 2022, the interest the Bank receives on its assets and the interest the Bank pays on its liabilities will fluctuate.

This can cause decreases in the “spread” and can adversely affect the Bank’s income.

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Total securities sold under agreements to repurchase for the five largest relationships referenced above amounted to $31.4 million, or 65.76% of total securities sold under agreements to repurchase at December 31, 2022.

Loss of one or more of these deposit relationships could have a negative impact on the Bank’s liquidity position.

Withdrawals of deposits by any one of our largest depositors could force us to rely more heavily on borrowings and other sources of funding for our business and withdrawal demands, adversely affecting our net interest margin and results of operations.

We may also be forced, as a result of any withdrawal of deposits, to rely more heavily on other, potentially more expensive and less stable funding sources.

Consequently, the occurrence of any of these events could have a material adverse effect on our business, results of operations, financial condition and future prospects.

We may not be able to retain or grow our deposit base, which could adversely impact our funding costs.

Like many financial institutions, the Bank relies on customer deposits as its primary source of funding for its lending activities, and the Bank continues to seek customer deposits to maintain this funding base.

The Bank’s future growth will largely depend on its ability to retain and grow its deposit base.

As of December 31, 2022, the Bank had $1.4 billion in deposits.

The Bank’s deposits are subject to potentially dramatic fluctuations in availability or price due to certain factors outside of its control, such as increasing competitive pressures for deposits, changes in interest rates and returns on other investment classes, customer perceptions of its financial health and general reputation, and a loss of confidence by customers in the Bank or the banking sector generally, which could result in significant outflows of deposits within short periods of time or significant changes in pricing necessary to maintain current customer deposits or attract additional deposits.

The availability of deposits can also be impacted by regulatory changes (e.g., changes in FDIC insurance, the liquidity coverage ratio, etc.), changes in the financial condition of the Bank, or the banking industry in general, and other events which can impact the perceived safety and soundness or economic benefits of bank deposits.

Any loss by the Bank of its deposit base could limit its lending ability resulting in lower loan originations, which could have a material adverse effect on the Bank’s business, financial condition and results of operations.

Increases in FDIC insurance premiums may adversely affect our net income and profitability.

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Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations or deterioration in credit markets.

Risks related to decline in value of investment securities portfolio.

At December 31, 2022, unrealized losses in our available for sale investment securities portfolio totaled $62.3 million.

These unrealized losses arose due to changing interest rates and are considered to be temporary;

however, in the event that we sell these securities while they are in an unrealized loss position, we will recognize a corresponding loss.

In January and February 2023, we sold securities available for sale totaling $53.5 million, which resulted in gross losses of $2.7 million and gross gains of $177,000.

In the event that we decide to sell additional securities while they are in an unrealized loss position, we will experience additional losses, which could have a material adverse effect on our earnings and financial condition.

We could experience losses due to competition with other financial institutions.

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The combination of these provisions may prohibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

As a participating lender in the PPP, the Company and the Bank are subject to additional risks of litigation from the Bank’s customers or other parties regarding the Bank’s processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.

On March 27, 2020, President Trump signed the CARES Act, which included a loan program administered through the SBA referred to as the PPP.

Under the PPP, small businesses and other entities and individuals could apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria.

The Bank is participating as a lender in the PPP.

The PPP opened on April 3, 2020;

however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Company to risks relating to noncompliance with the PPP.

Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP.

The Company and the Bank may be exposed to the risk of similar litigation, from both customers and noncustomers that approached the Bank regarding PPP loans, regarding its process and procedures used in processing applications for the PPP and loan forgiveness applications.

If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation.

In addition, litigation can be costly, regardless of outcome.

Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.

The Bank also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP.

In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

RISKS RELATED TO THE COMPANY’S STOCK

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 1A. Risk Factors